Notice 87-79 (1987-2 — Internal Revenue Bulletin 2019-40

Notice 90-27 (1990-1 C.B. 336) Notice 2003-65 (2003-2 C.B. 747) Notice 2018-30 (2018-21 I.R.B. 610)

Special Analyses

I. Regulatory Planning and Review – Economic Analysis

Executive Orders 12866 and 13563 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including (i) potential economic, environmental, and public health and safety effects, (ii) potential distributive impacts, and (iii) equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, reducing costs, harmonizing rules, and promoting flexibility.

These proposed regulations have been designated as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) (MOA) between the Treasury Department and the Office of Management and Budget (OMB) regarding review of tax regulations. The Office of Information and Regulatory Affairs has designated these proposed regulations as significant under section 1(b) of the MOA. Accordingly, the OMB has reviewed these proposed regulations.

A. Background

In general, section 382 limits the usage of a corporation’s tax attributes after that corporation experiences an ownership

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change. Limited tax attributes include, among other items, NOLs and built-in losses. The limit equals the product obtained by multiplying a prescribed interest rate by the value of the stock of the corporation (referred to as the “old loss corporation”) on the change date. This product represents a proxy for the amount of income created by the assets held by the corporation prior to the ownership change. The section 382 limit reflects Congress’s intent that, generally, NOLs should not be more valuable to an acquirer than to the going concern that created them. In the conference report to the Tax Reform Act of 1986, Congress expressed that the previously described formula “is necessary to ensure that the value of NOL carryforwards to the buying corporation is not more than their value to the loss corporation.” H.R. Rep. No. 99-841, at II-185 (1986).

Section 382(h) specifies the treatment of gains and losses accrued by a corporation prior to a change in ownership. As explained in the legislative history, the rules are intended to treat built-in gains and losses that are recognized after the ownership change the same as if they had been recognized before the ownership change. As described by Congress, “[i]f builtin losses were not subject to limitations, taxpayers could reduce or eliminate the impact of the general rules by causing a loss corporation (following an ownership change) to recognize its built-in losses free of the special limitations (and then invest the proceeds in assets similar to the assets sold).” Joint Committee on Tax’n, General Explanation of the Tax Reform Act of 1986 (Pub. L. 99-514) (May 4, 1987), JCS-10-87, at p. 298. The neutral treatment of gains and losses recognized before and after a change in ownership is accomplished by allowing the recognition of built in gain to increase the section 382 limitation whereas the recognition of built in loss is subject to the section 382 limitation.

The following example (Example 1) illustrates this principle. Assume that a loss corporation (LossCorp), as of the change date, has $500 in NOL carryforwards and holds only one asset (Asset A) with a fair market value of $100 and a basis of $120. If LossCorp disposed of Asset A immediately prior to the ownership change, a $20

loss would be recognized. Additionally, assuming the taxpayer made a closing-ofthe-books election under §1.382-6(b), the amount of the NOL carryforwards would be $520. If instead, Asset A was disposed of after the change date, then sections 382(h)(1) and 382(h)(2) recognize that the $20 loss is attributable to the period prior to the ownership change and therefore subject it to a section 382 limitation in the same manner as if it was an NOL carryforward (disregarding a de minimis threshold rule set forth in section 382(h)(3)(B)). In the language of section 382, the $20 loss would be RBIL (that is, recognized builtin loss). These rules operate to eliminate the significance of the disposition’s timing and preserve neutrality.

Alternatively, assume in this example (Example 2) that Asset A’s fair market value on the change date were $150, and thus LossCorp had a built-in gain on the asset. If LossCorp disposed of Asset A prior to the change date, assuming the taxpayer made a closing-of-the-books election under §1.382-6(b), then the $30 in income would reduce its NOL carryforward to $470. If instead Asset A were disposed of after the change date, then sections 382(h) (1) and 382(h)(2) recognize that the $30 gain is attributable to the period prior to the ownership change and therefore increases LossCorp’s section 382 limitation for the year (disregarding the de minimis threshold rule set forth in section 382(h) (3)(B)), thereby allowing LossCorp to freely use the pre-change NOLs to offset the $30 in income. In the language of section 382, the $30 in income would be RBIG (that is, recognized built-in gain). In this fact pattern, the rules under section 382 would eliminate the significance of the disposition’s timing and preserve neutrality by allowing the NOLs to be applied following the ownership change with respect to gain that was “built-in” prior to the ownership change.

