§ 338 Election: Stock Purchase Treated as Asset Purchase

26 U.S.C. § 338 allows a purchaser of corporate stock — if it acquires 80% or more control of the target corporation within a 12-month period — to elect to treat the stock purchase as if it were an asset purchase for federal income tax purposes. The practical effect is dramatic: the target corporation is deemed to have sold all its assets at fair market value on the acquisition date, triggering gain or loss at the corporate level as if the assets were sold in a taxable transaction, and then immediately repurchased those assets at a new stepped-up fair market value basis. For buyers, this eliminates the fundamental problem with stock purchases — inheriting the target's historical low-basis assets and latent tax liabilities — by resetting the inside asset basis to current fair market value (see Step-Up in Basis). The § 338 election exists in two forms with very different economics: § 338(g), which the buyer makes unilaterally and which results in double taxation; and § 338(h)(10), a joint election available only in S-corporation and subsidiary acquisitions, which achieves single-level taxation while giving the buyer a full stepped-up asset basis. The § 338(h)(10) election is one of the most commonly negotiated provisions in acquisitions of S-corporations and corporate subsidiaries — the difference in tax outcome between making and not making the election can be tens of millions of dollars on a large deal.

Current Law (2026)

§ 338 election mechanics depend on whether it is a unilateral § 338(g) election or a joint § 338(h)(10) election.

Parameter	§ 338(g)	§ 338(h)(10)
Who elects	Purchaser alone	Purchaser + seller (joint)
Available in	Any qualified stock purchase	S-corp acquisitions; subsidiary acquisitions from corporate parent
Seller tax treatment	Treated as stock sale (capital gain)	Treated as asset sale (ordinary income + recapture)
Buyer tax treatment	New stepped-up asset basis	New stepped-up asset basis
Corporate-level tax	Yes — target deemed to sell assets	Yes — deemed asset sale taxed at target level
Double taxation?	Often (corporate + shareholder)	No (deemed liquidation eliminates corporate-level dividend)
Deadline to file	8.5 months after acquisition date	Same

Legal Authority

26 U.S.C. § 338 — Certain stock purchases treated as asset acquisitions. If the buyer acquires assets of the target during the consistency period (one year before through one year after the 12-month acquisition period), the buyer may be treated as having made the election automatically — except for ordinary-course sales, acquisitions whose basis is fully based on the seller's adjusted basis, pre-September 1, 1982 acquisitions, and other IRS-specified exceptions. If several related target companies are acquired in the same consistency period, the election for the first purchase generally applies to the others. Once made, the election cannot be revoked.
26 U.S.C. § 338(h)(10) — Joint election provision for qualified stock purchases of S-corps and corporate subsidiaries; results in deemed asset sale and liquidation at the seller level, single level of tax, full stepped-up basis for buyer
26 U.S.C. § 1060 — Special allocation rules for applicable asset acquisitions; buyer and seller must both report the purchase price allocation to the IRS (via Form 8594); failure to file triggers penalties under § 6721
26 U.S.C. § 382 — Limitation on net operating loss carryforwards following an ownership change; a § 338 election eliminates NOLs entirely (deemed liquidation of old target), making the § 382 limitation irrelevant — but eliminating the NOLs themselves
26 U.S.C. §§ 1245, 1250 — Depreciation recapture rules; applicable to the deemed asset sale under both § 338(g) and § 338(h)(10); recapture converts capital gain into ordinary income on depreciable personal property (§ 1245) and certain real property (§ 1250)

Key Mechanics

The § 338 election operates through a deemed-sale / deemed-purchase fiction imposed by 26 U.S.C. § 338. On the acquisition date, the "old target" is treated as if it sold all its assets to an unrelated party at fair market value — recognising gain or loss at the corporate level — and a "new target" is treated as purchasing those same assets at that fair market value, establishing a stepped-up inside basis for the buyer. The target's tax year closes on the acquisition date, splitting it into an "old target" pre-closing period and a "new target" post-closing period under 26 CFR § 1.338-1.

The two election forms differ primarily in who makes the election and how the seller is taxed:

§ 338(g) — buyer elects alone; seller retains stock-sale treatment; double taxation is the usual result
§ 338(h)(10) — joint election; seller is taxed as if the target sold its assets (ordinary income + recapture), then liquidated; buyer gets the same stepped-up basis; only one level of tax

The total purchase price is then allocated among the target's assets using the seven-class hierarchy under 26 U.S.C. § 1060 (and its regulation 26 CFR § 1.1060-1): Class I (cash), Class II (marketable securities), Class III (accounts receivable), Class IV (inventory), Class V (other assets at FMV), Class VI (§ 197 intangibles — 15-year straight-line), and Class VII (goodwill). That allocation determines the buyer's entire depreciation schedule going forward — and is therefore the subject of hard negotiation in purchase price allocation (Form 8594).

