What Is the 338(h)(10) Election and How Does It Work?

A Section 338(h)(10) election is a joint tax election that lets a buyer purchase the stock of a target corporation while both sides treat the deal as an asset sale for federal income tax purposes. The buyer walks away with a stepped-up tax basis in the target’s assets, which produces larger depreciation and amortization deductions for years afterward. The seller keeps the legal simplicity of a stock transfer, so contracts, licenses, and permits stay in place without third-party consents. The election is available only in specific situations, most commonly when the target is an S corporation or a subsidiary in a consolidated group, and the entire mechanism runs on a fictional sequence of events that the IRS treats as real.

The Problem the Election Solves

Every corporate acquisition faces the same structural tension. A buyer that purchases stock steps into the target’s shoes legally, but inherits the target’s old, often low, tax basis in the underlying assets. That limits future depreciation deductions. An asset purchase produces the opposite result: the buyer assigns fair market value to each asset and gets a fresh, stepped-up basis, but the target corporation recognizes gain on the sale. If the target is a C corporation, shareholders then face a second layer of tax when the proceeds are distributed, which makes asset deals unattractive for most C corporation sellers.

The 338(h)(10) election collapses that trade-off. The parties execute a stock sale, so the legal side stays simple. For tax purposes, the IRS treats the target as if it had sold all of its assets and then liquidated. The buyer gets the stepped-up basis. The seller reports a deemed asset sale rather than a stock sale. When the target is an S corporation, the gain flows through to the shareholders’ personal returns as a single level of tax.

Who Can Make the Election

The transaction has to meet the statutory definition of a “qualified stock purchase.” A purchasing corporation must acquire at least 80% of the target’s total voting power and 80% of the total value of its stock, by purchase, within a 12-month window that starts on the date of the first qualifying purchase.¹

Not every acquisition of stock counts. The statute excludes stock obtained through tax-free exchanges, gifts, inheritances, or transactions with related parties.¹ The buyer must itself be a corporation. Individuals, partnerships, and private equity funds structured as partnerships cannot make this election.

The target has to fit one of three profiles:

An S corporation immediately before the acquisition date. This is the most common scenario, because the single-level tax benefit is largest here.
A subsidiary in an affiliated group filing a consolidated federal return with a selling parent.
A member of an affiliated group that does not file a consolidated return.

Certain corporations are ineligible regardless of ownership structure, including foreign corporations and regulated investment companies.

Both Sides Must Consent

The buyer cannot make this election alone. For a consolidated group target, the common parent of the selling group must sign. For an S corporation target, every shareholder must consent, including any shareholder who is not selling stock in the transaction. The unanimous-consent rule gives selling shareholders real leverage in the negotiation. The agreement to make the election typically sits in the stock purchase agreement itself, often backed by indemnification for tax liabilities that flow from the deemed asset sale treatment. Once filed, the election is irrevocable.²

How the Deemed Transaction Actually Works

The heart of the election is a fiction. Stock changes hands in reality, but the IRS ignores that and substitutes a two-step sequence: a deemed asset sale followed by a deemed liquidation. Every tax consequence flows from that sequence.

Step One: The Deemed Asset Sale

The target before the election, called “Old Target,” is treated as having sold all of its assets to an unrelated party in a single transaction at the close of the acquisition date.² The deemed sale price is not the actual stock price. It is a calculated figure called the Aggregate Deemed Sale Price, or ADSP, determined under Treasury Regulation 1.338-4.³ Broadly, the ADSP is the grossed-up amount realized on the recently purchased stock plus the target’s liabilities.

Old Target recognizes gain or loss on this fictional sale as if it had actually happened. The gain is calculated asset by asset, comparing the allocated portion of ADSP to the target’s existing tax basis in each asset. This deemed sale occurs while Old Target is still owned by the selling group or the S corporation shareholders.

Step Two: The Deemed Liquidation

Immediately after the deemed asset sale, Old Target is treated as having liquidated and distributed all of the sale proceeds to its shareholders. The tax treatment depends on who the seller is:

For a consolidated group subsidiary, the liquidating distribution to the selling parent is generally tax-free under Section 332.⁴
For an S corporation, the gain from the deemed asset sale flows through to shareholders’ individual returns. That flow-through increases each shareholder’s stock basis, and the deemed liquidating distribution is then generally tax-free to the extent of that adjusted basis.

For S corporation shareholders, this flow-through is what produces the single level of tax. The shareholders calculate their final stock gain or loss as the difference between the distribution amount and their adjusted basis after the deemed sale gain has been picked up.