Under section 382(h), the total amount of RBIL must not exceed NUBIL (that is, net unrealized built-in loss) and the total amount of RBIG must not exceed NUBIG (that is, net unrealized built-in gain). More precisely, at the change date, a loss corporation must compute the difference between the aggregate fair market value and aggregate basis of all of its assets. In general, (i) to the extent that this difference

is positive, a NUBIG results; and (ii) to the extent that the difference is negative, a NUBIL results. Both NUBIG and NUBIL are adjusted by section 382(h)(6)(C), as discussed below. NUBIG and NUBIL act as limitations to the aggregate amount of RBIG and RBIL recognized during the recognition period. For illustration, if Example 2 were modified so that LossCorp owned additional assets such that it had NUBIL, the disposition of Asset A would not create RBIG.

These proposed regulations would primarily address the subcomponents of RBIL, RBIG, NUBIL, and NUBIG that are provided for by section 382(h)(6). Specifically, section 382(h)(6)(A) provides that income items that are “properly taken into account during the recognition period,” but which are “attributable to periods before the change date,” are treated as RBIG. Section 382(h)(6)(B) provides a similar rule for deductions to be treated as RBIL. Section 382(h)(6)(C) provides that the amount of potential income items under section 382(h)(6)(A) increases NUBIG (or reduces NUBIL), whether or not the income items were actually taken into account during the recognition period. Analogously, section 382(h)(6)(C) provides that the amount of potential deduction items under section 382(h)(6)(B) increases NUBIL (or reduces NUBIG), whether or not the deduction items were actually allowable as a deduction during the recognition period. The proposed regulations clarify the definition and calculation of these components.

As is the case for section 382(h) generally, the rules under section 382(h)(6) are again intended to preserve neutrality between pre- and post-change date transactions. Income items recognized prior to the change date may have been freely offset with pre-change NOLs; thus, if those same income items were recognized after the change date, the neutrality principle requires that pre-change NOLs be allowed to freely offset it. RBIG treatment accomplishes this effect. Similar logic applies with respect to deduction items.

In response to substantial uncertainty regarding which income and deduction items qualify under section 382(h)(6), the IRS issued Notice 2003-65. Generally, Notice 2003-65 provides two safe harbors for computing these items. The first

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safe harbor, referred to as the “1374 approach” (named after section 1374, which addresses tax consequences regarding built-in gains of C corporations that become S corporations), relies generally on accrual method of accounting principles. The second safe harbor, referred to as the “338 approach,” compares actual amounts of income and deductions to the amounts that would have been realized had a section 338 election been made with respect to a hypothetical stock purchase on the change date. Notice 2018-30 amended Notice 2003-65 by reversing an unintended change to both safe harbors that resulted from TCJA amendments to section 168(k). Broadly, for reasons discussed below, these proposed regulations would make mandatory the 1374 approach with certain adjustments. These adjustments include technical fixes to calculations involving COD income (that is, cancellation of indebtedness income), deductions for contingent liabilities, and cost recovery deductions. Additionally, these proposed regulations clarify that carryovers of section 163(j) disallowed business interest are counted only once for the purpose of section 382.

B. No-action Baseline

The Treasury Department and the IRS have assessed the benefits and costs of the proposed regulations relative to a no-action baseline reflecting anticipated Federal income tax-related behavior in the absence of these proposed regulations.

