IRC 338 Deemed Asset Sale: 338(g), 338(h)(10), Section 336(e), and OBBBA QPP Bonus Depreciation in M&A

IRC 338 allows a purchasing corporation that acquires at least 80% of a target's stock in a qualified stock purchase (QSP) to elect to treat that stock acquisition as a deemed asset purchase for federal income tax purposes. The election steps up old target's asset bases to fair market value, producing future depreciation and amortization deductions that can significantly reduce the combined entity's post-acquisition tax burden. In the post-OBBBA environment, where Congress permanently restored 100% first-year expensing on Qualified Production Property (QPP), the value of a stepped-up tangible asset base under a Section 338(h)(10) or Section 336(e) election has grown substantially: rather than waiting years to recover the step-up through depreciation, new target can deduct the full fair market value of tangible QPP in the year of the deemed purchase. That immediate deduction, weighed against the cost to the seller of agreeing to the election (and the loss of the target's pre-acquisition NOL carryforwards), is one of the most consequential M&A tax decisions in the current market environment.

This guide is a companion to the IRC 382 NOL limitation ownership change practitioner guide on this site, which covers the annual Section 382 limitation formula, NUBIG and NUBIL built-in gain rules, and the planning tension between preserving Section 382-limited NOLs in a stock purchase versus electing a 338(h)(10) step-up.

This guide is informational and does not constitute tax advice for any specific client situation. All IRC citations, regulatory references, and planning strategies should be verified against current law, enacted OBBBA, and IRS.gov guidance before application in practice. The mechanics of IRC 338, Section 336(e), and the ADSP computation are technical; engage qualified M&A tax counsel before structuring any acquisition that may involve these elections.

Section 1: The Qualified Stock Purchase (QSP) -- When Is Section 338 Available?

The threshold requirement for any IRC 338 election is that P has made a "qualified stock purchase" of T. If no QSP exists, no election is available, regardless of the parties' intent or the transaction's economic substance. Practitioners must verify each element of the QSP definition before advising a buyer to plan around a 338 election.

The IRC 338(d)(3) QSP definition: four requirements

Under IRC 338(d)(3), a qualified stock purchase is a transaction (or series of transactions) in which one or more purchasing corporations acquire stock of a domestic target corporation that meets ALL of the following conditions:

• 80% of both voting power and total value: P must acquire at least 80% of the total voting power of T's stock AND at least 80% of the total value of T's stock. Meeting only one threshold is insufficient. The 80% test applies to both dimensions simultaneously.
• 12-month acquisition period: the stock must be acquired within a 12-month acquisition period. The acquisition date (and thus the deemed sale date under any 338 election) is the first day on which P has made a QSP, i.e., the first day on which P's accumulated acquisitions satisfy both the 80% vote and 80% value tests within the 12-month window. IRC 338(d)(3).
• Acquiring corporation only: P must be a corporation. Individuals, partnerships, trusts, and other non-corporate entities cannot make a QSP and therefore cannot make a Section 338 election. (Section 336(e) fills this gap for certain non-corporate buyer situations; see Section 2 below.)
• Acquisition by "purchase": the acquisition must constitute a "purchase" within the meaning of IRC 338(h)(3). Not all stock acquisitions qualify. See below.

Practitioners should verify each element against IRC 338(d)(3) and Treas. Reg. 1.338-3, which provide the operational rules governing the QSP determination, including the rules for combining stock held by members of an affiliated group.

The "purchase" requirement under IRC 338(h)(3)

IRC 338(h)(3) defines "purchase" for QSP purposes. The definition is intentionally narrow: Congress wanted Section 338 available only for arm's-length, cost-basis acquisitions, not as a back-door mechanism for generating step-ups in transactions that are already tax-favored. The following do NOT qualify as a "purchase" under IRC 338(h)(3):

• Acquisitions from related parties: acquisitions from persons who are 5-percent shareholders of P within the 5-year period before the acquisition generally do not qualify. The related-party rules under IRC 338(h)(3) are designed to prevent manufactured cost-basis acquisitions between commonly controlled entities.
• Carryover-basis acquisitions: acquisitions in which the buyer takes a carryover basis in T's stock (rather than a cost basis) do not qualify. A carryover-basis acquisition typically occurs in certain corporate reorganizations where no gain is recognized.
• Certain tax-free reorganizations: acquisitions made as part of a tax-free reorganization under IRC 368 (a "B" reorganization, for example, involves a stock-for-stock exchange and produces a carryover basis) do not constitute purchases. Where a transaction could be characterized as both a reorganization and a QSP, the reorganization characterization generally prevails and prevents the QSP election. Consult the applicable reorganization provisions under IRC 368 directly; an IRC 368 reorganization guide is not currently available on this site.

