338(h)(10) Election: Treating a Stock Sale as an Asset Sale

The IRC Section 338(h)(10) election allows a buyer and seller to treat a stock purchase as an asset purchase for federal tax purposes while maintaining the legal simplicity of a stock transaction. According to IRS regulations under Treasury Reg. §1.338(h)(10)-1, this election can provide the buyer with a valuable step-up in basis on the target company's assets without actually transferring individual assets. For search fund acquisitions targeting S-Corporations, which represent a significant portion of SME targets, the 338(h)(10) is one of the most powerful tax planning tools available.

• Legal form: The buyer purchases 100% of the target company's stock (legal stock deal)
• Tax treatment: For federal tax purposes, the target is deemed to sell all its assets at fair market value and then liquidate
• Result: The buyer gets a new (stepped-up) tax basis in the target's assets, as if it had purchased them individually
• Joint election: Both buyer and seller must agree to make the election (both file Form 8023)
• Timing: Must be filed by the 15th day of the 9th month following the acquisition month

• S-Corporations: Most common use case. The election eliminates the double tax issue that would otherwise apply to S-Corp asset sales.
• Corporate subsidiaries: When the target is a subsidiary of a corporate group (C-Corp parent owns the target)
• Not available for: Standalone C-Corporations sold by individual shareholders (use Section 336(e) instead in some cases)

• Step-up in basis: All target assets are stepped up to FMV, generating future depreciation and amortization deductions
• Goodwill amortization: The excess purchase price over identified asset values becomes tax-deductible goodwill (15-year amortization under Section 197)
• Legal simplicity: No need to transfer individual contracts, licenses, or permits, you simply bought the stock
• Contract continuity: Contracts with anti-assignment clauses aren't triggered (since legal ownership doesn't change hands)
• No sales tax: In most states, stock purchases don't trigger sales tax on transferred assets

• S-Corp sellers: The deemed asset sale generates gain allocated to asset categories. Ordinary income on inventory, recaptured depreciation, and non-compete; capital gains on goodwill and other assets. This passes through to the S-Corp shareholders on Schedule K-1.
• Seller concern: Some asset categories generate ordinary income (higher tax rate) rather than capital gains
• Negotiation point: Sellers may request a higher price or favorable purchase price allocation to compensate for the tax impact
• State taxes: State treatment varies; some states don't conform to the federal 338(h)(10) election

• Same tax result: Both give the buyer a stepped-up basis in the target's assets
• Legal difference: 338(h)(10) is legally a stock purchase, so contracts, licenses, and employer status transfer automatically
• Liability: In a 338(h)(10) stock deal, the buyer assumes all liabilities (known and unknown). In an asset deal, the buyer can choose which liabilities to assume.
• Recommendation: If liability risk is manageable and the contract/license transfer benefit is significant, 338(h)(10) is often preferred

Buying an S-Corp for $5M with a 338(h)(10) election:

• Equipment FMV: $800K (5-7 year depreciation)
• Customer relationships: $600K (15-year amortization)
• Non-compete: $300K (15-year amortization)
• Real estate: $1.2M (39-year depreciation)
• Goodwill: $2.1M (15-year amortization)

Annual tax deductions: approximately $360K, saving ~$90K/year in taxes at a 25% rate. Over 15 years, the total tax savings approach $1.35M, a material reduction in the effective acquisition price. PwC's Tax Structuring for SME Acquisitions guide notes that the net present value of these deductions typically represents 15-25% of the total purchase price, making the 338(h)(10) election one of the most impactful negotiation points in any S-Corp deal.

When modeling the election, work with your CPA to run two scenarios, with and without the election, to understand the net benefit after accounting for any additional tax burden on the seller. The seller's incremental tax cost is the starting point for negotiating a price adjustment, and the buyer's tax savings typically exceed the seller's cost by a significant margin, creating a deal structure that benefits both parties. See our guide on tax optimization for acquisitions for a broader framework.

• The 338(h)(10) election gives buyers the tax benefits of an asset purchase with the legal simplicity of a stock purchase
• Most commonly used for S-Corp acquisitions, which represent a large portion of search fund targets
• Both buyer and seller must agree, the seller may need a price increase to compensate for their tax impact
• Annual tax savings can be $50K-$100K+ on typical search fund-sized deals
• Always model the tax impact with your CPA before and after the election to understand the net benefit

Use a 338(h)(10) when the target is an S-Corporation or corporate subsidiary and the legal benefits of a stock purchase outweigh the liability risk. Stock purchases are preferred when the target holds non-transferable contracts, hard-to-obtain permits or licenses, or government certifications that would be lost in an asset deal. If liability risk is your primary concern (environmental, litigation, unknown claims), a straight asset purchase gives you more protection because you choose which liabilities to assume.

Not for a standalone C-Corporation sold by individual shareholders. The 338(h)(10) election is available only for S-Corporations and corporate subsidiaries (where the target is owned by another C-Corporation). For standalone C-Corps, a Section 336(e) election may provide a similar result in certain circumstances. Consult a tax advisor to determine which structure works for your specific target. For more on entity-level considerations, see our guide on C-Corp vs. S-Corp vs. LLC.

On a typical $3M-$10M search fund acquisition, annual tax deductions from the stepped-up basis range from $200K to $700K, translating to $50K-$175K in annual cash tax savings at a 25% effective rate. Over the 15-year Section 197 amortization period, cumulative savings range from $750K to $2.6M. The net present value of these savings typically represents 15-25% of the purchase price, making the 338(h)(10) one of the most impactful structural decisions in any S-Corp acquisition.