You think "stock sale vs. asset sale" is just about who buys what. That assumption is why candidates miscalculate basis and gain on the TCP exam. The real trap isn't the basic definition; it's failing to see how one election—Section 338—can turn a stock purchase into an asset purchase for tax purposes, completely flipping the consequences for the buyer and seller.
In a stock sale, the buyer acquires the target company's stock, and the target's internal asset basis carries over. In an asset sale, the buyer acquires the assets directly, receiving a stepped-up basis. The CPA TCP exam tests your ability to apply rules for these structures, including the critical Section 338 election.
Key facts
- Exam Section: TCP (Tax Compliance and Planning)
- Core Concept: Distinguishing tax treatment of acquiring a business via stock purchase vs. direct asset purchase.
- Key Elections: Section 338(g) and 338(h)(10) treat a stock purchase as an asset purchase for tax purposes.
- Tax-Free Structures: IRC Section 368 reorganizations (e.g., Type B stock-for-stock).
- Buyer's Goal: Often a stepped-up asset basis for future depreciation.
- Seller's Goal: Often a single layer of capital gains tax.
What's the Core Difference Between a Stock and Asset Sale for TCP?
The core difference is what is legally being sold: either the ownership shares of the corporation (stock sale) or the individual assets held within it (asset sale). This choice dictates the tax outcome for everyone involved. On the Tax Compliance and Planning (TCP) exam, you aren't just defining terms; you're advising on the most tax-efficient structure.
Examiners use this topic to test your judgment. They'll give you a scenario and expect you to calculate the buyer's future depreciation, the seller's gain, and identify the character of that gain (capital vs. ordinary).
Studying for CPA TCP? Benchmark your score in 5 minutes.
Get an instant weak-spot assessment and a custom 12-week study plan PDF generated for your exam window.
The most common mistake is focusing on only one party. A candidate might remember that a stock sale is simpler for the seller (one transaction, usually all capital gain) but forget the massive disadvantage for the buyer: a carryover basis in the assets. The buyer is stuck with the seller's old, low basis and loses out on valuable depreciation deductions. To pass, you must analyze the deal from both sides of the table.
To see how these concepts fit into broader tax planning, our guide on CPA Tax Compliance & Planning: Qualified opportunity zones shows how other tax provisions can influence investment decisions. Mastering these interconnected rules is key. Ready to test your current knowledge? Try VoraPrep's adaptive CPA practice questions.
How Do You Decide Which Tax Rules Apply to an Acquisition?
You apply the rules using a decision tree. First, determine if the acquisition is taxable or tax-free. Then, if taxable, determine if it's a stock or asset sale and whether any elections apply.
1. Is the Acquisition Taxable or Tax-Free?This is your first question. The answer depends almost entirely on the type of consideration used.
- Condition: The buyer uses mostly cash or other non-stock property (boot).
- Result (Taxable): Gain or loss is recognized immediately.
- Seller: Recognizes gain/loss. The character depends on what was sold (stock or assets).
- Buyer: Gets a cost basis. If assets are bought, the basis is stepped up to fair market value (FMV). If stock is bought, the target's internal asset basis is unchanged (carryover basis) unless a Section 338 election is made.
- Condition: The buyer uses primarily its own voting stock and meets strict statutory requirements under IRC Section 368.
- Threshold: Must meet doctrines like Continuity of Interest (generally, at least 40% of the total consideration must be acquiring corp stock) and Continuity of Business Enterprise.
- Result (Tax-Free): Gain or loss is deferred, not eliminated.
- Seller: Exchanges old stock for new stock with no current tax. Their basis in the new stock is substituted from their old stock.
- Buyer: Takes a carryover basis in the acquired assets or stock. The target's tax attributes (like Net Operating Losses, or NOLs) also carry over.
This is the most heavily tested distinction.
- Stock Sale (Taxable):
- What Happens: The acquiring corp buys the target's stock from its shareholders.
- Seller (Shareholders): Recognizes capital gain/loss. The target corporation itself does not recognize gain or loss on the sale of its stock by its shareholders. For a C-corp, this avoids a corporate-level tax, making it highly attractive to sellers.
- Buyer: Gets a cost basis in the stock. The target's internal asset basis remains unchanged (carryover basis). This is the buyer's main disadvantage. The target's tax attributes (like NOLs) carry over, but are often severely limited by Section 382.
