Notice 2003-65 provides, among other

things, a single safe harbor for computing the NUBIG or NUBIL of a loss corporation, which (i) is based on principles underlying the calculation of net recognized

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built-in gain under section 1374 for purposes of the tax imposed on C corporations that elect to be S corporations, and (ii) analyzes a hypothetical sale or exchange of all assets of the loss corporation to a third party who assumed all of the loss corporation’s liabilities. In addition, Notice 2003-65 provides two safe harbors for the computation of a loss corporation’s RBIG or RBIL: the 1374 approach and the 338 approach. These safe harbors specifically inform the identification of built-in income and deduction items under section 382(h)(6)(A) and (B), and the adjustments to NUBIG or NUBIL that would result under section 382(h)(6)(C).

The 1374 approach identifies RBIG and RBIL at the time of the disposition of a loss corporation’s assets during the recognition period. Generally, this approach relies on accrual method of accounting principles to identify built-in income and deduction items at the time of the ownership change, with certain exceptions. In contrast, the 338 approach identifies items of RBIG and RBIL generally by comparing the loss corporation’s actual items of income, gain, deduction, and loss recognized during the recognition period with those that would have been recognized if an election under section 338 (section 338 election) had been made with respect to a hypothetical purchase of all of the outstanding stock of the loss corporation on the change date. Section V. of Notice 2003-65 provides that taxpayers may rely on either the 338 approach or the 1374 approach until the Treasury Department and the IRS issue temporary or final regulations under section 382(h).

Prior to the issuance of Notice 200365, the Treasury Department and the IRS issued Notice 87-79 (1987-2 C.B. 387) and Notice 90-29 (1990-1 C.B. 336), which provided much more limited guidance regarding the determination of builtin gains and losses. Notice 87-79, which Notice 2003-65 modified, discussed anticipated regulations regarding the interplay of section 382(h) and discharge of indebtedness income. Notice 90-29 set forth an approach that Notice 2003-65 adopted as part of its section 1374 safe harbor, and similarly discussed anticipated regulations (regarding the application of section 382(h) to gains reported using the installment method under section 453). As dis

cussed in more detail in part I.B.2 of this Explanation of Provisions, the Treasury Department and the IRS published Notice 2018-30 (2018-21 I.R.B. 610) following “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Public Law 115-97, 131 Stat. 2054 (2017), commonly referred to as the Tax Cuts and Jobs Act (TCJA). Specifically, Notice 2018-30 makes the section 338 safe harbor of Notice 2003-65 unavailable when computing items arising from bonus depreciation under section 168(k).

III. Response to Notice 2003-65

Over the past fifteen years, the Treasury Department and the IRS have received thoughtful formal and informal commentary highlighting numerous shortcomings of the interim guidance set forth in Notice 2003-65. Examples of these shortcomings include: (i) the overstatement of NUBIG (or understatement of NUBIL) that occurs when a loss corporation has excluded discharge or cancellation of indebtedness income (COD income), (ii) the asymmetry that occurs if certain amounts are included in the NUBIG/NUBIL computation when those amounts cannot be treated as RBIG or RBIL (such as contingent liabilities under the 1374 approach), which appears to contravene section 382(h)(6)(C), and (iii) taxpayer uncertainty and tax administration challenges that arise from a lack of definitive guidance under section 382(h). Commenters and commentators (collectively, commentators) generally have emphasized the simplicity, objectivity, and administrability of the accrual-based 1374 approach, as well as that approach’s close adherence to a plain reading of the statutory text of section 382(h) and section 382(h)’s legislative history. With regard to the 338 approach, commentators generally have appreciated that approach’s attempt to quantify and capture items that were economically built-in at the time of the ownership change, rather than simply accrued under tax accounting principles. Commentators have also noted that the 338 approach will reduce the impact of the recognition period’s limited duration, by not requiring taxpayers to dispose of certain assets within such period to be treated as RBIG. In sum, commentators have ac

knowledged merits, as well as weaknesses, unique to each of the 1374 and 338 approaches but have not reached consensus favoring a universal application of either approach during the 15 years since the IRS published Notice 2003-65.