Hedge all "purchase" determination details to IRC 338(h)(3) and Treas. Reg. 1.338-3(b). The interaction between reorganization provisions and the QSP definition is complex and fact-specific.

Affiliated group aggregation

When P is a member of an affiliated group, all members of the group may combine their stock acquisitions in determining whether a QSP has occurred. If Parent acquires 50% of T and a wholly owned subsidiary of Parent acquires 35% of T within the same 12-month window, the group is treated as having made a QSP of 85% of T. The affiliated group rules for QSP purposes are set forth in Treas. Reg. 1.338-3 and must be applied carefully in multi-buyer or step-acquisition structures.

Election filing deadline

The Section 338 election (and the joint Section 338(h)(10) election) must be filed by the 15th day of the 9th month beginning after the month that includes the acquisition date, subject to applicable extension rules. The election is irrevocable once filed. Hedge the exact due date mechanics, the applicable forms, and any extension procedures to Treas. Reg. 1.338-2 and current IRS.gov guidance, as the procedural requirements and form instructions may be updated. Missing the election deadline permanently eliminates the Section 338 step-up opportunity for that acquisition.

Section 2: IRC 338(g) vs. 338(h)(10) -- Choosing the Right Structure

Once a QSP is confirmed, the buyer faces a structural choice: make no election (stock purchase, no step-up), make the IRC 338(g) unilateral election, or (where available) make the IRC 338(h)(10) joint election. Each path produces materially different federal income tax consequences for both buyer and seller. In transactions where the buyer is non-corporate or the seller is an S-corp parent without a consolidated group, Section 336(e) offers an analogous deemed asset sale election. Getting this decision right before closing is irreversible; the wrong choice cannot be undone after the acquisition date.

IRC 338(g): the unilateral election

Under IRC 338(a) and (g), if a QSP occurs and P makes the unilateral IRC 338(g) election (without the target shareholders' consent), the following deemed transactions are treated as occurring immediately before the acquisition date:

• Old T is treated as having sold ALL of its assets to an unrelated party at the Aggregate Deemed Sale Price (ADSP), recognizing gain or loss on each asset. Old T then liquidates. Tax on this deemed sale falls on old T, which is now owned by P, meaning P indirectly bears the tax through its ownership of old T.
• New T is treated as a new corporation that purchased all of old T's assets from an unrelated party at the ADSP on the day after the acquisition date, giving new T a stepped-up basis in those assets equal to the ADSP allocated to each class.
• Critically: the selling shareholders' STOCK SALE GAIN is ALSO recognized separately. The seller reports gain on the stock sale (typically capital gain) AND old T pays tax on the deemed asset sale. This creates potential economic double taxation, making the 338(g) election unattractive unless specific circumstances justify it.

The primary scenario where IRC 338(g) makes economic sense is when old T holds large pre-acquisition NOL carryforwards that can shelter most or all of the deemed asset sale gain, while the step-up in asset bases generates significant future deductions (now including OBBBA QPP immediate expensing) that outweigh the double-tax cost. This analysis requires careful modeling. Hedge all IRC 338(g) mechanics to IRC 338(a) and (g) and Treas. Reg. 1.338-1 through 1.338-5.

IRC 338(h)(10): the joint election (preferred structure for most deals)

IRC 338(h)(10) is a joint election that modifies the 338(g) outcome in one critical respect: the stock-level gain at the shareholder or parent level is NOT separately recognized. The deemed asset sale under old T is the only taxable event. The total federal income tax consequence is equivalent to what would have been paid had T actually sold its assets directly. This eliminates the double taxation inherent in a pure IRC 338(g) election and is why practitioners prefer IRC 338(h)(10) in most negotiated M&A transactions.

IRC 338(h)(10) is available in two situations:

• Consolidated subsidiary target: T must be a member of a consolidated group immediately before the acquisition. The joint election is made by P AND the common parent of T's selling consolidated group. The selling group parent reports no separate gain on the stock sale; old T's deemed asset sale gain flows through the consolidated group's return. Cite Treas. Reg. 1.338(h)(10)-1 for the consolidated return mechanics.
• S-corporation target: T is an S-corporation, and the joint election is made by P AND ALL of T's S-corp shareholders (every shareholder must consent). In the S-corp context, the deemed asset sale gain flows through to T's shareholders on their individual returns (at S-corp pass-through rates), and no separate stock sale gain is recognized. See the IRC 1374 built-in gains tax guide for background on S-corp built-in gains tax mechanics that may interact with a 338(h)(10) election on an S-corp target that was previously a C-corp.

