The Basis Step-Up: Unlocking Value with Section 338(h)(10) Elections
In a corporate acquisition, a fundamental conflict of interest exists between the buyer and the seller. The seller almost always prefers a stock sale to achieve a clean exit at low capital gains rates. The buyer, however, prefers an asset sale so they can "Step Up" the tax basis of the target\'s assets (including goodwill) and begin depreciating them all over again. Section 338(h)(10) provides the ultimate compromise: it allows a stock sale to be treated as a "deemed asset sale" for tax purposes. This gives the buyer their cherished basis step-up while allowing the seller to avoid the legal complexity of transferring individual assets. Our M&A Advisory Group specializes in modeling the "Tax Gross-Up" required to make both parties whole under a 338(h)(10) election.
The "Deemed Asset Sale" Mechanics
When a 338(h)(10) election is made, the target corporation is treated as if it sold all its assets to a "new" corporation in a single transaction and then liquidated.
For S-Corporations or subsidiaries of consolidated groups, this results in a single layer of tax—the gain on the asset sale passes through to the sellers. Crucially, the buyer can now allocate the purchase price to tangible equipment, customer lists, and goodwill, creating massive future tax deductions through accelerated depreciation. We provide the forensic "Purchase Price Allocation" (PPA) required by IRS Form 8883, ensuring that the allocation survives an IRS challenge while maximizing the after-tax internal rate of return (IRR) for the acquiring entity.
Calculating the "Gross-Up" Benefit
Because a 338(h)(10) election often triggers "Ordinary Income" for the seller on things like inventory and depreciation recapture, the seller may demand a higher purchase price to compensate for their increased tax bill.
This is known as the "Gross-Up." A buyer is usually willing to pay this premium because the future tax savings from the basis step-up are significantly more valuable than the upfront cost. We architect "Equivalency Models" to prove the mathematical value of the election to both sides. For sellers exit through a 1042 ESOP Roll-over, the 338(h)(10) election is generally unavailable, making the choice of transaction structure the most consequential decision in the entire deal process. Our forensic review ensures that all eligibility requirements for a "Qualified Stock Purchase" (QSP) are met before the closing documents are signed.