IV. Enactment of the TCJA

On December 22, 2017, Congress enacted the TCJA, which introduced substantial changes to the Code. These changes have generated significant, additional uncertainty regarding the application of section 382 in general, and Notice 200365 in particular. As described in greater detail in part II. of the Explanation of Provisions, the changes to various provisions of the Code made by the TCJA have exacerbated longstanding, unresolved issues regarding the application of section 382(h) and created new areas of complexity and ambiguity for taxpayers and the IRS. In particular, the Treasury Department and the IRS have identified numerous issues that would arise from the interaction of the 338 approach with various provisions of the Code following the TCJA’s enactment. See Explanation of Provisions, part I.B.2.

Consequently, the Treasury Department and the IRS are issuing these proposed regulations to provide clearer and more comprehensive guidance for taxpayers in applying section 382(h) than that currently provided by notice. The Treasury Department and the IRS have determined that the proposed regulations would (i) simplify the application of section 382, (ii) provide more certainty to taxpayers in determining built-in gains and losses for section 382(h) purposes, and (iii) ensure that difficult questions regarding the application of the TCJA do not further complicate the application of section 382(h). The Treasury Department and the IRS note that, as provided in Section V. of Notice 2003-65, taxpayers may rely on the approaches set forth in Notice 2003-65 for purposes of applying section 382(h) to an ownership change that occurred prior to the issuance of Notice 2003-65 or on or after the issuance of the notice and prior to the effective date of temporary or final regulations under section 382(h). After consideration of all comments regarding the proposed regulations set forth in this notice of proposed

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rulemaking, the Treasury Department and the IRS expect to issue final regulations to adopt the proposed regulations, which may include modifications in response to those comments. It is further expected that the Treasury decision adopting these proposed regulations as final regulations will withdraw and obsolete Notice 200365 and other administrative guidance associated with section 382(h) set forth in the Effect on Other Documents section of this notice of proposed rulemaking.

Explanation of Provisions

I. Proposed Adoption of NUBIG/NUBIL Safe Harbor and 1374 Approach

A. Overview

With regard to the computation of NUBIG and NUBIL, these proposed regulations would adopt as mandatory the safe harbor computation provided in Notice 2003-65 based on the principles of section 1374, with modifications described in part II.B. of this Explanation of Provisions. Regarding the identification of RBIG and RBIL, based on study and taxpayer input, and as discussed further in part I.A. and part I.B. of this Explanation of Provisions, the Treasury Department and the IRS have concluded that the 1374 approach is more consistent with the text and the purpose of section 382 than the 338 approach and would simplify tax administration. Accordingly, these proposed regulations would adopt as mandatory the 1374 approach with certain modifications also described in part II.C. of this Explanation of Provisions.

As previously highlighted, the Treasury Department and the IRS, along with numerous commentators, view favorably the simplicity, objectivity, and administrability of the 1374 approach. The accrual-based 1374 approach to be used in determining RBIG and RBIL is simpler to apply than the 338 approach because, among other reasons, corporate taxpayers and their advisors are familiar with the accrual method of accounting. Indeed, a sizable volume of case law, Code provisions, and regulations govern the accrual method (for example, Schlude v. Commissioner, 372 U.S. 128 (1963), Brown v. Helvering, 291 U.S. 193 (1934), and United States v.

Anderson, 269 U.S. 422 (1926); sections 446, 451, and 461; and the regulations under those Code provisions). In addition, the accrual-based 1374 approach avoids many facts-and-circumstance inquiries by avoiding tracing, valuation uncertainties, and presumptions regarding whether items of income are realized for Federal income tax purposes.

The Treasury Department and the IRS have determined that the certainty provided by the 1374 approach would streamline (i) the calculation of built-in gains and losses for taxpayers, as well as (ii) the administration of this area for the IRS. The 1374 approach turns on an accrual analysis of the loss corporation’s actual transactions and circumstances, and consequently minimizes the importation of new issues arising from changes made by the TCJA, particularly those issues described in detail later in part I.B.2. of this Explanation of Provisions. The Treasury Department and the IRS welcome public comment on the proposed adoption of a modified 1374 approach for determining RBIG and RBIL.

B. Consideration and Proposed Elimination of the 338 Approach

After study, and based on taxpayer input, the Treasury Department and the IRS have decided not to incorporate the 338 approach into these proposed regulations. As described in part I.B.1. of this Explanation of Provisions, the Treasury Department and the IRS have concluded that the 338 approach lacks sufficient grounding in the statutory text of section 382(h). Further, the Treasury Department and the IRS have determined that the mechanics underlying the 338 approach (i) are inherently more complex than the accrual-based 1374 approach, (ii) can result in overstatements of RBIG and RBIL, and (iii) as a result of the TCJA, would require substantial modifications to eliminate increased uncertainty and ensure appropriate results. By eliminating the 338 approach, the Treasury Department and the IRS have determined that these proposed regulations would significantly reduce current and future complexity of section 382(h) computations for taxpayers and the IRS alike. The Treasury Department and the IRS welcome public comment on this

proposed elimination of the 338 approach for determining RBIG and RBIL.