Sellers in 338(h)(10) transactions typically demand a "gross-up" in purchase price to compensate for paying asset-level ordinary income tax (on items such as recaptured depreciation) rather than capital gain on a stock sale. This gross-up negotiation is a standard deal point; the buyer and seller must model the tax cost to each party to determine whether the step-up benefit (primarily through OBBBA QPP expensing and future depreciation) justifies the seller's tax acceleration. Hedge all IRC 338(h)(10) mechanics to IRC 338(h)(10) and Treas. Reg. 1.338(h)(10)-1.

Section 336(e): the non-corporate buyer alternative

IRC 338 requires that P be a corporation. Private equity funds structured as partnerships, individual buyers, and other non-corporate acquirers cannot make a QSP and therefore cannot access the IRC 338 elections. Section 336(e) fills this gap. Treasury issued regulations under Section 336(e) (Treas. Reg. 1.336-1 through 1.336-5) that create a deemed asset sale election with results similar to IRC 338(h)(10), available in the following situations:

• Corporate seller, any buyer: a domestic corporation (S) disposes of 80% or more of the stock of a domestic subsidiary (T) to persons who are NOT members of S's consolidated group; the buyer can be any person, corporate or non-corporate.
• S-corp and shareholders, any buyer: an S-corporation and its shareholders dispose of 80% or more of T's stock to any person.

A key procedural distinction: unlike IRC 338, the Section 336(e) election is made by the SELLER (not the buyer). In the S-corp context, the election must be made jointly by the S-corp and all shareholders. The buyer has no unilateral ability to force a Section 336(e) election. As with IRC 338(h)(10), the election is irrevocable once made. State conformity to Section 336(e) varies and must be analyzed separately for each state in which T operates. Hedge all Section 336(e) mechanics to Treas. Reg. 1.336-1 through 1.336-5 and current IRS.gov guidance.

Section 3: ADSP Calculation and the IRC 1060 Asset Class Allocation

When a Section 338(g) or 338(h)(10) election is made, old T is treated as selling all its assets at the Aggregate Deemed Sale Price (ADSP). New T acquires those same assets at a corresponding basis (the Adjusted Grossed-Up Basis, or AGUB). The ADSP and AGUB must then be allocated among T's assets in a specific priority order, because different asset classes have dramatically different tax treatment: tangible personal property now qualifies for OBBBA 100% QPP expensing, while goodwill amortizes over 15 years. Getting the allocation right (and supporting it with proper valuation documentation) determines the actual tax value of the election.

ADSP formula mechanics

The ADSP is (approximately) the grossed-up amount realized on the recently purchased T stock plus T's liabilities (assumed or taken subject to by new T). The "grossing-up" formula divides the purchase price paid for the recently purchased stock by the percentage of T's stock that was recently purchased, effectively computing a 100% implied equity value for T. This grossed-up equity value, plus T's assumed liabilities, produces the ADSP.

The mechanics of the ADSP computation are technical. The Treasury regulations under Treas. Reg. 1.338-4 address in detail: what constitutes the "amount realized" on the recently purchased stock, which liabilities are included, the treatment of contingent liabilities, and the interaction with installment sale obligations. Practitioners must apply the ADSP computation directly from Treas. Reg. 1.338-4 and should not rely on simplified approximations. The AGUB (the basis new T takes in old T's assets) is computed under a parallel formula in Treas. Reg. 1.338-5.

The IRC 1060 seven-class asset allocation

Once the ADSP is computed, it must be allocated among T's deemed-sold assets in the priority order prescribed by Treas. Reg. 1.338-6 (which incorporates the IRC 1060 framework used in actual asset purchase allocations and reported on Form 8594). The seven classes, allocated in order from Class I through Class VII, are:

The Class VII "residual" rule means that any ADSP not absorbed by Classes I through VI is allocated to goodwill and going-concern value. In transactions where the purchase price exceeds the fair market value of all identified assets, the excess flows into Class VII -- where it will amortize over 15 years with no ability to accelerate the deduction under OBBBA. This dynamic heavily penalizes goodwill-heavy deals relative to tangible-asset-heavy deals from a bonus depreciation standpoint.