- Asset Sale (Taxable):
- What Happens: The acquiring corp buys the assets directly from the target corporation.
- Seller (Target Corp): Recognizes gain or loss on each asset. Gain can be ordinary (inventory, Section 1245/1250 depreciation recapture) or capital/Section 1231. For a C-corp, this creates double taxation: tax at the corporate level on the asset sale, then again at the shareholder level upon liquidation.
- Buyer: Gets a cost basis in the assets, stepped up to FMV. The purchase price is allocated among the assets using the residual method under Section 1060. This step-up is a huge advantage, allowing for new, higher depreciation deductions. The target's tax attributes do not carry over.
This is where the exam gets tricky. Section 338 allows a buyer to treat a stock purchase as an asset purchase for tax purposes.
- Condition: The buyer makes a "qualified stock purchase" (QSP)—acquiring at least 80% of the target's stock by vote and value within a 12-month period.
- Action: The buyer makes an election.
- Section 338(g) Election (Buyer Only): The buyer unilaterally elects. The target is treated as selling its assets at FMV. The buyer gets a stepped-up asset basis. The Trap: For a C-corp target, this creates a deemed asset sale gain taxed to the target, while the shareholders are also taxed on their stock sale. This is double taxation and is rarely beneficial unless the target has massive NOLs to absorb the gain.
- Section 338(h)(10) Election (Joint Buyer/Seller): This is the preferred method. It's only available if the target is an S-corp or a subsidiary in a consolidated group. Both buyer and seller must elect. The transaction is treated as a deemed asset sale followed by a tax-free liquidation. This gives the buyer a stepped-up basis but, crucially, results in only one level of tax for the seller (at the shareholder level for an S-corp). It's the best of both worlds.
The exam expects you to know the basic types.
- Type A (Merger): A statutory merger under state law. The most flexible type regarding consideration.
- Type B (Stock-for-Stock): Acquiring corp exchanges solely its voting stock for control (80%) of the target's stock. This is a strict rule; any boot (non-stock consideration) disqualifies the entire transaction from being a Type B reorg.
- Type C (Assets-for-Stock): Acquiring corp gets "substantially all" (e.g., 90% of net/70% of gross assets) of the target's assets, primarily for voting stock. There's a narrow boot exception, but it's very restrictive.
The choice of entity is fundamental here. For more on how entity type affects tax outcomes, see our deep dive on the CPA Regulation: Qualified business income (199A) study guide, as it directly relates to S-corp vs. C-corp decisions.
How Do These Rules Play Out? A Step-by-Step Example
Let's use a realistic scenario to make this concrete.
Scenario: Acme Corp (Buyer) wants to acquire Target Corp (Target), a C corporation. Acme agrees to pay $1,000,000 cash and assume Target's $100,000 of liabilities. The total purchase price is $1,100,000.Target's balance sheet is:
Check Your State’s Exact CPA Exam Requirements
Every state has different credit hour, ethics, and residency rules. Use our 55-jurisdiction checker to verify your eligibility before applying.
| Asset | Adjusted Basis | Fair Market Value (FMV) |
|---|---|---|
| Inventory | $100,000 | $150,000 |
| Equipment (Net) | $200,000 | $350,000 |
| Building (Net) | $300,000 | $500,000 |
| Goodwill | $0 | $100,000 |
| Total Assets | $600,000 | $1,100,000 |
| Liabilities | $100,000 | $100,000 |
| Shareholder Equity | $500,000 | $1,000,000 |
Target's sole shareholder, Mr. Smith, has a $500,000 basis in his stock. The corporate tax rate is 21%.
Question: Analyze the tax consequences under three scenarios:- A taxable asset sale.
- A taxable stock sale (no election).
- A taxable stock sale with a Section 338(g) election.
---
Scenario 1: Taxable Asset Sale- Transaction: Target Corp sells its assets to Acme.
- Seller's Gain (Target Corp):
- Amount Realized: $1,000,000 cash + $100,000 liabilities assumed = $1,100,000.
- Total Asset Basis: $600,000.
- Target Corp's Gain: $1,100,000 - $600,000 = $500,000.
- This gain is a mix of ordinary (inventory, depreciation recapture) and capital/1231.