C. Economic Analysis of Proposed Regulations

Framework

In evaluating the economic efficiency of these proposed regulations, this analysis considers two main factors. The first factor regards compliance and administration costs. Mergers and acquisitions can be very complicated transactions; thus, compliance with certain aspects of Federal income tax law can be onerous for taxpayers, and examination can be difficult for the IRS. As discussed further below the Treasury Department projects that the proposed regulations will reduce compli

ance and enforcement costs relative to the baseline primarily by eliminating duplicative and potentially complicated calculations required to apply the 338 approach. Greater efficiencies will also be gained under the proposed regulations by reducing taxpayer disputes with the IRS regarding the application of the 1374 approach.

The second factor considered is whether changes in mergers and acquisitions potentially induced by the proposed regulations are likely to be efficiency-enhancing or efficiency-reducing. If a merger increases value only because of increased potential NOL usage, then that merger would be economically inefficient (even ignoring antitrust concerns). Section 382 attempts to ensure that the NOLs of the loss corporation can be used to the same extent whether or not the loss corporation is acquired by another corporation, which implies that no transaction would take place solely to increase NOL use. However, currently issued guidance regarding section 382 may not strike that balance perfectly. It is the determination of the Treasury Department and the IRS that, for the reasons discussed below, the currently issued guidance on section 382(h) allows too much NOL usage relative to the neutral baseline. These proposed regulations would modestly restrict NOL usage by reducing the amount that would qualify as RBIG, reducing the incentive to engage in inefficient, tax-motivated mergers and acquisitions.

The Treasury Department and the IRS have not quantified the expected gains to the U.S. economy arising from the discretionary aspects of the proposed regulations but expect them to be less than $100 million per year ($2019), a threshold established by the MOA and Executive Order 12866. For reasons discussed further in section C.2. of the analysis, the Treasury Department and IRS project that the effect of the proposed regulations on the number of mergers and acquisitions will be small. The Treasury Department and the IRS additionally project that the change (that is, reduction) in compliance costs will also be modest. The Treasury Department and the IRS solicit comments on this conclusion and particularly solicit comments that provide data, evidence, or models that would enhance the rigor by which the non-revenue economic effects

might be determined for the final regulations.

Making the 1374 approach mandatory

The Treasury Department and the IRS have determined that the 1374 approach would be simpler for taxpayers to comply with, and simpler for the IRS to administer. Under Notice 2003-65, as modified by Notice 2018-30, taxpayers subject to section 382 would typically compute estimates of NUBIG/NUBIL and RBIG/RBIL under both the 1374 and 338 approaches to determine which approach would provide the more favorable result. Such duplicative compliance costs are inherently economically wasteful, even if they may have been privately optimal (in other words, they generated expected tax savings for the corporation in excess of compliance costs). Under these proposed regulations, taxpayers would make computations under only one approach, thereby reducing inefficient compliance burdens.

In addition, the 1374 approach has lower compliance costs than the 338 approach. Under the 1374 approach, taxpayers need only record items of income and deductions that they already account for under well-known accrual method of accounting principles. Furthermore, the IRS can easily verify such amounts during an examination. Under the 338 approach, taxpayers must consider a hypothetical transaction involving deemed asset sales. With respect to tiered corporate structures, an ownership change of the corporate parent would require the analysis of deemed asset sales not only at the corporate-parent level, but also an analysis of deemed asset sales at every lower corporate level. The 338 approach would pose significant, iterative complexity for corporate structures with several tiers of subsidiaries.

The Treasury Department and the IRS have determined that between 7,000 and 15,000 firms per year will be affected by these proposed regulations, based on the checkbox on Line 16 of Form 1120, Schedule K and other tax attributes. These firms will see a reduction in compliance costs under the 1374 approach, if they were using the 338 approach or performing calculations under both approaches under the baseline. The Treasury Department and the IRS request public comment

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on any anticipated changes in compliance costs due to the proposed elimination of the 338 approach.

The Treasury Department and the IRS project that the adoption of the 1374 approach as the sole approach under section 382(h) will not have a large effect on the number of mergers and acquisitions that take place. Such adoption of the 1374 approach will make certain mergers and acquisitions somewhat less attractive. However, the Treasury Department and the IRS have determined that, historically, most acquiring corporations behave as if section 382 will limit the ability to utilize substantially all pre-change NOLs. This heuristic behavior implies that firms will not be highly responsive to the changes set forth by these proposed regulations.

