Section 338(h)(10) Election: Complete Guide for Business Sellers

When a buyer wants to acquire your S-corp, they may ask you to jointly elect §338(h)(10) — which lets them treat the deal as an asset purchase for tax purposes, even though you're legally selling stock. That election is worth significant money to the buyer. Whether it's worth money to you depends entirely on your asset mix, and whether it helps or hurts depends on something most sellers overlook: QSBS.

Who can make a §338(h)(10) election

Three requirements must all be met:¹

1. Qualified stock purchase (QSP): The buyer must purchase 80% or more of the target's stock (by vote and value) within any 12-month period. Purchases from related parties don't count. The buyer must be a corporation (not an individual or partnership).
2. Eligible target: The target must be an S-corporation (the most common case) or a member of a consolidated group of C-corps being sold by the parent. This guide focuses on the S-corp scenario.
3. Joint election: Both the buyer and all selling shareholders must consent. One holdout can block it. The election is made on Form 8023, due by the 15th day of the 9th month after the acquisition month.²

Note: §336(e), finalized in 2013, creates a similar election available when §338(h)(10) is not — for example, when the buyer is a partnership or individual, or when S-corp stock is sold by an S-corp parent. The mechanics and consequences are similar; §336(e) doesn't require a corporate acquirer.³

Why buyers want it: the basis step-up value

When a buyer acquires a business via a stock purchase without a §338(h)(10) election, they inherit the corporation's existing tax basis in its assets — often near zero for a long-standing business. That low basis means future depreciation and amortization deductions are minimal.

With a §338(h)(10) election, the buyer gets a "deemed asset purchase" that sets the tax basis of every acquired asset to its fair market value at the acquisition date. This creates a significant base of future deductions:

• Tangible personal property (equipment, vehicles, machinery): Under 100% bonus depreciation — permanently restored by the One Big Beautiful Bill Act (OBBBA) for property placed in service after January 19, 2025⁴ — the buyer can deduct 100% of the stepped-up basis in year one. On a $5M equipment component, that's $5M × 21% (C-corp rate) = $1.05M in immediate tax savings.
• §197 intangibles (customer lists, covenants, trade names, goodwill): Amortized over 15 years. On a $10M goodwill allocation, the buyer gets $667K per year in amortization, worth ~$140K per year in tax savings at the C-corp rate — present value roughly $1.2M–$1.5M over the amortization period.
• Real property: Depreciated over 39 years (commercial) or 27.5 years (residential). Less immediate, but still material for real-estate-heavy businesses.

This is why buyers ask for §338(h)(10). It's not a paperwork preference — it's worth real money. Sellers who consent without negotiating a premium are giving away 13–15% of the deal's buyer-side economics.

What it costs sellers: the recapture problem

In a plain stock sale (no §338(h)(10)), the seller recognizes one type of gain: capital gain on the difference between the stock's sale price and the shareholder's stock basis. Most long-term holders face a 23.8% federal rate (20% LTCG + 3.8% NIIT at high incomes).⁵

Under a §338(h)(10) election, the corporation is deemed to have sold its assets at FMV. That deemed asset sale produces a blended gain with multiple tax rates:

• Depreciation recapture (§1245): The amount by which accumulated depreciation exceeds original cost basis is recaptured as ordinary income — taxed at 37% for individual shareholders flowing through an S-corp. This is the big cost.
• §1250 recapture (real property): Unrecaptured §1250 gain on real property is taxed at a maximum 25% rate.
• Inventory and accounts receivable: Ordinary income, taxed at 37%.
• Goodwill and §1231 gain: Long-term capital gain at 23.8% — same as in a stock sale. No incremental cost here.
• Covenants not to compete: Ordinary income at 37%.

In a goodwill-heavy business (services, software, professional practices), the seller's extra cost is modest — most gain is already capital gain regardless of structure. In a capital-intensive business (manufacturing, transportation, construction), the recapture cost can be substantial.

How to negotiate the structure premium

Because the election benefits the buyer and costs the seller, a rational negotiation involves the buyer paying a "structure premium" — an upward price adjustment that compensates the seller for the incremental tax cost while leaving both sides better off than without the election.

