A stepped-up basis in M&A resets the tax cost of the target’s assets to what the buyer paid, unlocking depreciation and amortization deductions that the seller’s old, often heavily depreciated, tax books would never have produced. Whether a buyer gets that reset depends on deal structure. A direct asset purchase delivers it automatically. A plain stock purchase does not. In between sit a handful of tax elections that let the parties keep a stock-sale legal structure while producing asset-sale tax treatment: Section 338(h)(10), Section 338(g), and Section 336(e) for corporate targets, and a Section 754 election for partnerships and LLCs taxed as partnerships.
Why the Step-Up Matters
The economic point of a stepped-up basis is the stream of deductions it creates after closing. Tangible assets are recovered under MACRS, with periods running from five years for computers and vehicles to 39 years for commercial buildings.1Internal Revenue Service. Publication 946, How To Depreciate Property A buyer who steps up $10 million of equipment assigned a seven-year life picks up roughly $1.4 million in annual depreciation that would not have existed on a carryover basis.
Intangibles — goodwill, customer lists, trade names, non-competes — are amortized straight-line over 15 years under Section 197.2Internal Revenue Service. Intangibles In most deals, goodwill is the largest single component of the purchase price. Without a step-up, that goodwill produces zero deductions because it never had a tax basis on the target’s books in the first place.
Asset Sale vs. Stock Sale: The Default Result
In a direct asset sale, the buyer purchases individual items — equipment, real estate, inventory, intellectual property — and each asset’s basis is what the buyer paid for it.3Internal Revenue Service. Topic No. 703, Basis of Assets Fully depreciated equipment worth $2 million to the buyer starts life on the buyer’s books at a $2 million depreciable basis. That fresh basis is the entire tax appeal of asset-sale treatment.
A stock sale works the opposite way. The buyer acquires the target’s equity; the target’s assets keep whatever basis they carried before closing. Fully depreciated equipment stays at zero. Internally developed goodwill that never hit the tax books stays invisible. The premium the buyer paid shows up only as basis in the stock, not in the individual assets that generate deductions. The target’s internal books roll forward as if ownership never changed hands.
This mismatch drives the tax negotiation in almost every deal. Sellers usually want stock sales: one level of tax on the shareholder-level gain, often at long-term capital-gains rates. Buyers usually want asset sales for the deductions. The elections below exist to bridge that gap by producing asset-sale tax treatment inside a stock-sale legal wrapper, with no need to retitle property, reassign contracts, or chase third-party consents.
Section 338(h)(10): The Workhorse for Corporate Targets
A Section 338(h)(10) election is the most common way buyers of corporate targets get a stepped-up basis in a stock deal.4Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated as Asset Acquisitions Buyer and seller file jointly. The stock sale is ignored for tax purposes and the transaction is recharacterized as a single deemed asset sale by the target, followed by a deemed liquidation. Only one level of tax applies. The buyer gets the step-up. The seller avoids the double tax that would otherwise crush the economics.
Two eligibility gates. First, the buyer must be a corporation completing a “qualified stock purchase” — at least 80 percent of the target’s voting power and 80 percent of total stock value within a 12-month window. Second, the target must be either an S-corporation or a member of a consolidated group. A freestanding C-corporation target does not qualify for the (h)(10) version.
Because both sides benefit — buyer gets deductions, seller avoids double tax — the tax savings are frequently negotiated into the purchase price. The seller’s concession is that some of the gain will be taxed as ordinary income rather than capital gain, as discussed below.
Section 338(g): The Buyer-Only Election
A 338(g) election is unilateral. The purchasing corporation makes it; the seller doesn’t need to agree. On paper this looks like a clean path to a step-up, but for domestic C-corporation targets the economics almost never work. The selling shareholders still pay tax on their stock gain, and the target is also treated as having sold its assets at fair market value, generating a separate corporate-level tax. That corporate-level bill lands on the buyer, because the buyer now owns the target. Combined rates on the gain can approach or exceed 50 percent.
For that reason, 338(g) is rarely used on domestic targets unless the target has enough net operating losses or other attributes to soak up the deemed gain. Its real home is cross-border acquisitions of foreign target corporations, where the deemed asset sale can produce different — sometimes more favorable — consequences.
Section 336(e): Broader Purchaser Eligibility
Section 336(e) produces deemed-asset-sale treatment similar to 338(h)(10) but reaches situations 338 cannot.5Office of the Law Revision Counsel. 26 USC 336 – Gain or Loss Recognized on Property Distributed in Complete Liquidation Two features matter. The buyer does not have to be a corporation — individuals, partnerships, and private equity funds structured as LLCs can qualify.6eCFR. 26 CFR 1.336-1 – General Principles, Nomenclature, and Definitions for a Section 336(e) Election And the election covers stock distributions like spin-offs, not just sales, which makes it useful in restructurings where no traditional purchaser exists.
The mechanics require a written, binding agreement between the seller (or all S-corporation shareholders) and the target, signed by the due date of the relevant tax return including extensions.7eCFR. 26 CFR 1.336-2 – Availability, Mechanics, and Consequences of a Section 336(e) Election Without that agreement the election is invalid. Like 338(h)(10), it operates on an all-or-nothing basis; parties cannot step up some assets and leave others alone.