1. Historical Weaknesses of the 338 Approach

The 338 approach originated in subregulatory guidance set forth in Notice 2003-65, and possesses significantly less grounding in the statutory text of section 382(h) than the 1374 approach. The comparatively tenuous connection between the 338 approach and the plain meaning of the statutory text of section 382(h) is exemplified by the method by which the 338 approach identifies RBIG. Under the 338 approach, depreciation deductions on certain built-in gain assets give rise to RBIG, even though no actual recognition of gain or income has occurred. However, sections 382(h)(2)(A) and 382(h)(6)(A) do not authorize RBIG treatment in the absence of actual gain or income recognized by the loss corporation.

Further, commentators have noted that difficult questions arise regarding deemed tiered section 338 elections when the 338 approach is applied to a loss corporation that is the parent of other corporations. For example, there are often significant differences between the basis of stock held by a loss corporation in subsidiaries and the basis of the assets held by the subsidiaries, and those differences create disparate outcomes. Tiered section 338 elections, including with respect to controlled foreign corporations, could have significant impacts on the outcomes produced under this approach.

2. Additional Complications of the 338 Approach Following the TCJA

The Treasury Department and the IRS introduced the 338 approach in 2003 after substantial review of the manner in which then-applicable Code provisions would apply to a section 338 election. In the pre-TCJA environment, provisions of the Code largely would have applied to the taxpayer in the same manner under a hypothetical sale resulting from a section 338 election as those provisions would have applied to the taxpayer without that hypothetical-sale treatment. However, certain important changes under the TCJA have caused the treatment of newly pur

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chased assets to diverge from the treatment of historic assets, thus potentially compromising the mechanics of the 338 approach.

For example, the Treasury Department and the IRS have observed that TCJA amendments to section 168(k) invalidate the key assumption underlying application of the 338 approach to depreciable (“wasting”) assets, which is to reflect an estimate of income or expense generated by an asset during a particular period. Consequently, to prevent unintended collateral consequences of the additional first-year depreciation available under amended section 168(k), the Treasury Department and the IRS published Notice 2018-30 (2018-21 I.R.B. 610). Without the additional guidance set forth in Notice 2018-30, the Treasury Department and the IRS concluded that the 338 approach’s hypothetical cost recovery deduction resulting from a hypothetical application of additional first-year depreciation under section 168(k) would fail to provide a reasonable estimate of the income or expense produced by a built-in gain or loss asset during the recognition period.

Moreover, the Treasury Department and the IRS have identified additional issues that would arise from the interaction of the 338 approach with other provisions of the TCJA, each of which would require extensive study and potentially the issuance of additional guidance. For example, the limitation on a loss corporation’s interest deduction under amended section 163(j) and the modifications to the NOL deduction rules under amended section 172 are each based on variants of taxable income. However, a hypothetical sale of a loss corporation’s assets under section 338 upon an ownership change would result in different taxable income computations than before the TCJA. Unanswered questions related to sections 163(j) and 172 would further complicate application of the 338 approach. Further, income inclusions under section 951A may increase existing concerns (including as a result of potential changes in hypothetical QBAI basis from deemed tiered section 338 elections) arising under the 338 approach. Taken as a whole, the Treasury Department and the IRS have determined that the continued application of the 338 approach likely would not be tenable after

the changes to the Code enacted by the TCJA. The Treasury Department and the IRS request public comment on the proposed elimination of the 338 approach for determining RBIG and RBIL, including detailed comments with regard to whether it would be appropriate within the limits of the statute to consider special rules for insolvent or bankrupt loss corporations, and whether a redefinition of the date on which the recognition period begins would increase simplification.

II. Description of Proposed NUBIG/ NUBIL Safe Harbor and Proposed 1374 Approach

A. Overview

The proposed approach described in this part II incorporates certain modifications to the NUBIG/NUBIL safe harbor and the 1374 approach to ensure greater consistency between (i) amounts that are included in the NUBIG/NUBIL computation and (ii) items that could become RBIG or RBIL during the recognition period. These modifications would better implement the requirements of section 382(h)(6)(C). As described in this part II, the RBIG and RBIL rules remain closely based upon the 1374 approach set forth in Notice 2003-65. However, these proposed regulations would make the modifications described in this part II to improve accuracy, particularly with regard to COD income and deductions for the payment of contingent liabilities.

