S-Corporation Sale: Stock Sale vs. Section 338 Election Strategy

Selling an S-corporation avoids double taxation, but you still face the stock vs. asset choice. Learn about the Section 338(h)(10) election and basis tracking.

Stock sale is the default preference. Selling S-corp stock produces capital gains taxed once at the shareholder level. There is no entity-level tax on the sale. This is often the simplest path for the seller.

The 338(h)(10) election bridges the gap. If the buyer wants an asset purchase (for the depreciation step-up) but you want the simplicity of a stock sale, a joint Section 338(h)(10) election treats a stock sale as if it were an asset sale for tax purposes. The buyer gets their step-up, and you report it as an asset sale. This requires careful modeling because it changes the character and amount of your gain.

Built-in gains tax applies to converted corps. If the S-corp was previously a C-corp, the built-in gains tax under Section 1374 applies to appreciation that existed at the time of conversion, for a recognition period of five years. Selling within that window triggers corporate-level tax on the built-in gain.

Basis matters for each shareholder. Each shareholder's gain depends on their individual stock basis, which is adjusted annually by income, losses, distributions, and contributions. Inaccurate basis records are one of the most common S-corp audit issues.

The tradeoff: A stock sale is tax-efficient for you but less attractive to buyers. A 338(h)(10) election can satisfy both sides but converts your gain into a potentially less favorable character mix. Your CPA must model the net proceeds under each scenario.