New Target Picks Up the Assets

After Old Target ceases to exist for tax purposes, a “New Target” is treated as having purchased all the assets for an amount called the Adjusted Grossed-Up Basis, or AGUB, calculated under Treasury Regulation 1.338-5.⁵ The AGUB consists of the grossed-up basis of the recently purchased stock, assumed liabilities, and related acquisition costs. New Target is treated as a brand-new corporation, starting fresh with a stepped-up basis.

The actual legal entity continues to exist throughout. The corporation keeps its name, contracts, licenses, and permits. Nothing changes under state law. The fiction exists solely for federal tax reporting.

What the Buyer Gets

The buyer’s payoff is a higher tax basis in the target’s assets, which means bigger deductions. The AGUB is allocated across all of the target’s assets using the residual method, and the buyer then depreciates or amortizes each asset over its applicable recovery period. If the target’s historical asset basis sat well below fair market value, the step-up can be substantial. At the current 21% federal corporate rate, a $10 million step-up in depreciable assets translates into $2.1 million in federal tax savings over the recovery periods.

New Target is also treated as a new corporation. It can adopt a new tax year, choose a new accounting method, and is not bound by Old Target’s tax elections. It does, however, remain liable for Old Target’s unpaid tax obligations, including the tax from the deemed asset sale itself.² That inherited liability is usually handled through indemnification in the purchase agreement.

What the Seller Pays

The seller’s tax picture is more nuanced, because the deemed asset sale changes the character of the gain. Instead of a single capital gain on the sale of stock, the S corporation shareholders report whatever mix of ordinary income and capital gain the target’s assets produce. Depreciation recapture on equipment and real property generates ordinary income. Gain on capital assets and goodwill is taxed at capital gains rates. Ordinary income rates can run significantly higher, so the mix matters.

For S corporation sellers, the deemed asset sale gain flows through to each shareholder’s individual return in proportion to ownership. Shareholders pay personal income tax on the gain, and no separate corporate-level tax applies, assuming no built-in gains issue (see below). For a consolidated subsidiary target, the deemed asset sale gain is reported on the consolidated return of the selling parent, and the subsequent deemed liquidation is generally tax-free under Section 332.⁴

Because the deemed asset sale often shifts some gain into ordinary income, the seller’s total tax bill can be higher than it would have been on a straight stock sale. Deals typically address this with a gross-up: the buyer pays a higher purchase price so the seller nets the same after-tax result, while the buyer’s future depreciation savings still exceed that premium on a present-value basis. If the buyer’s tax benefit does not exceed the seller’s additional tax cost, the election destroys value and the parties should do a straight stock deal instead.

The Net Investment Income Tax

S corporation shareholders who do not materially participate in the target’s business face an additional 3.8% tax on their share of the deemed asset sale gain. Section 1411 imposes this net investment income tax on gains from property used in a passive activity and, effectively, on the deemed sale of an S corporation interest to the extent of unrealized gain in the corporation’s assets.⁶ Active shareholders who run day-to-day operations are exempt. Deals with a mix of active and passive owners have to model this additional tax for each shareholder separately.

Allocating the Price Across Asset Classes

Both the ADSP (seller’s side) and the AGUB (buyer’s side) are allocated across the target’s assets using the same method. Section 1060 requires the “residual method,” which fills asset classes sequentially in order of priority, and the allocation must be consistent between buyer and seller.⁷

The seven asset classes are:⁸

Class I: cash and bank deposits
Class II: actively traded securities and certificates of deposit
Class III: debt instruments and accounts receivable
Class IV: inventory
Class V: all other tangible and intangible assets not in another class
Class VI: Section 197 intangibles other than goodwill (customer lists, patents, non-compete agreements)
Class VII: goodwill and going concern value

The residual method reduces the total consideration by the Class I amount, then allocates the remainder to each successive class up to the fair market value of the assets in that class. Whatever is left after Classes I through VI drops into Class VII as goodwill.⁹

The Class VII residual is where negotiations get contentious. Goodwill is amortizable over 15 years under Section 197, giving the buyer steady annual deductions.¹⁰ For the seller, gain allocated to goodwill is typically capital gain, while gain on inventory or depreciated equipment can be ordinary. Both sides have strong incentives to push the allocation in different directions, but the consistency rule means they have to agree.