How It Works

A qualified stock purchase (QSP) — the predicate for any § 338 election — requires the purchasing corporation to buy at least 80% of the total voting power and at least 80% of the total value of all stock of the target corporation within a 12-month acquisition period. Purchases must be by purchase (not gift, inheritance, or § 351 contribution). Once the 80% threshold is crossed, the purchaser has until 8 and one-half months after the acquisition date to make the election.

§ 338(g) — The Unilateral Election: The purchasing corporation makes the election alone. The target is treated as having sold all its assets at "adjusted grossed-up basis" (AGUB) — essentially a proxy for the total purchase price allocated across all assets — at the end of the acquisition date. The deemed asset sale triggers gain at the corporate level. The target's shareholders are separately treated as having sold their stock in a taxable transaction. The result is double taxation: gain is recognized at the corporate level (asset sale deemed gain), and the selling shareholders also recognize gain on their stock sale. Because of this double taxation, § 338(g) is rarely used in acquisitions of C-corporations with low-basis assets. It is more commonly used to acquire foreign target corporations where the foreign corporate-level tax is irrelevant (foreign tax credit may absorb it) — in that context, the buyer gets a stepped-up basis in the foreign corporation's assets without the domestic double-tax problem.

§ 338(h)(10) — The Joint Election: This is the commercially important election. Available only for acquisitions of S-corporations and acquisitions of subsidiary corporations from a consolidated group, the § 338(h)(10) election requires agreement by both the buyer and the seller. The economic bargain: the seller (the parent corporation selling a subsidiary, or the S-corp shareholders) is treated as if the target sold its assets in a taxable transaction — recognizing ordinary income on depreciation recapture, gain on appreciated assets, and loss on underwater assets — rather than as a stock sale. The target is then treated as having distributed the sale proceeds to the seller in a deemed liquidation. The result: a single level of tax at the seller level, and the buyer receives a fully stepped-up basis in all target assets equal to fair market value.

Why would sellers agree to § 338(h)(10) if it converts their capital gain stock sale into an ordinary income asset sale? Two reasons: first, buyers pay a price premium for the election — because the buyer receives a stepped-up basis, generating substantial future depreciation deductions, those deductions have present value that the buyer can share with the seller via a higher purchase price ("grossing up" for the seller's incremental tax cost). Second, in S-corporation sales, the deemed asset sale taxes flow through to the S-corp shareholders anyway — there is no separate corporate-level tax because S-corps don't pay entity-level federal income tax. So S-corp shareholders are already in a pass-through tax environment; the § 338(h)(10) election primarily changes the character and allocation of the gain among shareholders.

Asset allocation: Under both § 338(g) and § 338(h)(10), the total purchase price (AGUB for § 338(g); modified ADSP for § 338(h)(10)) must be allocated among the target's assets under the § 1060 seven-class asset allocation hierarchy — cash, marketable securities, accounts receivable, inventory, certain assets at FMV, customer lists and intangibles (§ 197), and goodwill. The allocation directly determines the buyer's depreciation profile: allocation to § 197 intangibles (15-year straight-line amortization) and equipment (MACRS depreciation, now eligible for bonus depreciation under current law) generates immediate tax savings. Allocation to goodwill in excess of § 197 intangibles is less valuable (same 15-year amortization). Allocation to land generates no depreciation at all.

NOL interaction: A § 338 election — particularly § 338(h)(10) — eliminates the target's tax attributes (NOLs, tax credits, capital loss carryforwards). The deemed asset sale results in a deemed liquidation, and the target emerges as a "new" corporation with no carryforward history. This is a critical trade-off: if the target has substantial NOL carryforwards, the § 338 election destroys them. Without the election, a § 382 ownership change limitation would restrict their use, but they would survive. Tax counsel must model the value of surviving (§ 382-limited) NOLs against the value of the stepped-up asset basis from the election.

