Uh, elections out of sub K mean that there is no "eligible entity" because there is no "business entity" for tax purposes. You must have a business entity to have an eligible entity. This all is in the 7701 regs referenced in the 121 regs cited by @Anonymous_.
Elections out result in co-ownership--the entity is disregarded, and the spouses are treated as direct owners for tax purposes--which isn't the same as a disregarded entity under the 7701 regs but has a similar effect. Co-ownership generally is contemplated under 121.
