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Section 338(h)(10) Election: Stock Deal Treated as Asset Deal for Tax, Worked Example, Buyer Step-Up

By chrisomo

A Section 338(h)(10) election lets a buyer treat the acquisition of a target’s stock as an acquisition of the target’s assets for federal income tax purposes, even though the legal form is a stock purchase. The election produces a stepped-up basis in target assets for the buyer, depreciation and amortization deductions that recoup most of the purchase price, and a single layer of corporate-plus-shareholder tax for the seller. Under IRC §338(h)(10) and Reg. §1.338(h)(10)-1, the joint election is available when an S corporation or a member of a consolidated group is the target.

What is a Section 338(h)(10) election?

IRC §338 allows a buyer that acquires 80% or more of a target corporation’s stock in a “qualified stock purchase” (QSP) to treat the transaction as a deemed asset purchase. The basic §338(g) election produces double tax (corporate-level deemed gain at the target plus shareholder-level gain on the actual stock sale) and is rarely used. The §338(h)(10) variant solves the double-tax problem by treating the deemed asset sale as occurring while the target is still owned by the original seller, then deeming a liquidation of the post-sale target into the seller under IRC §332 or §331. The result: a single layer of tax at the seller level, with the buyer receiving the same step-up benefit as a true asset purchase. The election is jointly made by buyer and seller on Form 8023 under Reg. §1.338(h)(10)-1(c). Section 338(h)(10) is available only when the target is an S corporation or a member of a consolidated group.

Why Section 338(h)(10) matters

In a typical middle-market M&A transaction, the buyer wants a step-up in asset basis to amortize goodwill over 15 years under IRC §197 and to depreciate fixed assets over their MACRS lives. The seller often wants the simplicity, contract continuity, and exit ease of a stock sale (no asset-by-asset retitling, no third-party consents, no employee transitions). The §338(h)(10) election satisfies both: the buyer gets asset-deal tax treatment, the seller gets stock-deal legal treatment. The economic value of the step-up to the buyer often exceeds 10% of enterprise value at a 25% effective tax rate, computed as the present value of the depreciation and amortization tax shield over the relevant recovery periods. Because the election typically produces a higher tax bill for the seller (ordinary recapture rates on depreciation, deferred state income tax allocations), the buyer customarily compensates the seller for the incremental tax through a gross-up provision in the purchase agreement, often valued at 60%-85% of the buyer’s step-up benefit. See our 2026 CPA firm PE roll-up report for the prevalence of §338(h)(10) in current platform-and-add-on transactions.

How Section 338(h)(10) works (mechanics)

The election proceeds through four conceptual steps under Reg. §1.338(h)(10)-1(d). Step one: the buyer (a corporation) acquires 80% or more of the target’s stock from the seller in a QSP under IRC §338(d)(3). For an S corp target, the seller is the S corp shareholders; for a consolidated group target, the seller is the common parent of the selling consolidated group. Step two: the target is deemed to have sold all its assets at the close of the acquisition date to a new corporation (often called “new target”) in a single transaction. The deemed sale price is the aggregate deemed sale price (ADSP) under Reg. §1.338-4, equal to the buyer’s consideration plus target’s liabilities plus deemed sale tax. Step three: the target recognizes gain or loss on the deemed asset sale, allocated across seven asset classes under Reg. §1.338-6. Step four: the target is deemed to have liquidated under IRC §332 (if a consolidated subsidiary) or §331 (if an S corp), and the new target now stands in the buyer’s hands with stepped-up basis equal to the ADSP. The actual cash flow is a stock purchase; the tax flow is an asset purchase. IRS Form 8023 must be filed jointly by both parties by the 15th day of the 9th month following the month of the acquisition date.