Allocation mechanics, the treatment of contingent liabilities, and the consistency requirement between old T and new T's allocations must be applied under Treas. Reg. 1.338-6. The transaction must also be reported on the applicable Section 338 election forms and, where applicable, on Form 8594 (Asset Acquisition Statement Under Section 1060). Hedge all reporting requirements to current IRS form instructions. The Section 197 intangible amortization rules referenced in Classes VI and VII -- including the definition of a Section 197 intangible -- are not currently covered in a dedicated guide on this site; consult IRC 197 and the applicable Treasury regulations directly.

Valuation support and IRS scrutiny

Buyers have a strong economic incentive to allocate as much ADSP as possible to Class V tangible QPP (immediate deduction under OBBBA) and as little as possible to Class VII goodwill (15-year amortization). The IRS is aware of this incentive and scrutinizes 338 election allocations, particularly when the Class V allocation appears high relative to the fair market value of T's tangible personal property. Buyers must support their allocation with qualified appraisals and valuation work consistent with applicable valuation standards and Treas. Reg. 1.338-6. An aggressive Class V allocation without adequate substantiation is a significant audit risk.

Section 4: OBBBA QPP and the Immediate Deduction Opportunity

The passage of OBBBA fundamentally changed the economics of the IRC 338(h)(10) election for asset-heavy targets. Under prior law, even after stepping up T's asset bases, the buyer had to wait years to recover the step-up through depreciation (MACRS recovery periods of 5, 7, 15, or 39 years depending on asset class). Under OBBBA, new T can elect to deduct 100% of the stepped-up basis in Qualified Production Property (QPP) in the year of the deemed purchase, creating an immediate first-year deduction equal to the fair market value of the QPP. For a manufacturer, restaurant chain, or equipment-intensive business, this can generate hundreds of millions of dollars in current-year deductions that shelter post-acquisition taxable income or create loss carryforwards.

What qualifies as QPP under OBBBA

QPP under OBBBA is tangible depreciable personal property placed in service in the United States after January 20, 2025. For IRC 338 purposes, new T is treated as placing the deemed-purchased QPP in service on the acquisition date (the date of the deemed purchase). The QPP category maps to Class V assets in the ADSP allocation: machinery, equipment, fixtures, vehicles, computers, and similar tangible personal property used in T's business that is depreciable under MACRS and not permanently affixed as real property (which would be Class V but not QPP, as real property is not QPP under the statute).

Important limitations on the QPP immediate deduction:

• IRC 197 intangibles are NOT QPP: goodwill (Class VII), going-concern value (Class VII), customer lists, trade names, patents, franchises, covenants not to compete, and other Section 197 intangibles (Class VI) are NOT tangible personal property and do NOT qualify for OBBBA QPP expensing. They amortize ratably over 15 years under IRC 197(a). In a deal where 70% of the ADSP allocates to goodwill and customer relationships (typical in professional service, technology, and brand-heavy consumer companies), the OBBBA QPP benefit is limited to the relatively small Class V tangible component.
• Land is NOT depreciable: land included in Class V does not qualify for depreciation or bonus depreciation of any kind. Only the depreciable improvements and equipment on the land qualify.
• Real property improvements (buildings, structural components) are generally NOT QPP: MACRS real property (39-year non-residential or 27.5-year residential) is generally not included in QPP under OBBBA. The classification of specific assets as personal property versus real property can be complex and fact-specific; cost segregation analysis may increase the Class V QPP component (see the IRC 1245/1250 depreciation recapture and cost segregation guide for the real property versus personal property distinction and recapture mechanics).
• OBBBA final regulations not yet issued: as of the date of this guide, IRS has not issued final regulations implementing all aspects of OBBBA's QPP provisions. Practitioners must monitor IRS.gov for final regulations, guidance, and any transition rules. Hedge all OBBBA QPP mechanics to enacted OBBBA and current IRS.gov guidance.

Modeling the QPP benefit: the time-value comparison

The economic value of the OBBBA QPP step-up comes from the time value of money: a current-year deduction equal to the full fair market value of the QPP is worth far more than the same deduction spread over 5 or 7 years of MACRS recovery (as would have been the case under pre-OBBBA law). For the Class VII goodwill allocation, a 15-year straight-line amortization of the stepped-up goodwill value produces deductions of approximately one-fifteenth of the allocation per year -- a much slower recovery. The wider the gap between a target's QPP and its goodwill allocation, the more the 338(h)(10) election benefits the buyer's after-tax economics.

