An S corporation target has three routes to a step-up.

An S corporation seller who will only sell stock can still deliver asset-purchase tax treatment three ways: a section 338(h)(10) election, a section 336(e) election, or a pre-closing F reorganization. Your buyer entity’s tax classification opens one election and closes the other. Only the F reorganization gives you basis that does not depend on the target’s S election.

Why does buying stock leave you without the basis you just paid for?

Buying the stock of an S corporation gives you basis in shares, not in the company’s assets. The corporation keeps its historic asset basis and its existing depreciation schedules. Nothing you pay for the shares becomes deductible. An asset purchase instead gives you cost basis in what you bought, with purchased goodwill amortized over fifteen years.

The entity continues and its inside basis continues with it. Fully depreciated equipment stays fully depreciated, and goodwill the seller built carries no basis at all. Amounts paid separately under a covenant not to compete or a consulting agreement follow their own rules.

In a leveraged acquisition you pay principal out of after-tax dollars, and the step-up is the only thing standing between your debt service and your tax bill. Sellers resist an asset sale anyway, because recapture creates ordinary income and because contracts and permits need consents. The routes below keep the legal form a stock deal while the tax result becomes an asset deal.

Law: 26 U.S.C. 197(a) and 197(d); 26 U.S.C. 1060.

What does a section 338(h)(10) election require, and can your LLC make one?

A section 338(h)(10) election requires a corporate purchaser. The buyer must make a qualified stock purchase: stock described in section 1504(a)(2), eighty percent of total voting power and eighty percent of total value, acquired by purchase within a twelve-month acquisition period. The election is joint and is made on Form 8023.

Read the definition literally. Stock must be “acquired by another corporation by purchase.” An LLC taxed as a partnership is not a purchasing corporation, so there is no election. A single-member LLC is disregarded and its purchase is treated as made by its owner: a corporate owner still gives you a purchasing corporation, an individual owner does not. Making the acquiring taxpayer a corporation before closing fixes that, and changes how you take money out later.

Two traps sit inside the mechanics. Every shareholder of the target must join the election, including one who sells nothing. And stock the seller keeps was not acquired by purchase, so a seller retaining more than twenty percent of vote or value defeats the qualified stock purchase. Rollover taken at your buyer entity does not, and retained seller equity fails at this size for another reason, below.

Law: 26 U.S.C. 338(d)(3); 26 U.S.C. 1504(a)(2); 26 CFR 1.338(h)(10)-1(c)(2); 26 CFR 1.338-2(d); 26 CFR 301.7701-2(a).

What is a 338(h)(10) election worth to you, and what should you pay for it?

A section 338(h)(10) election moves tax from the buyer’s side of the table to the seller’s. The seller’s gain stops being capital gain on shares and becomes a deemed sale of assets, with ordinary recapture on the depreciated ones. The seller will ask to be made whole. The buyer’s ceiling is arithmetic, not negotiation.

• Allocate the price across asset classes, goodwill and going concern value in the residual.
• Amortize the residual straight-line over fifteen years under section 197, from the month of acquisition.
• Recover the tangible classes on their own periods, with whatever expensing your closing year allows.
• Check section 197(f)(9) first. If the business predates August 1993 and the seller will hold equity in your buyer entity, the anti-churning rules can deny the amortization you just priced.
• Multiply each year’s deduction by your marginal rate, then discount it. You are a leveraged buyer with a personal guaranty; your discount rate is not the ten-year Treasury.

Price the deduction, not the seller’s asking number.

That present value is the ceiling. Ask the seller’s accountant for the incremental tax in writing, not a percentage. Cap any make-whole at a stated figure, payable only when the election is made and the signed form reaches you. The regulation sets the deadline: no later than the fifteenth day of the ninth month beginning after the month that includes the acquisition date, with the allocation on Form 8883. Your loan funds at closing, so anything paid later comes off a seller note or out of pocket.

What is a section 336(e) election, and can the seller make it without you?

A section 336(e) election treats a qualified stock disposition as a sale of the target’s assets, and the regulations test the seller, not the buyer, so an individual or a partnership can buy. It needs a written binding agreement between the target and all its S corporation shareholders, plus an election statement. You sign neither.

The threshold is the same eighty percent of vote and value, but the trigger is broader: a sale, exchange or distribution within a twelve-month disposition period, to an unrelated purchaser. Every S corporation shareholder signs, including non-sellers, by the due date of the target’s return with extensions, and the statement goes on that return. The regulations apply from May 15, 2013.

The two elections do not stack: a transaction meeting the definition of a qualified stock purchase is not a qualified stock disposition. If your buyer entity is a corporation and you buy eighty percent or more of vote and value, section 336(e) is closed and section 338(h)(10) is the election you have. If your entity is not a corporation, the reverse is true, and the seller can elect after your closing without asking you.

A buyer usually wants the step-up, so that sounds like a gift. It is not always one. The deemed sale ends old target and its S election with it, any state entity-level tax lands on your company, and your allocation gets fixed without you. Take the covenant: no election changing the characterization of the deal without your written consent, plus an indemnity.

An election you never signed can change the deal you did.

Law: 26 CFR 1.336-1(b)(6); 26 CFR 1.336-2(h)(3); 26 CFR 1.336-5.