Section 338(h)(10) vs Section 338(g) vs straight asset deal vs stock deal

Worked example

Sterling Industries Inc. is a Texas S corporation manufacturing precision metal components, owned 100% by founder Marcus Reid. On June 1, 2026, Reid sells 100% of Sterling stock to Compass Industrial Partners LLC, a portfolio company of a private equity sponsor, for $25,000,000 in cash. Compass and Reid jointly file Form 8023 by March 15, 2027, electing §338(h)(10) treatment. Sterling’s pre-deal balance sheet shows: cash $2,000,000; accounts receivable $3,500,000; inventory $4,000,000; PP&E with tax basis $1,500,000 and FMV $6,000,000; no intangibles on the books; and $4,000,000 of operating liabilities. The aggregate deemed sale price (ADSP) equals the consideration ($25,000,000) plus the target’s liabilities ($4,000,000) plus the deemed sale tax. For simplicity, assume the deemed sale tax is $1,800,000 on the inside gain (computed iteratively under Reg. §1.338-4(b)(2)(ii)). ADSP becomes approximately $30,800,000. The buyer then allocates ADSP across the seven Reg. §1.338-6 classes: Class I (cash) $2,000,000; Class II (actively traded securities) $0; Class III (accounts receivable) $3,500,000; Class IV (inventory) $4,000,000; Class V (PP&E and other tangibles) $6,000,000; Class VI (intangibles other than goodwill) $0; Class VII (goodwill and going concern) the residual $15,300,000. The buyer obtains: stepped-up depreciable basis of $6,000,000 in PP&E (vs $1,500,000 prior basis, an extra $4,500,000 of depreciation across the relevant MACRS lives) plus $15,300,000 of §197 amortization over 15 years (an extra $1,020,000 of annual amortization). On the seller side, Reid recognizes gain on each asset class at the appropriate rate. The PP&E gain of $4,500,000 is §1245 ordinary recapture taxed at his marginal ordinary rate (currently 37% federal). The goodwill gain of $15,300,000 is long-term capital gain taxed at 23.8% combined (20% capital gains plus 3.8% NIIT). The total deemed sale tax of approximately $5,366,000 (federal only) flows up to Reid as the S corp shareholder. Compare to a straight stock sale: Reid would have paid 23.8% on the full $25,000,000 minus his $500,000 outside basis, or $5,830,000 of federal tax. The §338(h)(10) saves Reid approximately $464,000 in federal tax in this fact pattern because the inside basis allocations to receivables and inventory absorb gain at no incremental cost. The seller-side tax delta is highly fact-specific; in many transactions with high depreciable basis and significant recapture, the §338(h)(10) election produces a higher seller tax bill, and the buyer offers a gross-up payment to make the seller whole on a net-after-tax basis.

Recent changes (TCJA, OBBBA)

The TCJA of 2017 did not modify IRC §338 directly, but two TCJA provisions reshaped its economics. First, TCJA §13201 introduced 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, phasing down to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026 under IRC §168(k)(6). Second, the corporate rate dropped from 35% to 21% under IRC §11(b), reducing the value of the step-up deduction for a corporate buyer. The OBBBA of 2025 (Public Law 119-21, signed July 4, 2025), at §70401, restored 100% bonus depreciation permanently for qualified property acquired and placed in service after January 19, 2025, materially increasing the buyer’s economic benefit from a §338(h)(10) election. The OBBBA did not alter the §338(h)(10) mechanics or the Form 8023 filing deadline. IRS guidance in 2024 (CCA 202416010) reaffirmed that the §338(h)(10) election is irrevocable once filed and that incomplete Form 8023 filings may invalidate the election entirely, with no relief under Reg. §301.9100 absent good-cause showing.

Common pitfalls

• Missing the Form 8023 filing deadline. Reg. §1.338(h)(10)-1(c)(1) requires Form 8023 to be filed jointly by the 15th day of the 9th month following the month of the acquisition date. Late filings require §301.9100 relief, which is granted only on a showing of reasonable cause and good faith. Many late elections fail.
• Treating an S corp with built-in gains under §1374 as eligible without confirming. A §338(h)(10) election by an S corp target with pre-conversion built-in gain triggers §1374 corporate-level tax on the deemed sale if the BIG period has not expired. Reg. §1.1374-10 governs the interaction.
• Failing the 80% Qualified Stock Purchase requirement. IRC §338(d)(3) requires the buyer to acquire stock meeting the §1504(a)(2) requirements (80% vote and 80% value) within a 12-month acquisition period. Buyer rollovers or seller retained stock can break the QSP if not structured carefully.
• Mis-allocating ADSP across asset classes. Reg. §1.338-6 prescribes a strict residual allocation method. ADSP is allocated to Class I assets first, then II, III, IV, V, VI, in that order, up to the fair market value of each class. Goodwill in Class VII is the residual. Treating the allocation as discretionary or attempting to load value into a higher-amortization-rate class (e.g., Class IV ordinary inventory rather than Class VII goodwill) invites IRS challenge under Reg. §1.338-6(c).
• Ignoring state tax consequences. Many states (including California, New York, Pennsylvania) do not automatically conform to the federal §338(h)(10) election. The seller may face double tax at the state level if the state treats the transaction as a separate corporate-level asset sale plus a shareholder distribution. Cal. Rev. & Tax Code §23051.5 and NY Tax Law §660 require separate state-level analysis.
• Forgetting the seller-side tax gross-up in the purchase agreement. Because the seller usually pays more tax under §338(h)(10) than a straight stock sale (due to ordinary recapture on §1245 assets), the buyer customarily pays a gross-up. Failing to negotiate this provision pre-closing leaves the seller absorbing the incremental tax and often kills the deal post-LOI.
• Mis-handling target NOLs. Under Reg. §1.338(h)(10)-1(d)(8), a target’s NOLs and credit carryforwards are deemed to be used by the seller to offset the deemed asset sale gain. If the seller is a consolidated group with limited use, the NOLs may go to waste. For S corp targets, the deemed gain flows to shareholders and any built-in losses must be evaluated under IRC §382.

