Understanding the 338(h)(10) Election: When a Stock Sale Becomes an Asset Sale
- Langston Tolbert
- Jan 17
- 4 min read
In mergers and acquisitions, the difference between a stock sale and an asset sale can have a profound effect on tax outcomes for both buyers and sellers. Typically, buying stock allows the buyer to continue the target business without reassigning contracts or licenses, while buying assets may offer a step-up in basis that can lead to valuable tax deductions. However, there’s a strategic solution that combines the best of both worlds: the 338(h)(10) election.
Below is an overview of how it works, who benefits most, and what to watch out for. Here is what to expect in this article:
What Is a 338(h)(10) Election?
A 338(h)(10) election allows a buyer and seller to treat the purchase of a corporation’s stock as though it were an asset purchase for tax purposes. Legally, the buyer is purchasing stock, meaning the target company remains intact as a legal entity—contracts, licenses, and permits usually transfer over without extensive reauthorization.
Yet for federal income tax calculations, the transaction is deemed an asset sale. This means the buyer can “step up” the tax basis of the target’s assets to their fair market value, which can lead to larger depreciation and amortization deductions in the future.
When to Consider a 338(h)(10) Election
Target Is an S Corporation or Subsidiary of a C Corporation
The election is most commonly used when the seller is an S corporation (often a small to mid-sized private business). It can also be used if the target is a subsidiary member of an affiliated group.
Buyer Desires a Stepped-Up Basis
If the buyer wants the tax advantages of writing up asset values to fair market value, a 338(h)(10) election can be a game-changer.
Minimal Liabilities
Because the legal entity remains intact, the buyer inherits all known (and sometimes unknown) liabilities. If the target has extensive liabilities, the buyer may still prefer a pure asset purchase.
Joint Agreement
The buyer and seller must jointly elect 338(h)(10). Both parties need to see value in this structure for it to work.
How the Election Works
Stock Purchase
The buyer acquires at least 80% of the target company’s voting and value shares in a qualified stock purchase.
Deemed Asset Sale
For tax purposes, the target is treated as though it sold all its assets at fair market value to a hypothetical “new” corporation.
Step-Up in Basis
The buyer can step up the basis of the target’s assets to the purchase price, potentially leading to significant depreciation and amortization benefits over time.
Tax Liability for the Seller
The deemed asset sale may leave the seller with a higher tax bill, particularly if some assets (like inventory or equipment) generate ordinary income rather than capital gains. Negotiations often factor in this cost, potentially increasing the purchase price to compensate the seller.
Benefits for Buyers
Stepped-Up Basis
A higher basis in tangible and intangible assets means larger future depreciation and amortization deductions. This can reduce taxable income and enhance cash flow in the early years post-acquisition.
Legal Continuity
Since it’s legally a stock purchase, the buyer generally avoids the hassle of reassigning contracts or licenses. The target company continues under the same entity, simplifying operational transitions.
Attractive for Certain Acquisitions
If the target business is an S corporation or a wholly owned subsidiary, this election often yields a cleaner route for favorable tax treatment while retaining corporate continuity.
Considerations for Sellers
Potentially Higher Tax Liability
Recharacterizing the sale as an asset sale can increase the seller’s tax burden, especially if ordinary income assets like inventory or depreciation recapture are significant. Sellers often seek a higher purchase price to offset these costs.
Pass-Through Entities
In the case of S corporations, the sale proceeds and asset-level gains flow through to individual owners. Sellers must assess how the deemed asset sale affects their personal returns.
Joint Election Requirement
A 338(h)(10) election can only happen if both parties agree, which means negotiation is key. Sellers may refuse if they believe the tax costs outweigh any price premium offered by the buyer.
Common Pitfalls
Not Meeting the 80% Threshold
The buyer must acquire at least 80% of the target’s vote and value in a qualified stock purchase for the election to be valid.
Overlooking State Tax Impact
Some states follow federal rules closely, while others do not. Mismatched state laws can lead to surprises if not addressed early.
Underestimating Liabilities
Because it remains a stock sale legally, the buyer inherits the target’s liabilities. Proper due diligence is essential to ensure there are no hidden exposures.
Inadequate Price Negotiations
The seller’s higher tax bill may prompt them to ask for more compensation. If the buyer does not sufficiently account for this in the purchase price, negotiations can fail or lead to post-closing disputes.
Example Scenario
Target: An S corporation with valuable manufacturing equipment that has depreciated significantly.
Buyer’s Goal: Maximize future depreciation deductions to minimize taxable income after the purchase.
Seller’s Concern: Recast as an asset sale, the equipment sale portion might be taxed at ordinary income rates due to depreciation recapture.
Negotiated Outcome: The buyer agrees to a higher overall purchase price to compensate for the seller’s increased tax burden. Both parties jointly elect 338(h)(10). The buyer gains substantial step-up benefits; the seller accepts a one-time higher tax bill but is compensated through a larger upfront payment.
Final Thoughts
A 338(h)(10) election can bridge the gap between a stock deal and an asset deal, offering a stepped-up basis without losing the legal continuity of a stock purchase. But the election’s benefits hinge on careful negotiation and a clear understanding of both parties’ tax positions.
For buyers, it’s often a win if you want the advantages of an asset sale—like depreciation write-ups—while avoiding the administrative hurdles of reassigning contracts and permits. For sellers, it can mean a bigger tax bite, so expect to negotiate accordingly.
Ultimately, whether a 338(h)(10) election is right for your deal depends on the specific tax profiles, business structure, and negotiation dynamics between buyer and seller. When approached with proper foresight and expert guidance, it can be a powerful tool to optimize the overall economics of a transaction.
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