B. Proposed Rules for Computation of NUBIG or NUBIL

1. In General

The proposed rules regarding the computation of NUBIG/NUBIL set forth in these proposed regulations would capture a range of items that closely tracks the NUBIG/NUBIL safe harbor computation under Notice 2003-65. However, the proposed regulations would enhance the transparency and clarity of that computation by making its component steps more explicit. Specifically, the proposed NUBIG/NUBIL computation first takes into account the aggregate amount that would be realized in a hypothetical disposition of

all of the loss corporation’s assets in two steps treated as taking place immediately before the ownership change. In the first step, the loss corporation is treated as satisfying any inadequately secured nonrecourse liability by surrendering to each creditor the assets securing such debt. In the second step, the loss corporation is treated as selling all remaining assets pertinent to the NUBIG/NUBIL computation in a sale to an unrelated third party, with the hypothetical buyer assuming no amount of the seller’s liabilities. That total hypothetical amount realized by the loss corporation pursuant to steps one and two is then decreased by the sum of the loss corporation’s deductible liabilities (both fixed and contingent), and also decreased by the loss corporation’s basis in its assets. Finally, the decreased hypothetical total is then increased or decreased, as applicable, by the following: (1) the net amount of the total RBIG and RBIL income and deduction items that could be recognized during the recognition period (excluding COD income); and (2) the net amount of positive and negative section 481 adjustments that would be required to be included on the previously-described hypothetical disposal of all of the loss corporation’s assets.

The Treasury Department and the IRS welcome public comment on all aspects of these proposed rules regarding the computation of NUBIG and NUBIL.

2. Proposed Adjustments to Account for Built-in COD Income

Section 61(a)(12) of the Code provides that gross income includes COD income, except as provided by law. Section 108(a) provides, in part, that gross income of a C corporation does not include COD income of the taxpayer if the discharge occurs in a title 11 case, or the discharge occurs when the taxpayer is insolvent, but only to the extent of the insolvency (excluded COD income).

If a taxpayer has excluded COD income, section 108(b)(1) requires the taxpayer to reduce its tax attributes by the amount excluded. In general, pursuant to section 108(b)(2), tax attributes are reduced in the following order: NOLs and NOL carryovers, general business credits under section 38, minimum tax credits under section 53(b), net capital losses and

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capital loss carryovers, asset basis, passive activity loss and credit carryovers under section 469(b), and foreign tax credits and foreign tax credit carryovers. Any amount of debt discharge that remains after attribute reduction is not includible in income. See H.R. Rep. No. 96-833 at 11 (1980); S. Rep. No. 96-1035 at 13 (1980).

These provisions are designed to “preserve the debtor’s ‘fresh start’ after bankruptcy.” H.R. Rep. No. 96-833 at 9 (1980); see S. Rep. No. 96-1035 at 10 (1980). In addition, they are intended to “carry out the Congressional intent of deferring, but eventually collecting within a reasonable period, tax on ordinary income realized from debt discharge.” H.R. Rep. No. 96833 at 9 (1980); see S. Rep. No. 96-1035 at 10 (1980). By making attributes unavailable to offset income in later years, the provisions offer the debtor a temporary, rather than a permanent, deferral of tax.

As discussed in part II of the Background section, significant uncertainty has existed with regard to administering the built-in gain and loss framework of section 382(h). However, in administering this area, the Treasury Department and the IRS have always sought to implement a guiding principle discussed in the section 382 legislative history, which is commonly referred to as the “neutrality principle.” Under this principle, the built-in gains and losses of a loss corporation, once recognized after an ownership change, generally are to be treated in the same manner as if they had been recognized before the ownership change. For example, it is the neutrality principle that causes RBIL to be limited in the same manner as a pre-change NOL carryforward or net capital loss carryforward. Similarly, in the built-in gain context, the neutrality principle dictates that section 382-limited losses be freely usable against RBIG because, had the gain been taken into account before the ownership change, use of the loss would not have been subject to (that is, limited by) section 382. Under section 382(h), RBIG results in a dollar-for-dollar increase in the loss corporation’s section 382 limit in order to replicate this pre-ownership change treatment. See S. Rep. No. 99-313 at 235; H.R. Rep. No 99-426 at 261.