Frequently asked questions

What is the difference between Section 338(h)(10) and Section 338(g)?

A. A §338(g) election is a unilateral election by the buyer alone, available when the target is any C corporation. The §338(g) election triggers two layers of tax: the target recognizes deemed asset sale gain at the corporate level, and the selling shareholders recognize stock sale gain. The §338(h)(10) election is a joint election by buyer and seller, available only for S corp or consolidated-group targets, that collapses the two layers into one through deemed liquidation. The §338(g) election is rarely chosen domestically because of the double-tax penalty; it appears most often in acquisitions of foreign target subsidiaries.

Can a partnership or LLC use a Section 338(h)(10) election?

A. No. Section 338(h)(10) applies only to corporations. A partnership or single-member LLC cannot be the target. However, an LLC taxed as an S corp (via Form 2553) may use §338(h)(10). An acquisition of a partnership interest is governed instead by IRC §754 (allowing an inside basis step-up via §743(b)) on a partner-by-partner basis. The §336(e) election extends §338(h)(10)-like treatment to certain sales to noncorporate buyers, which is increasingly common in PE deals where the acquirer is an LLC.

What is the Section 336(e) election?

A. IRC §336(e), with Reg. §1.336-1 through §1.336-5 finalized in 2013, allows a §338(h)(10)-like deemed asset sale election when the buyer is not a corporation, such as a PE fund LLC or an individual. The election is made unilaterally by the seller on a statement attached to its tax return. It applies to S corp targets and consolidated subsidiaries, mirrors §338(h)(10) economics, and is increasingly used in PE acquisitions where setting up a corporate acquisition vehicle (a “blocker”) is undesirable. See EBITDA adjustments for how the related deal economics flow through to the model.

How is goodwill treated in a Section 338(h)(10) election?

A. Goodwill falls in Class VII under Reg. §1.338-6(b). It is the residual asset class, picking up whatever ADSP is left after allocations to Classes I through VI. On the buyer’s side, Class VII goodwill is amortized over 15 years under IRC §197(a). On the seller’s side, the gain attributable to goodwill is long-term capital gain (assuming the shareholders held their stock for more than one year) taxed at the 20% federal capital gains rate plus the 3.8% net investment income tax under IRC §1411.

Does Section 338(h)(10) require a corporate buyer?

A. Yes. Under IRC §338(d)(3), the “purchasing corporation” must be a corporation, including an S corporation, that makes a “qualified stock purchase” of the target. A partnership, LLC, individual, or trust buyer cannot make a §338 election. PE funds that want §338(h)(10) economics typically form a C corporation acquisition vehicle. Alternatively, the parties may use a §336(e) election to achieve the same federal income tax result without a corporate buyer.

What happens to target’s NOLs in a Section 338(h)(10) election?

A. Under Reg. §1.338(h)(10)-1(d)(8), the deemed asset sale by the target occurs while the target is still owned by the seller. Therefore, the target’s NOLs and credit carryforwards are available to offset the deemed sale gain at the seller level (consolidated group level for C corp targets, S corp level passing through to shareholders for S corp targets). The new target (in the buyer’s hands) does not retain those NOLs. This is one of the structural reasons a buyer with a target rich in NOLs may prefer a straight stock deal under §381 carryover rules.

What are the seller-side tax disadvantages of Section 338(h)(10)?

A. The deemed asset sale taxes recapture gain at higher rates. Section 1245 recapture on equipment, vehicles, and other depreciable personal property is taxed at the seller’s ordinary income rate (currently up to 37% federal) instead of the long-term capital gains rate (20%). Section 1250 unrecaptured gain on real property is taxed at a maximum 25% federal rate. Inventory gain is ordinary income. Accounts receivable gain may produce ordinary income. State conformity issues compound the tax. The buyer customarily compensates the seller via a tax gross-up calculated on a net-after-tax basis, typically valued at 60% to 85% of the buyer’s step-up benefit.

How long does the buyer have to recover the stepped-up basis?

A. The recovery period varies by asset class. Class V tangible personal property follows MACRS lives of 3, 5, 7, 10, 15, or 20 years depending on the asset, with bonus depreciation under IRC §168(k) accelerating most of the deduction to year one for tax years beginning after January 19, 2025 (per OBBBA §70401). Class V real property follows 39-year straight-line for commercial real estate, 27.5 years for residential rental, with no bonus depreciation. Class VII goodwill is amortized straight-line over 15 years under IRC §197(a). On a typical $50 million enterprise value transaction with $35 million allocated to goodwill, the buyer captures roughly $2.3 million of annual §197 amortization for 15 years.