- Corporate Tax: $500,000 gain * 21% = $105,000.
- Shareholder's Gain (Mr. Smith):
- Target Corp received $1,000,000 cash. After paying tax, it liquidates.
- Cash distributed to Smith: $1,000,000 - $105,000 tax = $895,000.
- Mr. Smith's basis in stock: $500,000.
- Mr. Smith's Capital Gain: $895,000 - $500,000 = $395,000.
- This is classic double taxation.
- Buyer's Basis (Acme Corp):
- Acme's basis in the assets is its cost: $1,100,000. This is a full step-up, allowing for higher depreciation.
---
Scenario 2: Taxable Stock Sale (No Election)- Transaction: Acme buys Mr. Smith's stock.
- Seller's Gain (Mr. Smith):
- Amount Realized: $1,000,000 cash.
- Mr. Smith's Basis in Stock: $500,000.
- Mr. Smith's Capital Gain: $1,000,000 - $500,000 = $500,000.
- There is no corporate-level tax. This is the seller's preferred outcome.
- Buyer's Basis (Acme Corp):
- Acme's basis in the Target stock is $1,000,000.
- Target Corp's internal asset basis remains at $600,000 (carryover basis). Acme gets no step-up and loses depreciation deductions. This is the buyer's main disadvantage.
---
Scenario 3: Taxable Stock Sale with Section 338(g) Election- Transaction: Acme buys Mr. Smith's stock and makes a 338(g) election.
- Seller's Gain (Mr. Smith):
- Identical to Scenario 2. The election does not affect the selling shareholder's treatment.
- Mr. Smith's Capital Gain: $500,000.
- Target Corp's Tax (Deemed Sale):
- Target is treated as if it sold its assets at FMV.
- Deemed Sales Price: $1,100,000.
- Asset Basis: $600,000.
- Target Corp's Deemed Gain: $1,100,000 - $600,000 = $500,000.
- Corporate Tax: $500,000 * 21% = $105,000. This tax is borne by "new" Target, now owned by Acme.
- This is double taxation again, just like the asset sale.
- Buyer's Basis (Acme Corp):
- "New" Target gets a stepped-up asset basis of $1,100,000. Acme gets the depreciation benefits it wants, but at the cost of the immediate corporate-level tax.
Can You Spot the Right Answer Under Exam Pressure?
VoraPrep's adaptive learning engine has over 9,500 questions to sharpen your skills. Here are a few to try.
Sample Q1: Acme Corp acquires 100% of Target Corp's stock for $5M cash. Target is a C-corp with an asset basis of $3M and FMV of $5M. Acme makes no tax elections. Which statement is correct?Ready to see where you stand? Practice all Stock vs. Asset Sales questions in VoraPrep and let our Vory AI tutor explain the answers.
What's the Smartest Way to Study This for the Exam?
This topic demands a strategic approach, not just memorization.
Time Allocation on Exam Day: Plan for 1.5-2 minutes per MCQ on this topic. If it's in a Task-Based Simulation (TBS), your first step is always to identify the transaction type (e.g., "This is a stock sale of an S-corp with a 338(h)(10) election"). Correctly categorizing the deal saves more time than anything else. Connections to Other TCP Topics: This isn't an isolated topic. It directly connects to:- Basis and Depreciation: The entire point of a step-up is to generate future depreciation deductions.
- Character of Income: An asset sale forces you to analyze depreciation recapture (ordinary income) vs. Section 1231 gains.
- Corporate Liquidations: Asset sales are often followed by a liquidation, triggering Sections 331 and 336.
- Tax Attributes: You must know when NOLs carry over (stock sale) and when they don't (asset sale).
- Make a Comparison Chart: Create a simple table with rows for "Asset Sale," "Stock Sale," "Stock Sale + 338(g)," and "Stock Sale + 338(h)(10)." Have columns for "Buyer's Basis," "Seller's Tax," and "Key Feature."
- Drill the "Solely for Voting Stock" Rule: Know that this is a hard-and-fast rule for Type B reorganizations. Any boot breaks it.
- Focus on the "Why": Ask yourself why a buyer would pay more for an asset deal or demand a 338(h)(10) election. The answer is always the present value of future tax savings from depreciation.
For a full breakdown of all sections on the exam, check out the official VoraPrep CPA exam guide.