For planning purposes: a buyer acquiring a business with significant tangible personal property should model the after-tax NPV of (a) 100% immediate QPP expensing plus 15-year goodwill amortization versus (b) inheriting pre-acquisition NOLs subject to the Section 382 annual limitation, versus (c) a straight stock purchase with no step-up and no NOLs. This three-way comparison, run at the buyer's applicable tax rate and discount rate, determines which structure produces the best outcome for the buyer. Hedge all tax rate and NPV assumptions to current law and IRS.gov; do not use specific tax rate figures without verifying against current enacted law.

The goodwill trap in service businesses

In acquisitions of professional service firms, technology companies, and brand-heavy consumer businesses, a large proportion of the purchase price typically allocates to goodwill, customer relationships, non-compete covenants, and trade names -- all Section 197 intangibles in Class VI or Class VII. These assets receive no OBBBA acceleration. The 338(h)(10) election in these deals produces limited immediate tax benefit to the buyer (primarily from the goodwill's 15-year amortization, which is also available in an actual asset purchase), while the seller may bear meaningful additional tax cost relative to a stock sale (ordinary income rate on recaptured depreciation rather than capital gain on stock). In these situations, the seller typically demands a substantial gross-up in purchase price to compensate for agreeing to the election, and the buyer must evaluate whether the present value of the incremental deductions (mostly 15-year amortization) justifies the gross-up cost. For pure-goodwill businesses, the 338(h)(10) election is often economically neutral at best and negative at worst.

Section 5: Section 382 vs. 338(h)(10) -- The NOL Trade-Off

The most consequential structural decision in acquisitions of loss companies is the NOL trade-off: a plain stock purchase preserves T's pre-acquisition NOL carryforwards but subjects them to the Section 382 annual limitation, while a Section 338(h)(10) election eliminates those NOLs (they are used up or lost at old T in the deemed sale) but generates a full asset step-up with immediate OBBBA QPP expensing. Neither choice is universally superior; the right answer depends entirely on the specific facts of the target and the deal. See the IRC 382 NOL limitation ownership change practitioner guide for a detailed treatment of the Section 382 annual limitation formula, NUBIG and NUBIL built-in gain rules, and the ownership change testing mechanics.

What happens to NOLs under each path

Under a plain stock purchase (no 338 election): T's pre-acquisition NOL carryforwards survive the acquisition and become available to new T (the same corporation, just with a new owner). However, P's acquisition of T's stock is an ownership change under IRC 382(g), triggering the annual Section 382 limitation. The maximum amount of pre-change NOLs that new T can use in any post-acquisition year is T's FMV (immediately before the ownership change) multiplied by the long-term tax-exempt rate (LTTER) published monthly by the IRS. The LTTER changes monthly; always consult the current IRS.gov Revenue Ruling for the applicable rate. Do not apply a specific LTTER percentage stated in any guide or article without verifying it reflects the current month's IRS.gov publication.

Under a 338(h)(10) election: old T uses its pre-acquisition NOL carryforwards to offset the deemed asset sale gain to the extent available. Any remaining pre-acquisition NOLs that are not used against the deemed sale gain are eliminated entirely; they do NOT carry over to new T. New T starts fresh with zero tax attributes, zero NOL carryforwards, and no Section 382 limitation -- but also no historical attributes of any kind. The step-up to FMV in T's assets (and the resulting OBBBA QPP expensing) is new T's primary tax benefit.

When the 338(h)(10) election wins

The 338(h)(10) election tends to produce a better outcome for the buyer when:

• T holds significant tangible QPP; the OBBBA 100% expensing generates immediate deductions that shelter new T's post-acquisition income or create carryforward losses with near-term utilization value.
• T's pre-acquisition NOLs are large in face amount but have a LOW Section 382 annual utilization limit (because T's FMV is low relative to its NOL balance, or because the LTTER is low), meaning the NOLs would take many years to fully absorb even if T is profitable post-acquisition.
• The discounted present value of the Section 382-limited NOL stream (over many years, discounted at the buyer's cost of capital) is less than the discounted present value of the immediate OBBBA QPP deduction and the long-term goodwill amortization from the step-up.
• The seller can be compensated for the asset-sale tax cost through a gross-up in the purchase price without eliminating the buyer's economic advantage from the election.

