A Section 338 election is a federal tax election that lets a corporate buyer treat its stock purchase of another corporation as if it had bought the target’s assets instead. The practical payoff is a stepped-up tax basis in the target’s assets equal to what the buyer effectively paid, which produces larger depreciation and amortization deductions in the years after closing. The cost is immediate: the target is treated as having sold all of its assets at fair market value and must recognize gain on that deemed sale right away. Whether the election is worth making comes down to whether the present value of those future deductions outweighs the upfront tax bill, and whether the deal structure qualifies for the version of the election that avoids double taxation.
What Has to Happen Before You Can Make the Election
The election is only available after a Qualified Stock Purchase, or QSP. A QSP occurs when one corporation acquires, by purchase, at least 80 percent of the voting power and at least 80 percent of the total value of the target’s stock within a 12-month period.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions The 80 percent threshold comes from the affiliated-group ownership test in Section 1504(a)(2).2Office of the Law Revision Counsel. 26 USC 1504 – Definitions
Three details matter for whether a deal clears the hurdle. First, the 12-month clock starts the day the buyer first acquires stock that counts toward the QSP, and every share contributing to the 80 percent must land inside that window. Second, certain nonvoting preferred stock, the kind that pays a fixed dividend, doesn’t participate in corporate growth, has capped redemption and liquidation rights, and isn’t convertible, is excluded from the calculation entirely.2Office of the Law Revision Counsel. 26 USC 1504 – Definitions Third, the shares must be acquired by “purchase” as the statute defines it. Stock picked up through tax-free exchanges, tax-free reorganizations, or transactions with related parties under constructive ownership rules doesn’t count toward the 80 percent.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
Clearing the QSP is a prerequisite. It doesn’t make the election happen on its own. The buyer, or the buyer and seller together depending on which version applies, still has to opt in by filing.
What the Election Actually Does
Once made, the election creates a legal fiction with two sides. The “old target” is treated as having sold all of its assets to a brand-new entity, the “new target,” at the close of the acquisition date. No assets actually change hands. But the old target has to recognize gain or loss on the deemed sale just as if they had.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
The deemed sale price is roughly the grossed-up amount the buyer paid for the stock, plus the target’s liabilities. Gain is then calculated asset by asset, with the character of the gain tracking the type of asset. Inventory produces ordinary income. Long-held capital assets produce capital gain. Depreciable property is subject to recapture under Sections 1245 and 1250, which recharacterizes some or all of the gain as ordinary income to the extent the target previously claimed depreciation.3Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets At the flat 21 percent federal corporate rate, a target with heavily depreciated assets and significant built-in gains can face a large bill the moment the election is made.
The other side of the fiction is the payoff. The new target is deemed to have purchased the assets at a total price called the Adjusted Grossed-Up Basis, or AGUB. The AGUB starts with the grossed-up basis of the buyer’s recently purchased stock, adds basis in any stock the buyer already held, and adds the target’s liabilities, including any tax liability from the deemed sale itself.4eCFR. 26 CFR 1.338-5 – Adjusted Grossed-Up Basis That total is then allocated across the target’s assets using the residual method, which fills seven asset classes in sequence and dumps whatever is left over into goodwill and going concern value.5eCFR. 26 CFR 1.338-6 – Allocation of ADSP and AGUB Among Target Assets
In most acquisitions, that residual bucket is where the real tax benefit sits. A buyer who pays a premium over the fair market value of the target’s identifiable assets ends up with that premium parked in goodwill, amortizable over 15 years under Section 197.6Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles A straight stock purchase without the election produces no amortization deduction for that premium at all, because stock purchases don’t create amortizable goodwill on the buyer’s books. For many deals, that single line of Section 197 amortization is the main reason the election exists.
What the Buyer Gives Up
Because the old target is treated as ceasing to exist, its tax attributes don’t carry over. Net operating losses, unused credits, and other carryovers that belonged to the old target are gone. The new target starts fresh: new asset basis, new depreciation schedules, no inherited losses. A buyer counting on the target’s NOLs to shelter future income needs to weigh that loss against the step-up benefit. If the NOLs are large enough, a plain stock purchase without the election is the better outcome.
The Two Versions: 338(g) and 338(h)(10)
Section 338 comes in two forms, and the choice between them usually determines whether making the election is economically sensible.
338(g): Available Everywhere, Taxed Twice
A 338(g) election can be made on any QSP regardless of how the seller is organized, and it is made by the buyer alone. The problem is double taxation. The old target recognizes gain on the deemed asset sale and pays corporate tax on it. Separately, the selling shareholders recognize gain on the actual stock sale and pay tax on that. Two layers of tax on one economic transaction make 338(g) a losing proposition in most domestic deals unless the target has enough NOLs or built-in losses to absorb the deemed-sale gain.