The math:

1. Calculate the buyer's benefit (PV of step-up deductions, as shown above)
2. Calculate the seller's extra tax cost (incremental ordinary income × rate differential)
3. The seller's minimum acceptable premium = extra tax cost ÷ (1 − seller's marginal rate), to gross up for the premium itself being taxable
4. The buyer's maximum willingness to pay = PV of buyer's tax benefit
5. Any deal between those two numbers is economically rational for both parties

If the buyer is unwilling to discuss a price adjustment for §338(h)(10), the election is not economically justified from the seller's perspective. The only reason a seller would agree to it without compensation is if the buyer has made it a deal condition — in which case the seller's negotiating position should be to insist the price reflect the concession.

See our asset sale vs stock sale guide for the Form 8594 allocation mechanics that determine how gains are classified once a §338(h)(10) election is made.

Critical: §338(h)(10) and QSBS do not mix

This is the most important thing to understand if you hold qualified small business stock (QSBS) in a C-corp: converting to S-corp eliminates QSBS eligibility going forward, but existing S-corp holders do not have QSBS. If your business is a C-corp with QSBS, a §338(h)(10) election can be structurally incompatible with maximizing your exclusion.

Here's why: §1202 excludes gain from the "sale or exchange" of qualified small business stock. When a §338(h)(10) election is made, the corporation is deemed to have sold its assets — the shareholder is deemed to receive liquidation proceeds, not stock sale proceeds. The character of the gain shifts from stock-sale gain to asset-sale gain flowing through the corporation.⁶

The practical consequence:

• The §1202 exclusion applies to gain from stock sale. A deemed asset sale means the gain recognized at the shareholder level comes from the deemed liquidation, not a direct stock sale — the §1202 exclusion may not attach to the recapture income that comes through.
• Even if the §1202 exclusion does reduce some of the recognized gain, the recapture income comes out first, at ordinary rates — there's no exclusion for recapture regardless of §1202.
• If your QSBS exclusion would cover the entire gain, agreeing to a §338(h)(10) election adds recapture income (ordinary) at no benefit — you've given the buyer a step-up and received only incremental ordinary income in return.

If you have qualifying QSBS: do not agree to a §338(h)(10) election unless an advisor has specifically modeled why it helps you in your situation. The default position for QSBS holders is to insist on a clean stock sale to preserve the exclusion. See our QSBS Section 1202 complete guide for qualification requirements and how the exclusion interacts with deal structure.

State tax: conformity varies

Federal §338(h)(10) treatment is not automatic at the state level. States handle the election differently:

• Conforming states: Most states that follow the Internal Revenue Code will respect the §338(h)(10) deemed asset sale for state tax purposes — meaning state tax also applies to recapture income at ordinary rates.
• Non-conforming states (e.g., California): California does not recognize the §338(h)(10) election for California tax purposes. A California seller in a §338(h)(10) deal recognizes capital gain (stock sale) for state purposes while recognizing ordinary income (recapture) at the federal level — creating a mismatch where federal tax is higher than state tax, rather than aligned.
• Multi-state S-corps: If the S-corp has employees and operations in multiple states, the deemed asset sale can create apportioned income in each state, with varying rates and conformity rules. This requires state-by-state analysis.

State non-conformity can significantly change the economics of the election. A California S-corp seller who agrees to a §338(h)(10) election pays California state income tax at capital gains rates (13.3% at the top, applied to all income including recapture — California has no preferential capital gains rate), while paying federal recapture tax at 37%. The combined effective rate on recapture income can approach 50%.

Filing requirements and timing

The §338(h)(10) election is made on IRS Form 8023. Key requirements:²

• Both the purchasing corporation and all selling S-corp shareholders must sign (or attach consent statements)
• Deadline: the 15th day of the 9th month beginning after the acquisition date. For an acquisition closing May 17, 2026, the deadline is February 15, 2027
• Filing is with the IRS Service Center where the S-corp files its return
• The election is irrevocable once filed

Practical implication: The election doesn't have to be agreed upon at closing — it can be agreed as a condition of the purchase agreement with actual filing after closing. But the negotiation and agreement must happen before closing in practice, because buyers won't close a deal expecting a §338(h)(10) without contractual commitment from all sellers. Deals with multiple shareholders require every shareholder to sign; one holdout (such as a minority partner who didn't agree to the structure) can defeat the election.

