Question

Corporation W owns 100% of the common stock of Corporation Z with a basis of $300. Z owns a rental building (its only asset) with a gross fair market value of $3,000, subject to a non-recourse mortgage of $1,200. Z’s adjusted basis for this building is $900. Z has $600 of E&P. Z is on the accrual method of accounting and reports on the calendar year. Z and W do not report on a consolidated basis. Z distributes the building to W in complete liquidation and W sells the building to Corporation V for $1,800 cash, subject to the debt. Same facts as above, except that W sells the Z stock to V for $1,800 cash instead of selling the building following a liquidation.

a. V should make a Section 338 election as a normal procedure in order to obtain a cost basis in the Z assets.

b. V should make a Section 338 election because of the tax under 338 on the hypothetical sale unless Z has losses.

c. V should make a 338 election if it is an S Corporation.

d. None of the above.

Answer 1

a. V should make a Section 338 election as a normal procedure in order to obtain a cost basis in the Z assets.

General requirements for a Section 338 election:

• A Section 338 election cannot be made in a non-taxable stock deal.
• The buyer must acquire control of the target in a qualified stock purchase (QSP), defined as the purchase of at least 80% of the total voting power and value ("vote and value") of the target's stock within twelve consecutive months of the first purchase of such stock. Preferred stock is not included in computing voting power or value. The "acquisition date" is the date on which the 80% threshold is reached.
• The buyer must be a C corporation. For financial sponsors typically organized as LLCs, therefore, the Section 338 election is not usually an option. Individuals and partnerships cannot make a QSP, and are consequently unable to make a 338 election. However, individuals and partnerships can circumvent this restriction by forming a new corporation ("NewCo") to acquire the target's stock.