In Notice 2003-65, the Treasury Department and the IRS attempted to provide

guidance integrating into the NUBIG/NUBIL computation the amount of insolvency of the loss corporation (the amount by which its liabilities exceed the value of its assets) and, therefore, the maximum possible amount of “built-in” COD income, as of the change date. However, Notice 2003-65 does not distinguish between the eventual excluded or included nature of COD income actually recognized by the loss corporation during the recognition period. After administrative experience under Notice 2003-65 and as highlighted by commentators, the Treasury Department and the IRS have determined that this failure to distinguish between includable and excludable COD income results in the overstatement of RBIG (or understatement of RBIL) in contravention of section 382(h)(6)(C). This failure also effectively provides for a duplicated benefit under the section 382(h) RBIG rules in certain cases. The Treasury Department and the IRS interpret section 382(h)(6)(C) as requiring inclusion in the NUBIG/NUBIL computation only the amounts that would be treated as RBIG or RBIL if those amounts were properly taken into account during the recognition period.

Further, the Treasury Department and the IRS have determined that the treatment of COD income under Notice 2003-65 violates the neutrality principle previously discussed. The Treasury Department and the IRS have determined that RBIG treatment (as well as the ancillary increase in NUBIG or decrease in NUBIL) should be available only to the extent that the neutrality principle requires an increase in the loss corporation’s section 382 limitation.

The application of the attribute reduction rules of section 108(b) to excluded COD income complicates the RBIG and NUBIG calculation. The Treasury Department and the IRS understand that most excluded COD income is offset under section 108(b) by reducing tax attributes of the loss corporation that are treated as pre-change losses under section 382. To the extent that pre-change losses have already been used to offset this pre-change income, the neutrality principle prohibits an increase in the section 382 limitation. Indeed, such an increase could make excluded COD income more attractive than included COD income (or any other builtin gain item) for purposes of section 382.

For this reason, the Treasury Department and the IRS have determined that the recognition of such excluded COD income should not generate RBIG. Because NUBIG functions as a ceiling on the amount of RBIG that may be claimed (and the corresponding amount of increase in the section 382 limitation), there does not appear to be a policy need nor a statutory basis for adjusting the NUBIG/NUBIL computation if there is no need to increase the section 382 limitation.

Inclusion of excludable COD income in the calculation of NUBIG/NUBIL would be particularly distortive if a loss corporation deconsolidates from a group as a result of its ownership change, and recognizes excludable COD income on the change date. Under the consolidated return regulations, any excludable COD income recognized on the date of deconsolidation is treated as attributable to the taxable year of the transferor group (rather than post-change, in the loss corporation’s separate taxable year). Therefore, such excludable COD income should not be treated as RBIG (pre-change income recognized in the post-change period).

Accordingly, these proposed regulations generally would not allow COD income to be included in the calculation of NUBIG/NUBIL, but would provide certain exceptions. Includable COD by its nature is not complicated by the interaction of section 108(b). Therefore, to satisfy the neutrality principle, all includable COD income of the loss corporation that is recognized on recourse debt during the 12-month period following the change date would be eligible for inclusion in the NUBIG/NUBIL computation, subject to limitations discussed in part II.C.2 of this Explanation of Provisions. However, these proposed regulations would permit excluded COD income items to be treated as RBIG (and thus affect NUBIG/NUBIL calculation) only to the extent described in part II.C of this Explanation of Provisions. The Treasury Department and the IRS welcome public comment on the proposed regulations’ approach regarding excludible and includible COD income in calculating NUBIG and NUBIL, including comments with regard to whether it would be appropriate within the limits of the statute to consider special rules for insolvent or bankrupt loss corporations. Comments

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are also invited with regard to the possibility of redefining the recognition period to begin on the date after the ownership change, and any issues that might be eliminated or created by such a redefinition.

C. Proposed Rules for Identification of RBIG and RBIL Income and Deduction Items

1. In General

These proposed regulations would apply a methodology for identifying RBIG or RBIL that closely tracks the 1374 approach described in Notice 2003-65. This approach is generally accrual based, with specific exceptions. Many of the special rules incorporated in these proposed regulations originate in regulations underlying section 1374. However, these proposed regulations would make minor changes to improve the computational accuracy of the 1374 approach. For example, in response to comments on Notice 2003-65, these proposed regulations would provide an improved methodology for computing the amount of depreciation deductions treated as RBIL during the recognition period.