Where 338(g) is routinely useful is in cross-border acquisitions. When a U.S. corporation buys stock in a foreign subsidiary, the deemed-sale gain recognized by the foreign target may not be subject to U.S. corporate tax, or the international tax rules may make the cost manageable. That removes or shrinks the double-tax problem, which is why 338(g) elections show up far more often in acquisitions of controlled foreign corporations than in purely domestic deals.
338(h)(10): Single Tax, Limited Eligibility
The 338(h)(10) election solves the double-tax problem, but only certain targets qualify. The target must be a member of a consolidated group, a member of an affiliated group filing separate returns, or an S corporation.1Office of the Law Revision Counsel. 26 USC 338 – Certain Stock Purchases Treated As Asset Acquisitions
Under (h)(10), the stock sale is disregarded for tax purposes. The selling group is treated as if the target sold its assets and then liquidated. The seller recognizes gain or loss only on the deemed asset sale, and the gain or loss that the actual stock sale would have produced is ignored. For a consolidated group, the deemed-sale gain flows up to the parent’s consolidated return. For an S corporation target, it passes through to the shareholders’ individual returns.
The result is one level of tax. The buyer gets its stepped-up basis, and the seller avoids a second layer on the stock sale. Because both sides benefit, the (h)(10) election is often reflected in a higher purchase price: the buyer pays more because future deductions are larger, and the seller demands more because asset-sale treatment may produce more ordinary-income character than a plain stock sale would.
Procedurally, (h)(10) is a joint election. Both buyer and seller must sign and file. Neither side can trigger it unilaterally, which forces the tax treatment into the deal negotiation rather than leaving it as something the buyer decides after closing.
When the Election Makes Sense
A Section 338 election is worth considering when four conditions line up. The deal is a QSP. The target has significant value in goodwill or in assets whose fair market value sits well above their current tax basis, so the step-up produces meaningful future deductions. The target doesn’t have large NOLs or credits that the buyer wants to preserve. And either the deal qualifies for (h)(10) (consolidated subsidiary or S corporation target) or the target is a foreign corporation where the (g) version’s double-tax issue doesn’t bite.
In a domestic acquisition of a freestanding C corporation with no (h)(10) eligibility, a 338 election is usually a bad idea. The double tax under (g) wipes out the benefit of the step-up in all but unusual fact patterns.
How the Election Gets Filed
The election is made on IRS Form 8023.7Internal Revenue Service. About Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases For a 338(g) election, the buyer files on its own. For a 338(h)(10) election, the buyer and the selling consolidated group or S corporation shareholders jointly sign and file.
The deadline is firm: Form 8023 must be filed by the 15th day of the 9th month after the acquisition date.8Internal Revenue Service. Instructions for Form 8023 Miss it and the election is lost unless the IRS grants late-election relief, which requires reasonable cause and isn’t guaranteed.
Filing Form 8023 is only the first step. Both the old target and the new target must also file Form 8883, the Asset Allocation Statement, to report how the deemed sale price was divided among the seven asset classes.9Internal Revenue Service. Instructions for Form 8883 – Asset Allocation Statement Under Section 338 Each party attaches Form 8883 to the relevant return: for the old target, the selling group’s consolidated return, the S corporation’s Form 1120-S, or the standalone deemed-sale return under 338(g); for the new target, its first return after the acquisition date. If a post-closing purchase price adjustment changes the allocation, an updated Form 8883 is required for the year the change is accounted for. The IRS uses the buyer’s and seller’s Forms 8883 to cross-check consistency, and a mismatch is a reliable audit trigger.
If the Deal Doesn’t Qualify: Section 336(e)
Not every stock sale that could benefit from asset-sale treatment is eligible for a Section 338 election. Section 338 requires the buyer to be a single corporation. If the buyer is an individual, a partnership, an LLC, a trust, or several buyers in combination, Section 338 is unavailable.
Section 336(e) covers some of that gap. It uses a similar deemed-sale mechanism but doesn’t require a corporate buyer, and it also reaches certain tax-free dispositions beyond ordinary purchases. The seller must be a domestic corporation or consolidated group disposing of at least 80 percent of a domestic subsidiary’s stock, and dispositions to related parties don’t count toward the threshold. One hard rule: if a transaction qualifies for both a 338(h)(10) election and a 336(e) election, the (h)(10) election takes precedence and 336(e) is off the table.