How It Affects You

If you're selling your S-corporation and a buyer requests a § 338(h)(10) election: This is extremely common. The buyer's request for a § 338(h)(10) election is standard in S-corp deals because it gives them a stepped-up basis in all your company's assets — valuable depreciation deductions they wouldn't get in a pure stock sale. For you as an S-corp shareholder, the election converts your sale from a capital gain transaction into an asset sale, which means more of the proceeds will be taxed at ordinary income rates (on depreciation recapture for equipment, real estate, etc.) and less at the lower capital gains rates you'd get selling stock. The buyer will typically offer a higher purchase price to compensate — the "gross-up" premium. You need your tax advisor to run the numbers on both scenarios: the after-tax proceeds from a stock deal at the lower quoted price versus the after-tax proceeds from an asset deal at the grossed-up price. Neither is automatically better — it depends on your asset mix, your basis in the S-corp stock, and the magnitude of recapture embedded in the assets.

If you're acquiring a company and deciding whether to buy stock or assets: The § 338(h)(10) election bridges the gap — it lets you close a deal as a stock purchase (cleaner for regulatory licenses, contracts, employment relationships) while achieving the tax economics of an asset purchase (stepped-up basis, future depreciation). The key constraint is that § 338(h)(10) is only available for S-corporations and subsidiary acquisitions (where there's a corporate parent selling a subsidiary). If you're buying the stock of a standalone C-corporation with no parent, you cannot use § 338(h)(10) — you're stuck with either a stock purchase (lower asset basis) or negotiating a direct asset purchase (which requires the seller to pay corporate-level tax on a direct asset sale, then tax again on the liquidation proceeds). In that scenario, many deals are structured as § 368 reorganizations instead — see Corporate Reorganizations (§ 368).

If you're a PE fund or strategic acquirer modeling an acquisition: The basis step-up from a § 338(h)(10) election is a real, quantifiable dollar amount in your model. Note that if the deal includes earn-outs or seller notes, those deferred payments complicate the ADSP calculation — see Installment Sale Rules for how deferred consideration interacts with gain recognition. For a target with $50 million in depreciable assets (equipment, intangibles, customer relationships) with fully depreciated bases, a full step-up to FMV generates $50 million in additional future deductions. At a 21% corporate rate and discounted at your cost of capital, that's $8-10 million in present-value tax savings — effectively reducing your acquisition cost by that amount. The buyer's incentive to pay a premium to the seller to obtain their consent to a § 338(h)(10) election is bounded by this PV of tax savings. Sophisticated sell-side advisors know this math and often model the optimal gross-up for their clients before negotiations begin.

If you're an S-corp shareholder who didn't model recapture carefully: This is where deals go sideways. Suppose you built a manufacturing company over 15 years, and most of the equipment was fully depreciated under accelerated MACRS schedules. Your accountant told you the sale price was $8 million — all capital gain, right? Not if the buyer requested a § 338(h)(10) election and you agreed without running the recapture numbers. Depreciation recapture under §§ 1245 and 1250 on those fully-depreciated machines converts what looked like capital gain into ordinary income taxed at your marginal rate. On $2 million of fully-depreciated equipment, that can swing your federal tax bill by $150,000 to $200,000 or more. Always model recapture before agreeing to any § 338(h)(10) election. Your M&A attorney can help structure the gross-up — but you have to know to ask.

State Variations

State conformity to § 338 elections varies significantly. Most states follow the federal § 338(g) election for state corporate income tax purposes — the deemed asset sale triggers state-level gain recognition. For § 338(h)(10), state conformity is less uniform: some states respect the federal election; others require a separate state-level election or do not recognize the deemed liquidation for state purposes. California generally conforms to § 338 for corporations subject to California franchise tax, but California's treatment of S-corporation status and the state-level election mechanics differ. New York respects § 338(h)(10) for New York corporate tax purposes. Multi-state targets with real property may trigger state real estate transfer taxes on the deemed asset transfer — a significant cost that cash deal models must address.

Implementing Regulations

26 CFR § 1.338-1 — General principles; status of old target and new target (the core deemed-sale/deemed-purchase framework; tax year closing rules; the "old target" and "new target" concepts)
26 CFR § 1.338-3 — Qualification for the section 338 election (qualified stock purchase requirements; 12-month acquisition period; what counts as a "purchase")
26 CFR § 1.338-4 — Aggregate deemed sale price; various aspects of the deemed asset sale (ADSP calculation; how total consideration is determined for the deemed sale)
26 CFR § 1.338-5 — Adjusted grossed-up basis (AGUB calculation for § 338(g); liabilities assumed; transaction costs)
26 CFR § 1.338(h)(10)-1 — Deemed asset sale and liquidation (the joint election mechanics; S-corp specific rules; the deemed distribution and liquidation sequence)
26 CFR § 1.1060-1 — Special allocation rules for certain asset acquisitions (the 7-class allocation hierarchy applied to both direct asset purchases and § 338 deemed purchases)