In addition, these proposed regulations would significantly modify the 1374 approach set forth in Notice 2003-65 to include as RBIL the amount of any deductible contingent liabilities paid or accrued during the recognition period, to the extent of the estimated value of those liabilities on the change date. Commentators noted that Notice 2003-65 appeared to include this estimated amount in its NUBIG/ NUBIL computation, but did not treat deductible liability payments or accruals as RBIL. That incongruity contravenes section 382(h)(6)(C), which requires that items be included in the NUBIG/NUBIL computation if they would be treated as RBIG or RBIL if properly taken into account during the recognition period.

Further, these proposed regulations would add a rule clarifying that certain items do not constitute RBIG. For example, the proposed regulations provide that dividends paid on stock during the recognition period are not RBIG, even if the loss corporation has a NUBIG and there is gain built into the pertinent stock immediately before the ownership change. On the

other hand, gain recognized on the disposition of stock generally would be treated as giving rise to RBIG. However, gain taxable as a dividend under section 1248 would generally give rise to a deduction under section 245A, with no net income being generated. Because no losses would be required to offset this item of income, the Treasury Department and the IRS have determined that this income item should not give rise to RBIG.

The Treasury Department and the IRS welcome public comment on the proposed regulations’ identification of RBIG and RBIL. In particular, the Treasury Department and the IRS request comments regarding whether dividends paid on builtin gain stock should constitute RBIG, and whether final regulations should clarify the eligibility of other, similar income items for RBIG treatment.

2. Proposed Treatment of COD Income as RBIG

These proposed regulations would provide limitations on the extent to which excluded COD income is treated as RBIG, and thus would impact the calculation of NUBIG/NUBIL. As discussed in part II.B.2 of this Explanation of Provisions, RBIG effectuates the neutrality principle in the post-change period and therefore COD income must be able to be taken into account during the post-change period in order to qualify for RBIG status. Thus, COD income that is taken into account during the pre-change period (for example, excluded COD income recognized by a consolidated group member on an ownership change that causes the member to deconsolidate) should not qualify as RBIG. The proposed regulations also provide that COD income recognized during the post-change period generally would not be treated as RBIG. However, these proposed regulations would provide taxpayers with the option to treat certain COD income recognized during the first 12 months of the recognition period as RBIG (and consequently to make corresponding adjustments to the taxpayer’s NUBIG/NUBIL computation). For example, the proposed regulations provide that COD income on recourse debt that is included in a loss corporation’s taxable income under section 61(a)(12) during the

first 12 months of the post-change period would be treated as RBIG as described in part II.B.2. of this Explanation of Provisions. Therefore, the loss corporation’s section 382 limitation would be increased by the amount of such COD income, and pre-change losses may be deducted in the amount of the COD income. The 12-month limitation on RBIG treatment is adopted from the 1374 approach under Notice 2003-65.

Under the proposed regulations, excluded COD income recognized during the post-change period generally would not be treated as RBIG, in order to prevent the duplication of section 382 benefits. For example, if excluded COD income recognized during the post-change period (but not included in a loss corporation’s income) is offset by pre-change losses, the loss corporation would receive the same benefit as a loss corporation that recognized included COD income: the ability to offset the COD income with pre-change losses. Therefore, the Treasury Department and the IRS have determined that extending the additional benefit of RBIG treatment (and the resulting increase in NUBIG or decrease in NUBIL) to postchange period excluded COD income generally would result in a duplication of section 382 benefits to the loss corporation.

However, these proposed regulations would provide two exceptions to this general rule to address cases in which excluded COD income recognized by a loss corporation during the first 12 months of its post-change period is offset by postchange tax attributes under section 108(b) or by basis reduction in assets held as of the change date under section 1017. To the extent that excluded COD income is offset by post-change tax attributes, the loss corporation would not yet have used prechange loss equal to the amount of that excluded COD income. Therefore, the excluded COD income would be treated as RBIG, and the loss corporation’s NUBIG/ NUBIL would be adjusted accordingly. Similarly, to the extent that excluded COD income is offset by reduction in the tax basis of assets held immediately before the ownership change, the loss corporation would not have used pre-change loss equal to that excluded COD income. Under these proposed regulations (as un

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der Notice 2003-65), that basis reduction would be treated as occurring immediately before the ownership change. As a result of that basis reduction, the corresponding amount of excluded COD income would be included in the NUBIG/NUBIL computation, and no further adjustment would be necessary. Accordingly, the excluded COD income would not be treated as RBIG, to avoid double-counting. Any additional gain on the disposition of assets during the recognition period resulting from the basis adjustment would be treated as RBIG, to the extent of the NUBIG limitation.