It is important to note that any merger or acquisition dissuaded by these proposed regulations would tend to have been economically inefficient not have been undertaken except for the purpose of reducing tax liability. Recall from Part C.1 of this section that the goal of section 382 is to ensure that NOL usage is approximately unaffected when a loss corporation is acquired by a profitable corporation. The Treasury Department and the IRS have determined that the ability to toggle between the 338 approach and the 1374 approach allows more NOL usage in the case of an acquisition than would be the case if the loss corporation continued independently. By eliminating the 338 approach, these proposed regulations move closer to a neutral, economically efficient position.

In particular, the most notable feature of the 338 approach is that assets with builtin gains can generate RBIG even without a realization event. This is generally advantageous for taxpayers. This treatment follows from the logic that such built-in gain assets would have generated income in subsequent years; in the absence of an acquisition, such income could have been offset freely by the old loss corporation’s NOLs. The 338 approach prescribes a proxy for that excess income amount: the extent to which cost recovery deductions (disregarding bonus depreciation under section 168(k), per Notice 2018-30) under a hypothetical purchase of each asset at its current fair market value exceed actual allowable cost recovery deductions.

The Treasury Department and the IRS have determined that this treatment of built-in gain assets under the 338 approach is problematic for two reasons. First, the schedules for cost recovery deductions were never intended to match the production of income from each asset; rather, they were intended to accelerate cost recovery to stimulate investment. Thus, this proxy is likely to, on average, overstate income created by those assets, further increasing NOL usage beyond the neutral baseline. Second, such an adjustment for income created by built-in gain assets is unnecessary, as it is already taken into account by section 382. Section 382 provides that the NOLs of the old loss corporation can be used by the new loss corporation up to the annual limit. This annual limit is equal to a prescribed interest rate multiplied by the value of the stock of the old loss corporation, and serves as a proxy for the income created by the assets of the old loss corporation. Thus, to the extent that the appreciated value of a built-in gain asset is reflected in the value of the stock, the general rule of section 382 allows for the NOLs of the old loss corporation to offset the flow of income created by that asset. Therefore, the treatment created by the 338 approach creates a double benefit. By eliminating this treatment, the proposed regulations reduce the attractiveness of inefficient, tax-motivated acquisitions, which enhances economic efficiency.

Modification to treatment of COD income

The proposed regulations also modify the treatment of COD income under the 1374 approach. The baseline rules provide that COD income enters into the NUBIG/ NUBIL calculations without regard to whether that income was ultimately included in, or excluded from, income by the new loss corporation under the rules of section 108. This issue is especially relevant under the consolidated return regulations regarding the application of section 108. Such regulations provide that, generally, when a member leaves its consolidated group, excluded COD income will be taken into account by the consolidated group and not the new loss corporation. Therefore, inclusion of the COD amount

in the NUBIG/NUBIL calculations does not reflect the economic reality of the taxpayer and may inappropriately influence a taxpayer’s decision of whether to voluntarily enter into bankruptcy. The proposed regulations address this issue by ensuring that COD income enters into the RBIG and NUBIG/NUBIL calculations only to the extent actually taken into account by the new loss corporation. The Treasury Department and the IRS have determined that this revision will treat different types of transactions more neutrally. Such treatment will increase economic efficiency by causing taxpayers to choose transactions that are optimal for non-tax reasons rather than for tax reasons.

Modification to treatment of contingent liabilities

These proposed regulations would revise the 1374 approach with respect to the treatment of contingent liabilities. Under Notice 2003-65, the estimated value of contingent liabilities (as of the change date) was included in the NUBIG/NUBIL calculation. However, the ultimate payment of such liability did not give rise to RBIL. This asymmetry violates the principle of neutrality between pre-change and post-change deductions. If the old loss corporation were able to pay a third party to assume the liability prior to the ownership change, it would generate a deduction that increases the pre-change NOLs, which would be limited after the ownership change. If the liability were not treated as RBIL, the post-change realization of that liability could freely offset other sources of income. This non-neutrality may distort decision-making and reduce economic efficiency.