When the Section 382 stock purchase wins

The plain stock purchase with Section 382 NOL inheritance tends to be superior when:

• T's pre-acquisition NOLs are large AND the Section 382 annual limit is HIGH (because T's FMV is high or the LTTER is high), allowing rapid utilization of the NOLs against new T's strong projected taxable income.
• T holds a net unrealized built-in gain (NUBIG) that increases the effective Section 382 annual limit under IRC 382(h)(1)(A) during the 5-year recognition period, allowing even faster NOL absorption than the base formula.
• T's tangible personal property is a small share of the purchase price (e.g., a service business or software company), so the OBBBA QPP benefit in a 338(h)(10) deal would be minimal while the goodwill amortization over 15 years provides only modest acceleration relative to the NOL inheritance option.
• The seller refuses to consent to a 338(h)(10) election (or demands a gross-up that eliminates the buyer's advantage), making the stock purchase the only available path.

Hybrid and partial structures

In some transactions, practitioners explore partial or hybrid structures -- for example, structuring a transaction so that T directly sells specific highly appreciated tangible assets to P (generating a step-up on those assets and OBBBA expensing) while T's stock is purchased separately (preserving the remaining NOLs in the surviving entity). These structures are complex, require careful analysis of the consistency rules under IRC 338(f) (see Section 6), and require experienced M&A tax counsel. Any structure that attempts to cherry-pick the step-up benefit on specific assets while preserving NOLs in the surviving corporate entity may be subject to IRS scrutiny under the step-transaction doctrine or the substance-over-form principles.

The Section 382 and NOL comparison must always be run at the specific facts of the deal: T's exact NOL balance, the Section 382 annual limit computed at the acquisition-date FMV and current LTTER, T's projected taxable income trajectory, the QPP content of T's assets, and the discount rate. The comparison should use current enacted law; hedge all tax rates, LTTER, and discount rate assumptions to current IRS.gov and applicable authority rather than to estimates or averages stated in secondary sources.

Section 6: State Tax and Practical Considerations

State tax conformity: the hidden variable

A Section 338(h)(10) election that produces a massive first-year deduction for federal income tax purposes may produce zero deduction for state income tax purposes if the state where T operates does not conform to the federal election. Many states -- including several large-population states where corporate targets frequently operate -- do not recognize the IRC 338(g) or 338(h)(10) election. In a non-conforming state, the transaction is treated as a stock sale: no deemed asset sale, no step-up, no bonus depreciation on the stepped-up basis. The buyer receives no state-level deduction for the step-up.

This state-federal mismatch creates a timing difference (the federal deduction is taken immediately; the state deduction never materializes, or materializes much more slowly on actual asset sales in later years) that can significantly erode the net economic benefit of the 338(h)(10) election for targets that generate substantial income in non-conforming states. Practitioners must identify every state in which T has nexus, determine the applicable conformity rule for each state, and build the state tax impact into the transaction model before advising on whether to make the election. Hedge all state conformity determinations to current state tax guidance; the conformity landscape changes as states enact new legislation, and a state that conformed in a prior year may have decoupled or vice versa.

The consistency rules under IRC 338(f)

If P makes a QSP of T, and T has one or more subsidiaries (Sub1, Sub2) of which P also acquires stock during the "consistency period" (generally the period beginning 12 months before the QSP acquisition date and ending 12 months after the acquisition date), the IRS may deem a Section 338 election to apply automatically to those subsidiaries -- even if P did not intend to make a 338 election on them. Conversely, P may be denied basis step-ups on stock or asset acquisitions that are inconsistent with a 338 election made (or not made) at the T level.

The consistency rules under IRC 338(f) and Treas. Reg. 1.338-8 are complex and are frequently overlooked in multi-tier acquisition structures where P acquires T and also separately acquires stock in one or more of T's subsidiaries in step transactions. Practitioners advising on multi-tier M&A transactions should flag the consistency rules as a mandatory due diligence item early in the deal process. An unintended deemed 338 election on a subsidiary (or an unintended inconsistency that triggers IRS scrutiny) can produce unexpected taxable income at the subsidiary level that was not modeled in the deal economics. Hedge all consistency rule analysis to IRC 338(f) and Treas. Reg. 1.338-8.

Employment tax continuity: Rev. Proc. 2004-53

A 338(h)(10) election creates a deemed liquidation and re-incorporation of T, which technically terminates old T's employer identification number (EIN) and creates a new T. For employment tax purposes, this could require new T to start a new EIN, file new Forms W-2 for the entire year, and re-establish payroll withholding accounts -- creating significant administrative burden mid-year. The IRS addressed this issue in Rev. Proc. 2004-53, which allows old T and new T to be treated as a single employer for employment tax reporting purposes in the acquisition year under an "Alternate Procedure." Practitioners should verify the applicability of Rev. Proc. 2004-53 to each deal, and hedge the specific procedural requirements to Rev. Proc. 2004-53 and current IRS.gov guidance.