Different treatment is required, to the extent that excluded COD is offset by reduction in the tax basis of assets that were acquired after the ownership change. The basis adjustments to those assets would not result in an adjustment to NUBIG/ NUBIL, nor could any RBIG be produced from those assets because assets not held at the time of the ownership change are not included in the NUBIG/NUBIL computation. Similarly, RBIG cannot be generated on the sale of assets that were not held at the time of the ownership change. Therefore, the excluded COD income would be treated as RBIG and the NUBIG/NUBIL would be adjusted accordingly.

The Treasury Department and the IRS welcome public comment on the proposed regulations’ approach regarding the treatment of excludible and includible COD income as RBIG. Further, the Treasury Department and the IRS request comments regarding what rules should govern the treatment of COD that is excluded under section 108(a)(1)(C) and (D) (qualified farm indebtedness and qualified real estate business indebtedness).

3. Overall limitations on amount of RBIL for COD on Recourse Debt

These proposed regulations set forth two different RBIG ceilings with regard to COD on recourse debt. The first ceiling applies to taxpayers that are in bankruptcy at the time of the ownership change, and have COD income pursuant to that bankruptcy action during the first twelve months of the recognition period. The maximum RBIG for those taxpayers related to excluded COD income would be the amount of indebtedness discharged

in that bankruptcy action. The second ceiling applies to all other taxpayers who recognize COD income during the first twelve months of the recognition period. The maximum RBIG for those taxpayers is the excess of liabilities over asset value immediately before the change date, with certain adjustments. Adjustments must be made to avoid double counting amounts of excluded COD that are offset by reductions in asset basis under sections 108(b) and 1017. The Treasury Department and the IRS welcome public comment on these two RBIG ceilings with regard to COD income on recourse debt.

4. Special Rules for Nonrecourse Debt

RBIG status for COD income on nonrecourse debt recognized in the first 12 months of the recognition period is subject to rules similar to those previously described. However, such COD income is treated as built-in gain only to the extent that the nonrecourse debt was under-secured immediately before the ownership change. Because a nonrecourse creditor has a claim only on the assets securing the indebtedness, the amount of the impairment at the time of the ownership change is the appropriate measure of built-in COD in the nonrecourse debt. Further, RBIG recognized on nonrecourse debt during the recognition period does not result in an adjustment to NUBIG/NUBIL, because the amount of the impairment to the nonrecourse debt is already built into the initial NUBIG/NUBIL computation with regard to the deemed disposition of assets. The Treasury Department and the IRS welcome public comment on the treatment of COD income on non-recourse debt, including comments on the treatment of accrued but unpaid interest.

D. Interactions between sections 163(j) and 382

The addition of new section 163(j) under the TCJA has created numerous issues concerning the interaction of those interest deduction limitations with section 382. These proposed regulations attempt to eliminate the possibility of duplication of RBIL items, as well as to clarify the treatment under section 382 of certain items that are allocated from a partnership.

1. Elimination of Possible Duplicative Recognized Built-in Loss

Proposed §1.382-7 addresses the possible duplicative application of section 382 to certain disallowed business interest expense carryforwards, including the portion of any disallowed business interest expense of the old loss corporation that is (i) paid or accrued in the taxable year of the testing date (as defined in §1.382-2(b)(4)), (ii) attributable to the pre-change period, and (iii) carried forward into later years (collectively, a section 382 disallowed business interest carryforward). Section 382 disallowed business interest carryforwards are subject to section 382 by virtue of section 382(d)(3), which treats any section 163(j) (2) carryover from a pre-change period as a pre-change loss. Additionally, such carryforwards are potentially subject to the section 382 limitation under section 382(h) (6) as RBIL. Section 382(h)(6)(B) provides that any amount allowable as a deduction during the recognition period (within the meaning of section 382(h)(7)), determined without regard to any carryover, that is attributable to periods before the change date is treated as a RBIL for the taxable year for which it is allowable as a deduction. Further, section 382(h)(6)(C) provides that the amount of NUBIG or NUBIL must be properly adjusted for amounts that would be treated as RBIG or RBIL under section 382(h)(6) if such amounts were properly taken into account or allowable as a deduction during the recognition period.