These proposed regulations would address this issue by providing that payments of contingent liabilities represent RBIL to the extent of the estimated value of the contingent liability as of the change date.

Modification to treatment of cost recovery deductions

Section 382(h)(6)(B) provides that cost recovery deductions during the recognition period are treated as RBIL, except to the extent that the new loss corporation

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can establish that the deduction is not attributable to a built-in loss. Intuitively, RBIL includes cost recovery deductions taken against assets whose depreciation deductions are too large relative to the value of the asset. Under the baseline rules of Notice 2003-65, the suggested approach is to compare (1) actual depreciation deductions on a given asset to (2) the depreciation deductions that would be allowable (disregarding bonus depreciation under section 168(k), per Notice 2018-30) if the asset were hypothetically purchased at the change date from a third party at its fair market value. The excess of (1) over (2) is treated as RBIL. Because depreciation deductions under section 168 tend to be larger closer to the beginning of an asset’s life, this approach can lead to absurd results. In particular, it is possible to create RBIL even when the fair market value is equal to the adjusted basis.

These proposed regulations would abandon that approach. Instead, the hypothetical cost recovery deduction would be computed by applying the same depreciation schedule actually used by the corporation to the fair market value of the asset. This will generally narrow the role of such RBIL treatment to taxpayers with an asset with a fair market value that is less than adjusted basis. Given the front-loading of depreciation schedules (including under section 168(k)), the Treasury Department and the IRS project that the new rule will cause RBIL to be calculated for far fewer taxpayers and thus the change will reduce compliance burden. Additionally, the new rule will generally cause an increase in allowable NOLs by reducing RBIL, contrary to the other rule changes in these proposed regulations. However, the Treasury Department and IRS project that the effect of this change (in terms of generated RBIL/RBIG) will be quantitatively less significant than other modifications, such as the elimination of the section 338 approach.

Clarification of treatment of disallowed business interest expense

Section 382(d)(3) provides that carryovers of disallowed interest under section 163(j) (as amended by the TCJA) are to be treated analogously to NOLs, meaning that their use would be limited after an

ownership change. Additionally, the general rules of section 382(h)(6) could be interpreted to cause such disallowed interest to be RBIL if recognized during the recognition period, as they may be “allowable as a deduction during the recognition period” but “attributable to periods before the change date.” Such treatment would cause section 163(j) carryovers to be counted twice for the purpose of section 382.

These proposed regulations would preclude this possibility by clarifying that the use of section 163(j) carryovers during the recognition period would not give rise to RBIL. This proposed clarification would provide certainty to taxpayers that section 382 will operate as intended in this regard.

II. Paperwork Reduction Act

Pursuant to §1.382-11, a loss corporation must include a statement on or with its tax return for each taxable year that it is a loss corporation in which an owner shift, equity structure shift, or other transaction described in §1.382-2T(a)(2)(i) occurs. The statement must include, among other things, attributes described in §1.382-2(a) (1)(i) that caused the corporation to be a loss corporation. One of the attributes described in §1.382-2(a)(1)(i) is a loss corporation’s NUBIL (that is, net unrealized built-in loss), if any. The existing collection of information under §1.382-11 has been reviewed and approved by the OMB in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (PRA) under OMB control number 15452019. The collection of information is necessary to enable the IRS to verify the amount of any attributes that are subject to section 382.