Covenants not to compete and Section 197

If the purchase agreement allocates value to a covenant not to compete from T's key personnel or shareholders, that covenant is a Section 197 intangible (IRC 197(d)(1)(E)) allocated to Class VI. The covenant amortizes over 15 years, not over the shorter period of the covenant's actual term, and is NOT eligible for OBBBA QPP expensing. Both buyer and seller are bound by the asset allocation reported consistently on the applicable forms; an allocation to a covenant that one party subsequently attempts to recharacterize will be subject to IRS scrutiny and potentially overridden. Practitioners should confirm that the purchase price allocation explicitly addresses covenants and that both parties' tax returns reflect the agreed allocation consistently.

Flag the election at the LOI stage -- not at closing

The single most important practical point for practitioners representing buyers: raise the Section 338(h)(10) or Section 336(e) election possibility in the letter of intent or term sheet phase, not at or after closing. Once the deal closes without a 338(h)(10) or 336(e) election, the opportunity is permanently and irrevocably lost. There is no post-closing mechanism to elect a step-up on a transaction that did not include the election. Sellers who agree to the election in the LOI phase before the purchase price is set can have their gross-up cost built into the negotiated price; sellers who are asked to consent post-signing (when the deal economics are already set) have significantly more leverage to refuse or demand a disproportionate gross-up. Including the election option -- and the associated economics -- in the initial deal documentation protects the buyer's ability to make the decision with all parties properly incentivized.

