Tax question: Equity rollover when making a 338(H)(10) election

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June 08, 2021

by an investor from University of California, Berkeley - Haas School of Business in San Francisco Bay Area, CA, USA

Does anyone know how much equity a seller can roll over in a transaction that is treated as an asset sale for tax purposes via an 338(H)(10) election. I understand it is 20%, but I’m not sure how the 20% is calculated.

Example: Assume $10M purchase price financed with $6M of Debt and $4M of preferred equity. In this example, the preferred equity has a 60% participation in common (preferred equity investors own 60%).


How do you calculate the 20% rollover limit for 338(H)(10) purposes?

  1. Is it 20% of the purchase price = $2M, or
  2. Is it 20% of the preferred equity value = $0.8M, or
  3. Is it the value of the preferred stock that corresponds to a 20% stake on a fully diluted basis (e.. 20% of fully diluted target equity = $1.33M
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commentor profile
Reply by an investor
from University of California, Berkeley in San Francisco Bay Area, CA, USA
Really appreciate the thoughtful responses above. To further clarify the question, here is the actual scenario: Target is an s-corp and we want to used a new c-corp entity to acquire the business. The purposes of using a c-corp acquisition entity is to get QSBS tax benefits. We agreed with the seller on an asset sale for tax purpose resulting in a step up in basis. Assume the purchase price is $10M and one of the s-corp shareholder is willing to re-invest $3M of the purchase in the acquisition entity. We would like to structure the reinvestment as a $3M rollover into preferred equity with some preferred return and 20% ownership in common stock.

Will this work for purposes of the 20% limitation related to the 338 election? Asking because the $ amount is more than 20% but the ownership in newco meets the 20% threshold. Also, is there a way to structure the transaction for the seller to get a tax deferral on the $3M rollover? If not, what if he rolls into debt and we give him 20% of common as part of a consulting agreement?
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Reply by a professional
from Walsh College of Accountancy and Business Administration in Detroit, MI, USA
Assuming you meet all the rules to qualify to jointly make a section 338(h)(10) election, the Purchaser must by at least 80% of the stock. Note that the Seller does not get tax deferral on the 20% rollover. This is one of the negatives of using a section 338(h)(10) election when Seller wants tax deferral on their rollover. Instead, you should consider an alternative structure such as a F-reorganization followed by a part sale and part tax deferred rollover.

I never structure an acquisition using a section 338(h)(10) election if I can avoid it and substantially all of my transactions I can avoid it. When they must be used, it is for a 100% acquisition of the stock.

email me at redacted if you want to talk further and we can set up a date and time to talk.
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