These proposed regulations provide guidance regarding the calculation of built-in gains and losses under section 382, including whether a corporation has a NUBIL. Therefore, these proposed regulations could cause a corporation to have a NUBIL when they would not have had one in the absence of these proposed regulations. As a result, a corporation would have to file a statement under §1.382-11, or include an item on its statement under §1.382-11, when the corporation would not have had to do so in the absence of these proposed regulations. The §1.38211 statement is a one-time paperwork

burden that is required to be filed in the taxable year during which an owner shift, equity structure shift, or other transaction described in §1.382-2T(a)(2)(i) occurs. On the other hand, these proposed regulations, if finalized, also could cause some firms to no longer have a NUBIL, thereby eliminating their requirement to file a statement under §1.382-11. Furthermore, by eliminating the 338 approach, the Treasury Department and the IRS project that compliance burdens will fall for most existing filers of the §1.382-11 statement. The Treasury Department and the IRS have based this projection on their observations that (i) taxpayers currently incur costs to compute their NUBIG/NUBIL under each of the two methods in order to be able to choose the more beneficial method, and (ii) the 338 approach requires taxpayers to determine hypothetical amounts (for example, what depreciation would have been available in the case of a deemed asset sale under section 338). As a result, removing the hypothetical computations, as well as the optionality, will reduce compliance burden.

For purposes of the PRA, the reporting burden associated with these proposed regulations will be reflected in the collection of information under §1.382-11 (OMB control number 1545-2019). The aggregate estimates for all collection of information conducted under OMB control number 1545-2019, including the §1.382-11 statement and other statements, are that 225,000 respondents will require 1 hour and 40 minutes per response for a total annual reporting burden of 375,000 hours and total annual monetized costs of $15,930,000 (2016 dollars). The Treasury Department and the IRS have not estimated the burden, including that of any new information collections, related to the requirements under these proposed regulations.

Based on the checkbox on Line 16 of Form 1120, Schedule K and other tax attributes, the Treasury Department and the IRS estimate that between 7,000 and 15,000 firms per year will be affected by these proposed regulations. The Treasury Department and the IRS estimate that these proposed regulations will, if anything, cause a slight reduction in the total amount of paperwork burden for most affected taxpayers. This reduction in burden

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is driven by the elimination of the 338 approach. As a result of such elimination, taxpayers may perform fewer calculations when complying with section 382. The Treasury Department and the IRS, however, have not estimated the burden, including that of any new information collections, related to the requirements under the proposed regulations.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. The IRS has posted information for taxpayers on their recordkeeping requirements at https://www.irs.gov/taxtopics/tc305. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

The Treasury Department and the IRS request comments on all aspects of information collection burdens relating to these proposed regulations, including (i) estimates for how much time it would take to comply with the paperwork burdens described earlier for each relevant form and (ii) ways for the IRS to minimize the paperwork burden. Proposed revisions to the information collections contained in these proposed regulations will not be finalized until after these regulations take effect and have been approved by OMB under the PRA. The Treasury Department and the IRS have not estimated the burden, including that of any new information collections, related to the requirements under the proposed regulations. The Treasury Department and the IRS estimate PRA burdens on a taxpayer-type basis rather than a provision-specific basis. Those estimates would capture both changes made by the TCJA and those that arise out of discretionary authority exercised in the proposed regulations.

III. Regulatory Flexibility Act

As described in more detail in this section, pursuant to the Regulatory Flexibility Act (RFA), 5 U.S.C. chapter 6, the Treasury Department and the IRS hereby certify that these proposed regulations

will not have a significant economic impact on a substantial number of small entities. Notwithstanding this certification, the Treasury Department and the IRS invite comments on any impact that these regulations would have on small entities.

These proposed regulations, if finalized, would amend the calculation of certain items under section 382, which pertains to the tax attributes of certain acquired corporations (known as “loss corporations”) in the hands of the acquiring corporation after an ownership change. Broadly, the proposed regulations, if finalized, would (i) eliminate one safe harbor under which firms were formerly entitled to calculate items of income and deduction under section 382(h)(6), and (ii) make a number of other conforming changes. In particular, these regulations could change the amount of net unrealized built-in gain or loss (NUBIG and NUBIL, respectively) computed by the loss corporation. Importantly, section 382(h)(3)(B) provides a de minimis rule for which it is expected that substantially all small entities will qualify. Specifically, if a loss corporation’s NUBIG or NUBIL is not greater than the lesser of (i) 15 percent of the fair market value of the loss corporation’s non-cash corporate assets on the ownership change or (ii) $10 million, then the loss corporation’s NUBIG or NUBIL is deemed to be zero. Furthermore, these proposed regulations would not change this de minimis rule. Therefore, to the extent that small firms understood that they historically qualified for the de minimis rule, substantially all of them could determine, with little burden, that they will qualify as well under these proposed regulations (if finalized). The Treasury Department and the IRS invite comments on the impact of these proposed rules on small entities.

