We want to structure our exit as an installment sale under Section 453, but the buyer is pushing for a Section 338(h)(10) election to get a step-up in asset basis. How does this election complicate our tax deferral plan, and how do we structure the deal to protect our net cash proceeds?

Question

Tyler Smith · Accepted Answer

A Section 338(h)(10) election allows a buyer to treat a stock purchase as an asset purchase for tax purposes, giving them a valuable step-up in asset basis. However, for you, the seller, this election can destroy the tax benefits of your Section 453 installment sale.

When you agree to a 338(h)(10) election, you are treated as having sold assets and then liquidated the corporation. Under Section 453, certain assets are ineligible for installment reporting. For example, depreciation recapture on personal property under Section 1245 and inventory must be recognized as ordinary income in the year of the sale, regardless of when you receive the cash payments.

To protect your net cash proceeds, you must run a detailed analysis of your asset allocation. Work with your CPA to negotiate the allocation under Section 1060. Push to allocate as much of the purchase price as possible to goodwill and other capital assets that qualify for long-term capital gains and installment reporting, while minimizing the allocation to fast-depreciating equipment and inventory.

Additionally, you should demand a tax gross-up from the buyer. Because the Section 338(h)(10) election is highly advantageous to them, they should compensate you for the incremental tax drag and the loss of your installment deferral benefits. Frame this during negotiations not as an arbitrary price increase, but as a mathematical adjustment to keep your net, after-tax proceeds whole. This ensures you do not finance their tax break with your hard-earned equity.