Filing the Election

The election is made on Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases. It must be filed by the 15th day of the ninth month after the acquisition date.¹¹ The purchasing corporation and either the selling consolidated parent or all S corporation shareholders must sign.¹²

Both buyer and seller then file Form 8883, Asset Allocation Statement Under Section 338, with their respective income tax returns for the year of the acquisition.⁸ Form 8883 reports the allocation of ADSP and AGUB across the seven classes, and the amounts on the two versions have to match. Inconsistencies draw IRS scrutiny.

For an S corporation target, the deemed asset sale is reported on a final Form 1120-S for Old Target covering the short tax year that ends on the acquisition date.¹³ For a consolidated group target, the deemed sale is reported on the selling parent’s consolidated return.

Relief for a Missed Deadline

Missing the Form 8023 deadline does not always kill the election. Revenue Procedure 2018-58 provides an automatic extension if the election is made on or before the due date (including extensions) of the target’s return for the year of the deemed sale, attached to a timely filed original return or an amended return filed before that due date for either the selling corporation, the target, or the purchasing corporation.¹⁴ Once that window closes, the parties generally have to seek a private letter ruling, which is expensive, slow, and not guaranteed. The safer path is to file well before the nine-month deadline and build the obligation into the closing checklist.

Traps That Can Undercut the Benefit

Built-in Gains Tax for Former C Corporations

If the target S corporation was formerly a C corporation, a corporate-level built-in gains tax under Section 1374 may apply to the deemed asset sale. The tax hits net recognized built-in gain at the highest corporate rate (currently 21%) during a five-year recognition period that begins when the corporation elected S status.¹⁵ If the conversion from C to S happened less than five years before the acquisition, the tax effectively reintroduces a partial double tax and can significantly reduce the deal’s economics. Once the recognition period has passed, the trap is gone.

State Tax Conformity

Not every state follows the federal treatment. Most conform, but some treat the gain as nonbusiness income sourced to the seller’s state of domicile rather than business income apportioned across states. A few states allow parties to make a state-level 338(h)(10) election independently of the federal one. The mismatch can create unexpected state tax bills for the seller or complicate the buyer’s state-level basis calculations, so multi-state deals need a state-by-state model.

Installment Notes

When the buyer pays partly with installment notes rather than all cash, the deemed asset sale can qualify for installment reporting under Section 453. Old Target is treated as receiving “new target installment obligations” mirroring the actual notes and distributing them to shareholders in the deemed liquidation.² The distribution of the note is not itself taxable to S corporation shareholders, and gain is reported as payments come in. Installment reporting does not apply to inventory or to depreciation recapture on personal property.

Post-Closing Adjustments

If contingent liabilities are discovered or paid after the acquisition date, both ADSP and AGUB are adjusted. An amended Form 8883 must be filed when the purchase price shifts because of earn-outs, indemnification payments, or the resolution of contingent claims. Those adjustments can retroactively change the seller’s gain and the buyer’s basis, which is why deal agreements typically include detailed true-up provisions.

When 338(h)(10) Is Off the Table: Section 336(e)

The 338(h)(10) election requires the buyer to be a corporation. If a private equity fund structured as a partnership acquires an S corporation, this election is unavailable. Section 336(e) can sometimes fill the gap: it also produces a deemed asset sale, and the regulations state that its results should generally coincide with a 338(h)(10) election, but the buyer can be any type of person, including an individual, a partnership, or a trust.¹⁶ The seller must be a domestic corporation or S corporation shareholders that dispose of at least 80% of the target’s stock within a 12-month period, and the election is made by the seller alone. Section 336(e) also reaches taxable stock distributions, which 338(h)(10) does not.

1
Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions
2
eCFR. 26 CFR 1.338(h)(10)-1 – Deemed Asset Sale and Liquidation
3
eCFR. 26 CFR 1.338-4
4
Office of the Law Revision Counsel. 26 USC 332 – Complete Liquidations of Subsidiaries
5
eCFR. 26 CFR 1.338-5
6
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
7
Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions
8
Internal Revenue Service. Instructions for Form 8883
9
eCFR. 26 CFR 1.1060-1 – Special Allocation Rules for Certain Asset Acquisitions
10
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
11
Internal Revenue Service. Instructions for Form 8023
12
Internal Revenue Service. About Form 8023
13
Internal Revenue Service. 2025 Instructions for Form 1120-S
14
Internal Revenue Service. Revenue Procedure 2018-58
15
Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains
16
eCFR. 26 CFR 1.336-1 – General Principles, Nomenclature, and Definitions for a Section 336(e) Election