IRC Section 338: Deemed Sale, Elections, and Form 8023

An IRC Section 338 election lets a corporation that buys another corporation’s stock have the deal taxed as if it had bought the target’s assets instead. The payoff is a stepped-up tax basis in those assets, which creates fresh depreciation and amortization deductions a straight stock purchase would not deliver. The election is irrevocable once filed, and whether it saves money turns on the gap between the target’s existing asset basis and current fair market value, weighed against the immediate tax hit from the deemed sale.¹

How the Deemed Sale Works

When the purchasing corporation makes the election, federal tax law creates a legal fiction. The target is treated as having sold every asset it owns at fair market value in a single transaction at the close of the acquisition date. The next day, a “new” target is treated as buying those same assets at a stepped-up basis. No assets actually move, and the target remains the same legal entity under state corporate law. For tax purposes, though, the old target and the new target are treated as two separate corporations.¹

The old target recognizes gain or loss as if it had really sold its assets, which creates an immediate tax liability. In return, the new target takes a fresh basis in each asset equal to its share of the total purchase price, called the Adjusted Grossed-Up Basis (AGUB). AGUB is built from the grossed-up basis of the buyer’s recently purchased stock, plus the basis of any stock the buyer already held before the acquisition period, adjusted for the target’s liabilities.¹

The stepped-up basis is where the long-term benefit lives. If the target owns equipment, buildings, patents, or goodwill whose basis has been depreciated down to near zero, the buyer starts depreciating those assets again from current fair market value. Over time, those deductions can outweigh the upfront deemed-sale tax.

338(g) vs. 338(h)(10)

Section 338 offers two distinct elections. They share the same mechanism but differ sharply in who pays the tax and how many layers of tax result.

The 338(g) Election

A 338(g) election is made by the buyer alone, without the seller’s involvement. It triggers the deemed asset sale inside the target, so the target recognizes gain on all its assets. The selling shareholders still recognize their own gain on the actual stock sale. That produces two levels of tax: one on the deemed asset sale inside the target, and one on the shareholders’ stock sale. The double hit makes a straight 338(g) election economically painful in most domestic deals. It shows up mainly in cross-border acquisitions where the buyer can use foreign tax credits or similar mechanisms to offset part of the cost.²

The 338(h)(10) Election

The 338(h)(10) election eliminates the double tax but comes with tighter eligibility rules. It is available only when the target is a member of a selling consolidated group or is an S corporation immediately before the acquisition date. The election must be made jointly by the buyer and the selling group, or by the buyer and the S corporation’s shareholders. Every S corporation shareholder must consent, including those who are not selling.³

Under 338(h)(10), the old target recognizes gain on the deemed asset sale while still a member of the selling consolidated group (or still an S corporation). The target is then treated as liquidating and distributing its assets to the selling group. No separate gain or loss is recognized on the actual stock sale. That produces a single level of tax, which is why this version is the common choice in domestic acquisitions where the target qualifies.¹

Both versions are irrevocable once filed.⁴

Qualified Stock Purchase Requirements

Neither election is available unless the transaction is a “qualified stock purchase.” Three components matter: how much stock is acquired, how quickly, and what counts as a purchase.

The 80 Percent Threshold

The buyer must acquire stock representing at least 80 percent of the total voting power and at least 80 percent of the total value of the target’s outstanding stock. Both thresholds come from Section 1504(a)(2), the same test that governs consolidated return inclusion.⁵

The 12-Month Acquisition Period

The qualifying purchases must all happen within a 12-month window. It begins on the date of the first purchase of stock that ends up counted in the qualified stock purchase. The acquisition date itself is the first day in that window on which the buyer crosses the 80 percent line. If the buyer cannot reach 80 percent within 12 months, no Section 338 election is available.⁶

What Counts as a Purchase

Section 338(h)(3) defines “purchase” narrowly. Three categories of acquisition do not qualify:

Carryover-basis acquisitions, where the buyer’s stock basis is determined by reference to the seller’s basis. Stock received through inheritance under Section 1014(a) is also excluded.
Tax-free exchanges, including stock acquired in reorganization exchanges under Sections 351, 354, 355, or 356, and any other transaction in which the seller does not recognize the full gain or loss.
Related-party acquisitions, where the seller’s ownership would be attributed to the buyer under the Section 318(a) constructive ownership rules. This stops a parent from manufacturing a step-up by “buying” stock from an entity it already constructively owns.

There is a carve-out for related-party acquisitions: if the buyer also purchased at least 50 percent of the related corporation’s stock in an arm’s-length purchase, acquisitions from that related corporation can count toward the 80 percent threshold.¹

Making the Election on Form 8023

The election is made on IRS Form 8023. The filing deadline is the 15th day of the 9th month after the month containing the acquisition date. An acquisition dated March 15 produces a December 15 filing deadline in the same year.⁷

Form 8023 identifies the buyer, the target, and (for a 338(h)(10) election) the common parent of the selling consolidated group or the S corporation shareholders. It also reports the acquisition date and the percentage of stock purchased. Each target in a multi-target deal gets its own schedule.⁸

The form is mailed to the IRS processing center in Ogden, Utah, or submitted by electronic fax to a dedicated toll-free number. Keep proof of timely filing and attach a copy to the next income tax return.⁷