What the Seller Gives Up
When the seller agrees to deemed-asset-sale treatment through 338(h)(10) or 336(e), the character of the gain shifts. Any gain attributable to prior depreciation on tangible personal property is recaptured as ordinary income under Section 1245 rather than taxed at long-term capital-gains rates.8Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property If the target had depreciated $5 million of equipment and that equipment is deemed sold at $3 million, the full $3 million is ordinary income. For sellers in the top bracket, the rate difference is significant.
How the purchase price is allocated across asset classes drives how much of the seller’s gain is ordinary versus capital. Value pushed into inventory and equipment tends to produce ordinary income; value in goodwill is generally capital gain. Section 1060 sets up a seven-class residual method, buyers usually want to load value into shorter-lived tangible classes to accelerate deductions, and both parties must report a consistent allocation on Form 8594.9Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions10Internal Revenue Service. Instructions for Form 8594 – Asset Acquisition Statement Under Section 1060 The allocation set in the purchase agreement will be scrutinized on audit, so it is negotiated with real intensity.
Partnership and LLC Targets: Section 754
The 338 and 336(e) elections apply to corporations. When the target is a partnership or an LLC taxed as a partnership, Section 754 is the analog. If a buyer purchases a partnership interest and the partnership has a Section 754 election in effect, Section 743(b) adjusts the inside basis of the partnership’s assets to reflect what the buyer paid for the interest.11Internal Revenue Service. FAQs for Internal Revenue Code (IRC) Sec. 754 Election and Revocation The adjustment is personal to the buying partner; other partners’ shares of asset basis are unchanged.
The adjustment equals the difference between the buyer’s basis in the acquired interest and their proportionate share of the partnership’s existing adjusted basis in its assets.12Office of the Law Revision Counsel. 26 USC 743 – Special Rules Where Section 754 Election or Substantial Built-In Loss Pay $10 million for a 50 percent interest in a partnership whose total asset basis is $6 million, and the buyer’s share of inside basis is $3 million. The 743(b) adjustment adds $7 million to that share, matching the $10 million purchase price. The extra basis produces depreciation and amortization allocated solely to the buyer.
One caveat worth flagging to the partnership before making the election: once made, a 754 election applies to all future transfers of interests and distributions of property, not just the triggering transaction. If a future partner sells at a loss, the same mechanism produces a downward adjustment.
The Anti-Churning Trap on Goodwill
A valid election does not guarantee that every stepped-up intangible can actually be amortized. Section 197’s anti-churning rules block 15-year amortization of goodwill, going-concern value, and certain other intangibles when the transaction involves related parties or fails to produce a genuine change in ownership or use.13Internal Revenue Service. Revenue Ruling 2004-49
The related-party threshold is lower than most: 20 percent, not the 50 percent used elsewhere.14eCFR. 26 CFR 1.197-2 – Amortization of Goodwill and Certain Other Intangibles A buyer who already owns 20 percent of the target, or has a family member or commonly controlled entity that does, may find that the goodwill portion of the purchase price generates no amortization deductions at all after the election. The trap catches private equity roll-over deals and management buyouts where the existing owner keeps a meaningful stake. Model it before signing.
What Happens to the Target’s Existing Tax Attributes
A 338 or 336(e) election wipes the target’s slate clean. Because the target is treated as a new corporation that just bought its own assets, pre-existing net operating loss carryforwards, credit carryforwards, and capital loss carryforwards do not carry over to the buyer. In a 338(h)(10) deal, the selling consolidated group can use the target’s remaining attributes against gain on the deemed asset sale, but whatever is left disappears in the deemed liquidation.
Even a plain stock acquisition — no election, no step-up — that produces an ownership change triggers the Section 382 limitation on the target’s pre-change NOLs. Section 382 caps the annual use of pre-change losses at roughly the target’s equity value multiplied by the long-term tax-exempt rate.15Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change The NOLs survive, but their annual usability is sharply restricted. Buyers counting on target NOLs to shelter post-closing income need to run the 382 numbers before agreeing on price.
Forms and Filing Deadlines
A Section 338 election is made on IRS Form 8023 and must be filed by the 15th day of the ninth month following the month of the acquisition date.16Internal Revenue Service. Instructions for Form 8023 An acquisition closing on March 15 has a December 15 deadline. Miss it and the election is generally forfeited. Late-election relief exists under Treasury Regulations 301.9100-1 through 301.9100-3, but it requires a private letter ruling, a five-figure user fee, months of waiting, and a showing of reasonable good-faith conduct with no prejudice to the government.17eCFR. 26 CFR 301.9100-3 – Other Extensions Calendar the deadline the day the deal closes.
Alongside Form 8023, the parties file Form 8883, the Asset Allocation Statement under Section 338, reporting the Aggregate Deemed Sales Price and the Adjusted Grossed-Up Basis across the seven asset classes.18Internal Revenue Service. Instructions for Form 8883 – Asset Allocation Statement Under Section 338 Both buyer and seller attach the allocation statement and election forms to their timely filed returns for the year of the transaction. A Section 336(e) election has no dedicated form; the written binding agreement between the parties is the election, and each attaches a statement with the required information to their return.
State Conformity Is Not Automatic
A federal 338 or 336(e) election does not automatically carry to state returns. States vary: some conform to the federal election, some require a separate state-level election, and some ignore the federal treatment entirely. A buyer claiming stepped-up depreciation on state returns needs to check conformity in every state where the target operates. A non-conforming state creates a permanent gap between federal and state depreciation schedules that has to be tracked for the life of the assets.