The buyer is proposing a stock purchase but is demanding a Section 338h10 election to get the tax step-up benefits of an asset sale. How do we calculate the tax friction of this structure and negotiate a gross-up payment to ensure our net walk-away proceeds do not take a massive hit?

Question

Tyler Smith · Accepted Answer

When a buyer requests a Section 338h10 election, they are asking to treat a legal stock purchase as an asset purchase for federal income tax purposes. This allows the buyer to step up the tax basis of your assets and claim massive depreciation deductions post-closing. While this is highly beneficial for them, it can trigger severe tax consequences for you, including ordinary income tax rates on recaptured depreciation instead of capital gains rates.

If you agree to this structure, you must negotiate a tax gross-up payment as part of the deal. Start by calculating your exact tax liability under both a pure stock sale and a Section 338h10 structure. The difference between these two numbers is the tax friction that the buyer must cover.

To defend this negotiation, use the quantitative data from your Step by Step Exit Value Growth Audit. Show the buyer the current tax basis of your equipment, intellectual property, and goodwill.

Insist that the purchase price allocation be agreed upon and written into the Letter of Intent before you enter exclusive diligence. If the buyer refuses to pay a gross-up that makes you whole, hold firm on a standard stock sale. Never let a buyer capture all the tax benefits of an asset transaction while leaving you to pay the tax bill.