How does the F reorganization in Rev. Rul. 2008-18 actually work?

Rev. Rul. 2008-18 describes a pre-closing sequence: the target’s shareholders form a new holding company, contribute their S corporation stock to it, and the holding company elects to treat the target as a qualified subchapter S subsidiary. The target then converts to an LLC. The buyer purchases LLC interests instead of corporate stock.

• The shareholders form a new corporation and contribute all target stock to it, in the same proportions. The historic S election carries over without a new Form 2553.
• The holding company files Form 8869, effective immediately after the contribution. Timing is where this structure fails.
• The target converts under state law into an LLC, disregarded for tax purposes.
• You buy the interests. Buying all the interests in a disregarded entity is a purchase of its assets, giving you cost basis and a section 1060 allocation. Buy less than all and you get basis only in the share you bought.

Two practical notes. The new holding company generally needs a new employer identification number while the target keeps its own, which matters for payroll and bank accounts. And a subsidiary election filed late does not self-correct; that puts the parties into section 1362(f) relief, granted at the discretion of the IRS. Read the state conversion statute, and the target’s change-of-control clauses, before assuming everything survives.

Guidance: Rev. Rul. 2008-18; IRS Form 8869; 26 CFR 301.7701-2(a); Rev. Rul. 99-5.

Why does the F reorganization protect you against a defective S election?

It does not cure the defect. It changes what your basis depends on. Both elections require S status at the target, so a defect destroys them. Your cost basis in the interests of a disregarded LLC comes from the purchase itself, and it stands whether or not the target’s S election was ever valid.

A section 338(h)(10) election for a target held by individuals is made by its S corporation shareholders, and section 336(e) reaches individual sellers only as S corporation shareholders. Strip out S status and you are buying a C corporation from individuals, with neither election available. It is not a free pass: the contribution and the subsidiary election are tax-free only if the holding company is validly an S corporation, and if it is not, the conversion is a taxable event inside the entity you are buying. Take the indemnity.

S elections break in boring ways: an unfiled Form 2553, a spouse who never consented, stock sitting in a trust with no qualified subchapter S trust election, uneven distributions raising a second class of stock question.

I read the Form 2553 and the IRS acceptance letter before I read the draft purchase agreement, and I ask for every shareholder consent and trust election before anyone writes a tax covenant.

Relief exists, and none of it is automatic. Rev. Proc. 2013-30 offers late election relief, generally within three years and seventy-five days of the intended effective date, on reasonable cause and consistent reporting. Rev. Proc. 2022-19 resolves several common defects without a ruling. Section 1362(f) relief is discretionary and runs on the IRS calendar. Put the fix on the seller, before closing, as a condition.

Guidance: Rev. Proc. 2013-30; Rev. Proc. 2022-19; 26 U.S.C. 1362(f).

Which route does your own entity permit?

The buyer’s tax classification decides the question before anything else does. A corporate purchaser making a qualified stock purchase can use section 338(h)(10) or a pre-closing F reorganization, but not section 336(e). An LLC taxed as a partnership, or disregarded and owned by an individual, must rely on section 336(e) or the F reorganization.

Does your SBA lender care which route you choose?

SBA lenders care about the legal form of the transaction, the borrower entity, the guarantors and the collateral, not about a tax election. A section 338(h)(10) or section 336(e) election leaves a stock purchase a stock purchase. An F reorganization changes what you actually buy, which changes the loan documents, the entity records and the lien searches.

Stated as of September 2026: SOP 50 10 8 governs 7(a) origination, having taken effect June 1, 2025, and SBA published SOP 50 10 8.1 on August 14, 2026, effective October 1, 2026. A lender applies the version in force when the loan number issues, so your deal may close under the newer one. Confirm the current SOP and your lender’s overlays. Under SOP 50 10 8, a partial change of ownership must be a purchase of stock or membership interests rather than assets, and a seller who keeps equity must guarantee the loan for the period the SOP sets. That is why retained seller equity is uncommon at this size.

Sequence it. Tell the lender the structure before credit approval. The authorization, the borrower entity, the guaranties and the UCC filings have to name the entity you will own on closing day. Nobody can promise that a late restructure will be approved on your timeline.

Rule: SBA SOP 50 10 8 (effective June 1, 2025); SOP 50 10 8.1 (Information Notice 5000-880695, effective October 1, 2026).

What goes in the letter of intent, and what do you do this week?

The tax route belongs in the letter of intent, because changing it later reprices the deal. A seller who learns at signing that a section 338(h)(10) election creates ordinary income will reopen price, and you will be negotiating from a signed lease, a resigned job and a lender’s clock. Name the route while the terms are still soft.

• The route, named, and the buying entity and its tax classification.
• Whether the price assumes the election, and who bears any incremental tax.
• A cap on any make-whole, paid only on a filed election.
• The allocation methodology, with a schedule before signing.
• A covenant against any election changing the transaction’s characterization without your consent.
• A condition that the seller deliver a clean S-election file, and complete any relief, before closing.

Then, this week: ask your accountant how your acquisition entity is classified, because that answer opens one election and closes the other. Request the Form 2553, the acceptance letter, every shareholder consent, any trust elections, and Forms 8869.