Section 338 Elections: Deemed Asset Sale, 338(h)(10), and 336(e)

A Section 338 election lets a corporate buyer that purchased the stock of another corporation treat the deal as if it had bought the target’s assets directly for federal income tax purposes. The legal transaction stays a stock sale. The tax treatment flips: the target is deemed to sell all its assets at fair market value, recognize the gain, and hand a stepped-up basis to the buyer. Whether that basis step-up is worth the accelerated tax depends on which version of the election you make and what kind of entity the target is.

What the Election Actually Does

Under Section 338 of the Internal Revenue Code, the target corporation is treated as having sold every one of its assets at fair market value on the acquisition date, and then a “New Target” is treated as buying those same assets the next day at that fair market value.¹ The legal entity never moves. Shareholders sold stock, the buyer received stock, and the corporate charter is unchanged. But for tax purposes, the IRS runs the numbers as if the old corporation liquidated its assets and a new one bought them.

That fiction produces two consequences. The Old Target recognizes gain or loss on the deemed sale. The New Target starts fresh, with an asset basis tied to what the buyer actually paid for the stock rather than to the target’s historical cost.

When the Election Is Available

The election is only on the table when the buyer makes a “qualified stock purchase”: at least 80% of the target’s total voting power and at least 80% of the total value of its stock, using the same threshold that governs consolidated return eligibility under Section 1504(a)(2).² Nonvoting preferred stock that is limited to a fixed dividend, does not participate in growth, and is not convertible is excluded from the value calculation.

All qualifying purchases must happen within a 12-month window that starts when the buyer first acquires stock counting toward the 80% test.³ The stock has to be actually purchased in a taxable transaction. Related-party transfers, tax-free exchanges, and other non-purchase acquisitions generally don’t count. And the buyer has to be a corporation. That last point is important: individuals, partnerships, and trusts can’t make a Section 338 election, no matter how much stock they buy.

Why a Buyer Wants One

The buyer’s entire reason to make the election is the basis step-up. Without it, the buyer inherits whatever tax basis the target’s assets already carried, which after years of depreciation is often close to zero. With the election, the New Target’s basis in its assets is reset to reflect the price actually paid for the stock, plus assumed liabilities.⁴

Consider a target that owns real estate bought 20 years ago for $2 million and now worth $10 million. A plain stock purchase leaves the buyer depreciating a mostly-exhausted $2 million basis. The election resets the depreciable basis to $10 million. That higher basis translates directly into larger depreciation and amortization deductions for years to come.

The seller knows this, which is why the buyer generally pays for the benefit through a higher purchase price. Whether the present value of future deductions justifies the premium is the core economic question in every deal where the election is on the table.

Anti-Churning Limits on Intangibles

The step-up doesn’t always yield amortization for intangibles. Section 197’s anti-churning rules block amortization on goodwill or going concern value when a “related person” held or used the intangible during a transition period from July 25, 1991 through August 10, 1993 and the user of the intangible doesn’t change as part of the transaction.⁵ The relatedness test borrows Section 267(b) but substitutes a 20% ownership threshold for the usual 50%. When it applies, the New Target has stepped-up goodwill it cannot amortize, which can wipe out most of the election’s value.

The Two Flavors: 338(g) and 338(h)(10)

There are two versions of the election, and the difference between them is the difference between one layer of tax and two.

The standard election, sometimes called a “338(g) election,” is made unilaterally by the buyer. When the target is a C corporation, it produces a punishing two-layer tax. The Old Target pays corporate tax at 21% on the deemed asset sale. Then the after-tax proceeds are treated as distributed in a liquidation, and the shareholders pay capital gains tax on the difference between what they receive and their stock basis. The combined burden typically exceeds any buyer-side benefit from the step-up. In practice, the standard election only makes sense when the target has enough net operating losses to absorb most of the corporate-level gain, or when the target is a foreign corporation and the mechanics interact differently with international tax rules.

The Section 338(h)(10) election collapses the deal into a single layer of tax. It requires the buyer and seller to file jointly, and it’s only available when the target is either an S corporation or a member of a selling consolidated group (or an affiliated group, even one that doesn’t file consolidated returns).¹ Under this version, the stock sale is effectively disregarded. The Old Target is treated as selling its assets and then liquidating, and no separate gain is recognized on the stock itself.

S Corporation Targets

When the target is an S corporation, the gain from the deemed asset sale passes through to the individual shareholders on their Schedule K-1s and is taxed at their individual rates. Their stock basis is adjusted upward by the amount of gain recognized, which eliminates any additional gain on the deemed liquidation. One layer of tax, at the shareholder level.⁶

Consolidated Group Targets

When the target is a subsidiary in a consolidated group, the gain flows into the selling group’s consolidated return. The selling group’s basis in the target stock is adjusted upward to prevent a duplicate tax on the deemed liquidation, again producing a single layer of tax at the selling group level.

