The Consistency Rule: Asset and Stock Rules Explained

In corporate acquisitions, Internal Revenue Code Section 338 allows a corporation that buys another company’s stock to treat the transaction as an asset purchase. This treatment is beneficial because the buyer can “step up” the tax basis of the target’s assets to their fair market value, leading to larger future depreciation deductions. The consistency rule exists to prevent buyers from gaining an unfair tax advantage.

Without it, a buyer could purchase specific, high-value assets to get a stepped-up basis, and then purchase the target’s stock without a Section 338 election. This “cherry-picking” allows the buyer to maximize tax benefits while the seller avoids the corporate-level tax a full asset sale would trigger. The rules under Treasury Regulation § 1.338-8 ensure transactions are treated uniformly as either a stock or an asset sale.

The Consistency Period Explained

The consistency rule applies only within a specific timeframe known as the “consistency period,” which is a multi-part timeline centered on the acquisition. The period is composed of three parts that combine to span more than two years. The first component is the one-year period before the start of the 12-month acquisition period. The second is the acquisition period itself, the 12-month timeframe during which an acquirer must complete a “qualified stock purchase” of at least 80% of the target’s stock. The third component is the one-year period after the acquisition date, which is the first day the qualified stock purchase is complete.

To illustrate, imagine P Corp begins buying stock in Target Corp on March 1, 2025. P Corp completes the 80% purchase on November 1, 2025, making this the acquisition date. The consistency period would begin one year before the start of the acquisition period (March 1, 2024), run through the acquisition, and end one year after the acquisition date (November 1, 2026). Any relevant transactions during this timeframe are subject to the rules.

Understanding the Asset Consistency Rule

The asset consistency rule is the primary mechanism for preventing the selective step-up in asset basis. It applies when a corporation purchases an asset from a target during the consistency period and also completes a qualified stock purchase of that same target without making a Section 338 election. This is particularly relevant when the target is part of a consolidated group, as the seller’s gain on the asset sale can increase its basis in the target stock, reducing the taxable gain on the subsequent stock sale.

The main consequence of triggering the rule is that the acquiring corporation cannot take a cost basis in the purchased asset. Instead, it is forced to take a “carryover basis,” meaning it inherits the same basis in the asset that the target had. This counteracts the buyer’s attempt to selectively step up an asset’s basis while avoiding a full Section 338 election.

For example, Acquirer Inc. buys a patent from Target Corp for its $2 million fair market value, though Target’s tax basis is only $50,000. Shortly after, Acquirer Inc. buys all of Target Corp’s stock but does not make a Section 338 election. The asset consistency rule would apply, and Acquirer Inc.’s basis in the patent would be carried over at $50,000, not the $2 million purchase price. This outcome eliminates the economic incentive for such a transaction.

Understanding the Stock Consistency Rule

The stock consistency rule addresses acquisitions involving multiple related companies from the same selling consolidated group. This rule applies when an acquiring corporation buys the stock of a target and, during the consistency period, also purchases the stock of one or more of that target’s affiliates. The purpose is to enforce uniform tax treatment and prevent a mix-and-match approach to Section 338 elections.

If the acquirer makes a Section 338 election for the first target, it is deemed to have made the same election for any other target affiliate purchased from the same group during the consistency period. This creates an all-or-nothing proposition. It prevents a buyer from making an election for a target affiliate with high-basis assets to create a tax loss, while not making an election for the parent target holding low-basis, high-gain assets. Current regulations have narrowed this rule’s application to situations needed to prevent avoidance of the asset consistency rules.

Protective Carryover Basis Elections

In the past, the consistency rules were more punitive, as the IRS had the authority to force a “deemed” Section 338 election on a transaction if a buyer violated the asset consistency rule. This could result in a surprise tax liability for the acquirer. To manage this risk, acquirers could make a “protective carryover basis election,” a formal statement filed with a tax return to proactively accept a carryover basis for any asset purchase that might trigger the rule.

Under current regulations, this formal protective election is obsolete. The rules now automatically impose a carryover basis on an asset when the consistency rule is triggered. A deemed Section 338 election is no longer a tool the IRS can use in this context. This evolution provides the same protection the old election secured, making the mandatory carryover basis the direct and automatic consequence.