Missing the deadline generally means losing the election. Relief under Treasury Regulation 301.9100 is available only if the taxpayer shows it acted reasonably and in good faith and that granting the extension would not prejudice the government. The standard is discretionary, not a safety net.⁹

Reporting the Asset Allocation on Form 8883

Form 8023 makes the election. Form 8883 reports the details of the deemed asset sale, and both the old target (or its selling group) and the new target must file it. It is attached to the income tax return on which the effects of the deemed sale are reported. For a 338(h)(10) election involving an S corporation target, Form 8883 goes with the target’s Form 1120-S.¹⁰

Form 8883 is where buyer and seller report how the purchase price was allocated across the seven asset classes. If the allocation later changes because of a purchase price adjustment or a contingent payment, a supplemental Form 8883 is filed with the return for the year the adjustment is taken into account. Missing or incorrect filings can trigger penalties absent reasonable cause.¹⁰

Allocating the Purchase Price Across Asset Classes

Once the election is made, AGUB is spread across the target’s assets using a residual method. The allocation follows a strict hierarchy of seven classes. Each class must be filled up to the fair market value of the assets in it before any remaining basis flows to the next class.¹¹

Class I: cash and general deposit accounts (savings and checking, but not certificates of deposit). Allocated at face value, with AGUB reduced by that amount before anything flows down.
Class II: actively traded personal property, including U.S. government securities, publicly traded stock, certificates of deposit, and foreign currency.
Class III: accounts receivable, most debt instruments, and assets marked to market annually. Certain related-party debt and convertible instruments are excluded.
Class IV: inventory, meaning stock in trade or property held primarily for sale to customers.
Class V: all other tangible and intangible assets — typically furniture, equipment, buildings, land, and vehicles.
Class VI: Section 197 intangibles other than goodwill, including trademarks, trade names, patents, and covenants not to compete.
Class VII: goodwill and going concern value. Whatever AGUB is left after Classes I through VI lands here.

The allocation matters because each class has different tax treatment. Cash and receivables produce no future deductions. Tangible property in Class V is depreciated under MACRS. Section 197 intangibles in Classes VI and VII are amortized over 15 years. The more AGUB that lands in depreciable or amortizable classes, the more the election is worth.¹¹

Consistency Rules

Section 338(e) contains consistency rules meant to stop a buyer from selectively stepping up the basis of some assets while keeping a carryover basis on others. The rules define a consistency period that runs from 12 months before the stock purchase date through 12 months after it. If the buyer acquires an asset directly from the target or a target affiliate during that window, the buyer generally takes a carryover basis in the asset rather than a cost basis, unless a Section 338 election is made for the target. Assets acquired in the ordinary course of business are excepted.¹²

When the Election Makes Economic Sense

The tradeoff is direct. The buyer accepts tax now on the deemed-sale gain in exchange for higher depreciation and amortization deductions later. The election works best when the target’s assets have a low existing basis relative to fair market value, because that gap drives the biggest deduction stream. It works poorly when the assets are already carried near fair market value: little basis to step up, and the upfront tax outweighs the incremental deductions.

In a 338(h)(10) deal, the seller carries the deemed-sale tax cost, since the target recognizes the gain while still inside the selling group. Sellers usually negotiate a higher purchase price to compensate. If the price bump the seller demands exceeds the present value of the buyer’s future deduction benefits, the election does not pencil out. That negotiation is one of the central dynamics of any deal where a 338(h)(10) is on the table.

Asset composition matters too. A target loaded with fully amortized goodwill and other intangibles produces substantial Section 197 amortization over 15 years after a step-up. A target whose value sits mostly in cash and receivables generates almost no incremental deductions, since those assets are allocated at face value. Running the numbers before signing a letter of intent is not optional, because the election can swing the effective purchase price by millions.

State Tax Considerations

Not every state automatically follows a federal Section 338 election. Some conform without a separate filing. Some require a separate state-level election. Others do not conform at all. A corporation can end up with a stepped-up basis for federal purposes and a carryover basis for state income tax in the same year. State conformity rules vary and change, so the specific rules in every state where the target does business belong in the analysis. State tax effects can shift the economics of the election in ways a federal-only view will miss.

1
Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions
2
Internal Revenue Service. 26 CFR 1.338-1 – General Principles; Status of Old Target and New Target
3
Internal Revenue Service. 26 CFR 1.338(h)(10)-1 – Deemed Asset Sale and Liquidation
4
Office of the Law Revision Counsel. 26 U.S. Code 338 – Certain Stock Purchases Treated as Asset Acquisitions
5
Office of the Law Revision Counsel. 26 USC 1504 – Definitions
6
Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions
7
Internal Revenue Service. Instructions for Form 8023 – Elections Under Section 338 for Corporations Making Qualified Stock Purchases
8
Internal Revenue Service. Form 8023 – Elections Under Section 338 for Corporations Making Qualified Stock Purchases
9
eCFR. 26 CFR 301.9100-3 – Other Extensions
10
Internal Revenue Service. Instructions for Form 8883
11
eCFR. 26 CFR 1.338-6 – Allocation of ADSP and AGUB Among Target Assets
12
eCFR. 26 CFR 1.338-8 – Asset and Stock Consistency