Pending Legislation

H.R. 1 / "One Big Beautiful Bill Act" (Rep. Arrington, R-TX; became law 2025) — The 119th Congress reconciliation act includes provisions restoring 100% bonus depreciation for qualified property placed in service after January 19, 2025. If Treasury implements this as enacted, the PV value of § 338 step-ups on equipment-heavy targets rises dramatically — a buyer stepping up $30M in MACRS property at 100% bonus saves ~$6.3M in year-one taxes versus ~$2.5M at 40% bonus. Deals that closed in 2025 before the law's effective date may be affected by retroactive bonus depreciation provisions.
S. 187 / ALIGN Act (Sen. Lankford, R-OK; introduced 119th Congress) — Would make 100% bonus depreciation permanent for qualified property placed in service after September 27, 2017. Status: Introduced. If enacted, this would lock in the full step-up value for all future § 338 elections without phase-down uncertainty.
H.R. 3967 / CREATE JOBS Act (Rep. Grothman, R-WI; introduced 119th Congress) — Would permanently allow 100% first-year expensing for qualified property and also changes building and R&D cost recovery. Status: Introduced.
§ 338 and bonus depreciation interaction: Under current TCJA phase-down law, bonus depreciation stands at 40% for 2025 (down from 60% in 2024 and 100% in 2022). Proposed legislation in 2025 — including provisions in the House-passed reconciliation framework — would restore 100% bonus depreciation for property placed in service after January 19, 2025. If enacted, that restoration would dramatically increase the immediate tax value of § 338 step-ups for equipment-heavy acquisitions: a buyer who steps up $30 million in MACRS equipment at 100% bonus would get a current-year $6.3 million tax savings (at 21% rate), versus $2.5 million at 40% bonus. The difference can shift deal economics by millions and is actively affecting deal timing as buyers weigh whether to close before or after any legislative fix is signed.
State tax harmonization: Several states are evaluating whether to conform more uniformly to federal § 338 elections, particularly for multi-state business sales where inconsistent state treatment creates significant compliance complexity. Until Congress and the states resolve these gaps, multi-state deals require state-by-state analysis of the deemed transfer — particularly in states with their own franchise tax regimes.

Recent Developments

§ 338(h)(10) remains the standard in S-corp M&A: The § 338(h)(10) election is now a standard feature of virtually every acquisition of an S-corporation by a corporate buyer. Deal lawyers and tax advisors treat it as a default negotiating point — the question is not whether to include it but at what price premium the seller will agree. Its prevalence has made S-corporation acquisitions structurally similar to asset purchases in economic terms even when structured as stock deals.
Bonus depreciation phase-down is reshaping § 338 deal math (2024–2025): With bonus depreciation at 60% in 2024 and 40% in 2025, the real-dollar value of a § 338 step-up on equipment is materially lower than it was when TCJA first passed. Buyers are factoring the reduced immediate write-off into their gross-up offers, and some deals are being structured with contingent gross-up provisions tied to potential legislative restoration of 100% bonus depreciation. Watch the 2025 reconciliation bill closely — a restoration to 100% bonus retroactive to January 19, 2025 would alter in-progress deal negotiations.
F reorganization preceding § 338: Tax practitioners increasingly use "F reorganizations" (Type F — a mere change of identity or form) as a pre-closing step before a § 338(h)(10) election. An S-corporation undergoes an F reorganization to create a new holding company structure; the buyer then acquires the operating subsidiary stock using § 338(h)(10). This allows the seller to retain certain pre-closing assets (real estate, cash) in the old entity while conveying the operating business — providing significant seller flexibility while preserving the buyer's step-up election. The technique is now well-established enough that the IRS has issued guidance on the proper sequencing and reporting requirements.
IRS Form 8023 and reporting compliance: The IRS requires buyers (and sellers for § 338(h)(10)) to file Form 8023 (Elections Under Section 338 for Corporations Making Qualified Stock Purchases) by the 15th day of the 9th month following the acquisition date. Late elections are not permitted — missing the deadline permanently forecloses the option for that acquisition. Practitioners report that missed deadlines, particularly in complex multi-entity deals, remain a recurring malpractice exposure.