Section 382 disallowed business interest carryforwards should not be counted twice for purposes of the application of section 382. Subjecting the same section 382 disallowed business interest carryforward to the section 382 regime in two different ways could result in a double reduction of the annual section 382 limitation. Moreover, because disallowed business interest expense carryforwards would be absorbed before NOL carryovers under proposed §1.383-1(d), subjecting the same disallowed business interest expense carryforward to the section 382 regime twice could preclude taxpayers from utilizing their NOL carryovers or other attributes. In addition, treatment of disallowed business interest carryforwards as potential RBIL would result in an unwarranted increase in NUBIL (or decrease in NUBIG).

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Accordingly, proposed §1.382-7(d)(5) would provide that section 382 disallowed business interest carryforwards would not be treated as RBIL under section 382(h) (6)(B) if such amounts were allowable as a deduction during the recognition period.

2. Treatment of Excess Business Interest Expense of a Partnership

Proposed §1.382-7 addresses the application of section 382(h) to excess business interest expense of a partnership to the extent that the item was not suspended under section 704(d) and is allocable to an old loss corporation (as partner) with regard to a period prior to an ownership change (section 382 excess business interest expense). Section 382(h)(3)(A)(i) provides that the amount of the old loss corporation’s NUBIG or NUBIL includes the amount by which the aggregate fair market value of certain assets is more or less than the aggregate adjusted basis of such assets. As provided in section 163(j)(4) (B)(iii) and proposed §1.163-6(h)(3)(i), if a partner disposes of all or substantially all of its partnership interest, the adjusted basis of the partner in the partnership interest would be increased immediately before the disposition to reflect the partner’s section 382 excess business interest expense from the partnership, if any. Therefore, proposed §1.382-7(c)(3)(iii)(E) would provide that, for purposes of determining RBIL under section 382(h)(2)(B)(ii), as well as for computing NUBIG or NUBIL under section 382(h)(3)(A), a loss corporation’s adjusted basis in a partnership interest is adjusted as if the loss corporation disposed of all or substantially all of its partnership interests immediately before the ownership change.

During the recognition period, a deduction or loss equal to the section 382 excess business interest expense could be recognized either when the loss corporation is able to deduct the section 382 excess business interest expense, or when it sells all or substantially of its partnership interest. In either case, such amount is properly characterized as RBIL. However, in either case, no adjustment to the loss corporation’s NUBIG or NUBIL computation would be necessary, because the positive adjustment to the basis of the partnership interest ensures that an amount equal to

the section 382 excess business interest expense is included in the computation.

A partner also can be allocated section 382 excess business interest expense that is characterized as negative section 163(j) expense. See §1.163(j)-6(h)(1) as proposed in REG-106089-18 (83 FR 67490, 67556 (Dec. 28, 2018)). Negative section 163(j) expense does not reduce the partner’s basis in the partnership and therefore would not be taken into account if the partner sold all or substantially all of its partnership interest. However, if the loss corporation were able to deduct the negative section 163(j) expense during the recognition period, then such expense presumably could be treated as RBIL pursuant to section 382(h)(6)(B). These proposed regulations do not address whether deductions resulting from negative section 163(j) allocations are RBIL. The Treasury Department and the IRS request comments as to whether a corporate partner’s section 382 excess business interest expense and negative section 163(j) expense should be treated as a built-in item under section 382(h)(6) or as a section 382 disallowed business interest carryforward, and therefore be treated as a pre-change loss.

Applicability Dates

Section 7805(b)(1)(A) and (B) of the Code generally provides that no temporary, proposed, or final regulation relating to the internal revenue laws may apply to any taxable period ending before the earliest of (A) the date on which such regulation is filed with the Federal Register, or (B) in the case of a final regulation, the date on which a proposed or temporary regulation to which the final regulation relates was filed with the Federal Register .

Except as otherwise provided in the following sentence, these regulations are proposed to be effective for ownership changes occurring after the date the Treasury decision adopting these proposed regulations as final regulations is published in the Federal Register . However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b) (1), may apply these proposed regulations to any ownership change occurring during a taxable year with respect to which the period described in section 6511(a) has not

expired, so long as the taxpayers and all of their related parties consistently apply the rules of these proposed regulations to such ownership change and all subsequent ownership changes that occur before the applicability date of final regulations.

Effect on Other Documents

The following publications are proposed to be withdrawn and obsoleted effective the day after the date the Treasury decision adopting these proposed regulations as final regulations is published in the Federal Register :