Frequently Asked Questions: IRC 338 Deemed Asset Sale

Related Practitioner Guides

• IRC 382 NOL Limitation on Ownership Changes Practitioner Guide -- the annual Section 382 limitation formula (FMV times LTTER), NUBIG and NUBIL built-in gain rules, Section 382 ownership change testing, Sections 383 and 384, and the post-OBBBA comparison of Section 382-limited NOL inheritance versus a 338(h)(10) step-up election.
• IRC 368 Tax-Free Reorganization Types A, B, C, D, G Practitioner Guide -- tax-free reorganizations under IRC 368 are the principal alternative to a taxable IRC 338(h)(10) or 336(e) asset step-up election; when a buyer can negotiate a tax-free Type A, B, or C reorganization, the target's shareholders defer gain recognition while the buyer inherits the target's carryover inside basis; practitioners must model the after-tax cost of the tax-free reorganization (no basis step-up, no bonus depreciation) versus the taxable election (basis step-up, bonus depreciation, but immediate gain to target shareholders) before recommending a structure.
• IRC 1374 Built-In Gains Tax: C-Corp to S-Corp Conversion Practitioner Guide -- the parallel built-in gains tax applicable to S-corps that converted from C-corp status; relevant to the 338(h)(10) election on an S-corp target that was previously a C-corp, where the IRC 1374 recognition period and the 338(h)(10) deemed asset sale interact.
• IRC 1245 and IRC 1250 Depreciation Recapture and Form 4797 Practitioner Guide -- IRC 1245 and 1250 recapture on the disposition of Class V tangible personal property and real property; directly relevant to old T's gain recognition on the deemed asset sale (recaptured depreciation is ordinary income) and to the cost segregation analysis that determines the Class V QPP component of the ADSP allocation.
• IRC 1245 1250 depreciation recapture cost segregation OBBBA bonus depreciation guide -- how cost segregation reclassifies real property into Section 1245 personal property and how OBBBA 100% QPP bonus depreciation reduces basis to zero; directly relevant to the recapture that old T recognizes on the deemed asset sale when the stepped-up Class V QPP is later disposed of, and to the ADSP allocation of the Class V component.
• IRC 368(a)(1)(F) F-Reorganization Guide -- the F-Reorganization used in Holdco/Opco restructuring that often precedes or follows a 338 election; the tax-free change in identity, form, or place of organization and the full IRC 381 attribute continuity that shapes the acquisition structure around a taxable 338 step-up.
• Section 197 Intangible Amortization Guide -- the 15-year amortization rules for Class VI and Class VII intangibles that limit the OBBBA QPP benefit in goodwill-heavy transactions. A dedicated Section 197 guide is not currently available on this site; consult IRC 197 and Treas. Reg. 1.197-2 directly.
• IRC 355 corporate spin-off split-off active business device test anti-Morris Trust guide -- the tax-free corporate separation alternative to a taxable 338 election; IRC 338 (taxable asset sale election) and IRC 355 (tax-free spin-off) are the two primary corporate separation alternatives, and the choice between a taxable step-up and a tax-free divisive transaction drives the structuring analysis.
• IRC 332/336/337 Corporate Complete Liquidation and Gain Recognition Guide -- IRC 332 tax-free liquidation (parent takes carryover basis under IRC 334(b)(1)) and IRC 338 deemed asset sale (step-up to FMV with OBBBA QPP bonus depreciation) are the two primary mechanisms for disposing of a corporate subsidiary; where IRC 338(h)(10) produces a full step-up but eliminates target NOLs, IRC 332 preserves tax attributes but delivers no step-up; the choice between these regimes drives the entire acquisition structuring analysis.
• IRC 304 Related Corporation Redemption Practitioner Guide -- when a buyer pays cash for Target Corp stock through a sister corporation (Acquiring) rather than buying stock directly, IRC 304(a)(1) may recharacterize the transaction as a deemed IRC 351 contribution and deemed redemption rather than a direct purchase eligible for an IRC 338 election; practitioners structuring acquisitions through commonly controlled entities must test IRC 304 before relying on IRC 338 treatment, since a IRC 304 recharacterization can eliminate the ability to make a 338(h)(10) or 338(g) election on what the buyer intends to be a stock purchase.
• IRC 1202: QSBS Gain Exclusion and Active Business Test Guide -- when a buyer makes an IRC 338(h)(10) election on the acquisition of a target C corporation, the target is treated as selling its assets on the acquisition date; this deemed asset sale terminates the QSBS holding period for the selling shareholders because the stock is treated as cancelled and new stock is deemed issued to the acquirer immediately after the deemed sale; sellers who hold stock that qualifies as QSBS and have met the 5-year holding period should carefully analyze whether an IRC 338(h)(10) election preserves or destroys the IRC 1202 exclusion before agreeing to the election, since the stock-level gain exclusion under IRC 1202 operates at the shareholder level and may not apply to an asset-level deemed sale (verify at IRS.gov and consult independent counsel, as these provisions involve recently enacted OBBBA amendments and implementation guidance may be pending).
• IRC 243: Dividends Received Deduction (DRD) for C Corporations -- when a corporate acquirer makes an IRC 338(h)(10) election on a stock acquisition, the target corporation is treated as having sold its assets on the acquisition date; any intercompany dividends that the target paid to the acquirer before the deemed sale date may qualify for the IRC 243 DRD if the acquirer owned at least 20 percent of the target and held the stock for the requisite 45-day period under IRC 246(c); however, once the IRC 338(h)(10) election is in effect and the target is treated as a new corporation, any post-election distributions are governed by a different E&P analysis, and practitioners must carefully track the dividend and DRD analysis for distributions occurring on or around the acquisition date (verify at IRS.gov and consult independent counsel).
• IRC 1291-1298: PFIC Regime -- Excess Distribution and QEF Election Guide -- a US person who acquires stock in a foreign corporation via an IRC 338 qualified stock purchase or an IRC 338(g) election should immediately analyze whether the acquired corporation qualifies as a PFIC, because the IRC 338 election has no effect on PFIC status and the acquired corporation may meet the 75 percent passive income or 75 percent passive asset tests; if PFIC status applies, the acquiring US shareholders must decide whether to make a QEF or mark-to-market election in the first year of ownership to avoid the default IRC 1291 excess distribution regime on subsequent distributions and dispositions (verify at IRS.gov and consult international tax counsel).
• IRC 318: Constructive Ownership and Attribution Rules Practitioner Guide -- the constructive ownership rules of IRC 318 are invoked by IRC 338(h)(3)(A)(ii) to define "purchase" for qualified stock purchase purposes and by IRC 338(d)(3) for the 80% ownership threshold; related-party acquisitions excluded from the "purchase" definition under IRC 318 attribution cannot support an IRC 338 qualified stock purchase election, making IRC 318 analysis an essential preliminary step in every acquisition transaction where a 338(h)(10) or 338(g) election is contemplated.
• IRC 280G Golden Parachute Payments and IRC 4999 Excise Tax Guide -- most 338(h)(10) deemed asset sale elections are triggered by a change in ownership or control that also triggers the IRC 280G golden parachute analysis; practitioners structuring an acquisition using a 338(h)(10) election must run the 280G parachute payment analysis concurrently to identify any disqualified individuals whose compensation arrangements are contingent on the sale closing.