Decision framework: when to accept a §338(h)(10) request

§338(h)(10) and installment sales: an important interaction

If you're considering an installment sale alongside a §338(h)(10) election, there's a critical wrinkle: §453(i) requires that any §1245 recapture income be recognized entirely in the year of sale — it cannot be spread over installment payments.⁷ In a §338(h)(10) deemed asset sale with significant recapture, the seller recognizes all the ordinary income at close, even if the consideration is an installment note. This materially reduces the tax-deferral benefit of the installment structure.

See our installment sale strategy guide for the full interaction between §453, §453(i), and §338(h)(10) in deal structuring.

The role of an exit-planning financial advisor

A §338(h)(10) negotiation is fundamentally a financial modeling exercise. The investment banker running your sale process knows deals but typically doesn't build the tax models. The M&A attorney drafts the election provisions but doesn't compute the after-tax spread. The CPA may compute the recapture but not the present value of the buyer's benefit or the negotiating range.

A fee-only financial advisor who specializes in business exits can model:

• Your exact recapture exposure based on your depreciation schedules
• The PV of the buyer's step-up benefit given their tax rate and expected amortization timing
• The minimum premium you need to break even after gross-up
• Whether QSBS, installment sale, or CRT structures interact with the election in ways that change the math
• State-specific after-tax outcomes if you operate across multiple states

This analysis needs to happen before the LOI is signed — not during due diligence. By the time definitive agreements are drafted, the structural framework is largely set. See our LOI guide for why the financial structure decisions made at the LOI stage determine the floor for everything that follows.

Related guides: Asset sale vs stock sale: complete tax guide · S-corp vs C-corp when selling · QSBS Section 1202 exclusion guide · Installment sale strategy guide · 7 strategies to reduce taxes when selling

Sources

1. IRC §338(h)(10) — Election for qualified stock purchases of S-corp targets. Requires qualified stock purchase (≥80% by vote and value within 12-month acquisition period), corporate acquirer, and joint election by buyer and all selling shareholders. Treas. Reg. §1.338(h)(10)-1 governs mechanics.
2. IRS Form 8023 — Elections Under Section 338 for Corporations Making Qualified Stock Purchases. Filing deadline: 15th day of the 9th month beginning after the acquisition month. Signatures required from both purchasing corporation and all selling S-corp shareholders.
3. IRC §336(e) — Election to treat certain asset dispositions as a deemed asset purchase. Available when §338(h)(10) is not (e.g., non-corporate acquirer, S-corp subsidiary sale). Final regulations under Treas. Reg. §1.336-1 through §1.336-5.
4. One Big Beautiful Bill Act (OBBBA), Pub. L. 119-XX (July 2025) — IRC §168(k) bonus depreciation permanently restored at 100% for qualified property placed in service after January 19, 2025. Eliminates the phasedown schedule that had reduced bonus depreciation in prior years.
5. IRS Revenue Procedure 2025-67 — 2026 inflation-adjusted parameters. LTCG rate of 20% above $613,700 MFJ / $576,450 single. NIIT of 3.8% under IRC §1411 above $250,000 MFJ / $200,000 single (not inflation-adjusted). Combined top rate: 23.8%.
6. Treas. Reg. §1.338(h)(10)-1(d)(3) — Treatment of old target S-corporation shareholders. Old target shareholders are treated as if they received the aggregate deemed sale price in liquidation of the S-corp. Gain recognized by shareholders comes from deemed liquidation, not direct stock sale — affecting §1202 QSBS analysis.
7. IRC §453(i) — §1245 and §1250 recapture income must be recognized in the year of sale, regardless of whether consideration is received on the installment method. This prevents installment sale deferral of recapture income on §338(h)(10) deemed asset sales.

Tax values in this guide reflect 2026 law including OBBBA (July 2025) and TCJA permanent provisions. §338(h)(10) mechanics are established law with no material changes from recent legislation. State tax conformity varies significantly — consult a tax advisor licensed in your state. This page does not constitute financial, tax, or legal advice.