The Section 336(e) Alternative

If the buyer isn’t a corporation, Section 338 isn’t available at all. Section 336(e) fills that gap with a parallel deemed-asset-sale mechanism that has no restriction on the buyer’s entity type. The acquirer can be an individual, a partnership, a trust, or a corporation.⁷

The 336(e) election is made on the seller’s side. The seller (or the S corporation shareholders) and the target enter into a written agreement and each attach an election statement to a timely filed return. The buyer’s cooperation is not technically required. The 80% “qualified stock disposition” test tracks Section 338, but the disposition need not be a “purchase” in the strict Section 338 sense, so the election reaches certain spin-offs and distributions that a Section 338 election could not.

How the Purchase Price Gets Allocated

Once the election is made, the total deemed purchase price has to be divided among the target’s individual assets using the “residual method” required by Section 1060, the same approach used in any applicable asset acquisition.⁸ Assets fall into seven classes, and price flows through them in order, each class absorbing basis up to the fair market value of its assets before any excess spills into the next:

Class I: cash and bank deposit accounts, excluding certificates of deposit.
Class II: actively traded securities and certificates of deposit.
Class III: debt instruments and accounts receivable.
Class IV: inventory and property held for sale to customers.
Class V: everything else, including equipment, real estate, and furniture.
Class VI: intangibles other than goodwill and going concern value, such as patents, trademarks, customer lists, and covenants not to compete.
Class VII: goodwill and going concern value.

Whatever price remains after filling Classes I through VI lands in Class VII.⁹ In most acquisitions of profitable businesses, that residual is substantial because the buyer paid a premium over the net fair value of identifiable assets. Goodwill in Class VII is then amortized over 15 years under Section 197.⁵

The allocation matters. A dollar allocated to inventory is deducted when the inventory sells, possibly within months. A dollar allocated to equipment is depreciated over five or seven years. A dollar stuck in Class VII takes the full 15. Sellers and buyers frequently negotiate the allocation because their interests diverge: sellers prefer capital gain treatment, buyers want basis in classes that generate faster deductions.

Filing the Election

The election itself is made on IRS Form 8023. For a standard 338(g) election, only the buyer signs. For a 338(h)(10) election, both the buyer and the seller (the common parent of the selling consolidated group, or the S corporation shareholders) must sign.¹⁰

The deadline is the 15th day of the 9th month after the month in which the acquisition date falls. Miss it and the election is gone. The IRS grants extensions only in narrow circumstances, and planning around late relief is a losing strategy.

Separately, both the Old Target and the New Target must file Form 8883 reporting the actual asset allocation. The Old Target attaches it to its final return (or, for an S corporation, to Form 1120-S; for a consolidated subsidiary, to the selling group’s consolidated return). The New Target attaches it to its first return after the acquisition date.¹¹

A Section 336(e) election follows a different procedure. The seller and target sign a written, binding agreement by the due date (including extensions) of the earlier of their returns for the year that includes the disposition, and each party attaches an election statement to a timely filed return.⁷ There is no standalone form.

Post-Closing Adjustments

The initial allocation is rarely the last word. Contingent liabilities that weren’t fixed on the acquisition date, earnout payments, working capital true-ups, and indemnification claims can all move the numbers after closing. When any element of the deemed sale price changes, the regulations require a full reallocation using the same seven-class residual method as if the redetermined amount had been the original price.¹²

The reallocation is subject to the same fair market value ceilings that applied on the acquisition date. If the price goes up, the additional basis flows through the classes in order and any excess lands in Class VII. If it goes down, basis is removed in reverse. Both the Old Target and the New Target file a supplemental Form 8883 for the year in which the adjustment is taken into account.¹¹

1
Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions
2
Office of the Law Revision Counsel. 26 USC 1504 – Definitions
3
eCFR. 26 CFR 1.338-3 – Qualification for the Section 338 Election
4
eCFR. 26 CFR 1.338-5 – Adjusted Grossed-Up Basis
5
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
6
GovInfo. 26 CFR 1.338(h)(10)-1 – Deemed Asset Sale and Liquidation
7
GovInfo. 26 CFR 1.336-2 – Availability, Mechanics, and Consequences of Section 336(e) Election
8
Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions
9
eCFR. 26 CFR 1.338-6 – Allocation of ADSP and AGUB Among Target Assets
10
Internal Revenue Service. Instructions for Form 8023 – Elections Under Section 338 for Corporations Making Qualified Stock Purchases
11
Internal Revenue Service. Instructions for Form 8883 – Asset Allocation Statement Under Section 338
12
eCFR. 26 CFR 1.338-7 – Allocation of Redetermined ADSP and AGUB Among Target Assets