Comments and Requests for Public Hearing

Before the proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “ AD- DRESSES ” heading. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. All comments will be available at www.

regulations.gov for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, then notice of the date, time, and place for the public hearing will be published in the Federal Register .

Drafting Information

The principal authors of this notice of proposed rulemaking are Kevin M. Jacobs and Marie C. Milnes-Vasquez of the Office of Associate Chief Counsel (Corporate). However, other personnel from the Treasury Department and the IRS participated in their development.

Statement of Availability of IRS Documents

IRS Revenue Procedures, Revenue Rulings, notices, and other guidance cited in this document are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov .

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by revising the entry for §1.382-7 to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.382-7 also issued under 26 U.S.C. 382(h)(3)(B)(ii) and (m).

Par. 2. Section 1.382-1 is amended by: a. Under §1.382-2, adding reserved entries for (a)(7) and (8) and entries for (a)(9) through (13), and (b)(4); and b. Revising the entry for §1.382-7.

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The additions and revision read as follows:

§1.382-1 Table of contents.

§1.382-2 General rules for ownership change.

(a) * * * (7) [Reserved] (8) [Reserved] (9) Net unrealized built-in gain. (10) Net unrealized built-in loss. (11) Recognized built-in gain. (12) Recognized built-in loss. (13) Section 382 regulations. (b) * * * (4) Rules provided in paragraphs (a)(9) through (13) of this section.

* * * * * §1.382-7 Built-in gains and losses . (a) Overview. (b) Definitions. (1) Change year. (2) Cost recovery deduction. (3) First-year nonrecourse COD income. (4) First-year recourse COD income. (5) Inadequately secured nonrecourse liabilities.

(6) Negative section 163(j) expense. (7) Nonrecourse liabilities. (8) Pre-change excess recourse liabilities.

(9) Recognition period. (10) Section 382 asset. (11) Section 382 excess business interest expense.

(12) Taxable income or timing limitation.

(1) In general. (2) Consistency rules. (i) In general. (ii) Members of consolidated groups. (3) Computation of net unrealized built-in gain and net unrealized built-in loss.

(i) In general. (ii) Adjustments related to discharge of indebtedness.

(A) In general. (B) Exception for first-year recourse COD income.

( 1 ) Discharge of indebtedness income included in gross income.

( 2 ) Excluded discharge of indebtedness income reducing post-ownership change attributes.

( 3 ) Excluded discharge of indebtedness income reducing basis.

(iii) Additional operating rules. (A) Value of contingent liabilities. (B) Inventory. (C) Limitation on total amount of adjustment to NUBIL/NUBIG regarding recourse COD income.

(D) Timing of adjustments described in paragraphs (c)(3)(ii)(B)( 1 ) through ( 3 ) of this section.

(E) Adjusted basis of the loss corporation’s section 382 assets.

(F) [Reserved] (d) Recognized built-in gain and loss. (1) In general. (2) Recognized built-in gain. (i) In general. (ii) Disposition of an asset. (iii) Income from discharge of indebtedness attributable to certain recourse liabilities.

(iv) Income from discharge of indebtedness attributable to certain nonrecourse liabilities.

(A) Treatment as RBIG. (B) Adjustment to basis. (C) Limitation on total amount of RBIG regarding nonrecourse COD income.

(D) No adjustment to the NUBIG/NUBIL computation.

(v) Installment method. (vi) Prepaid income. (3) Recognized built-in loss. (i) In general. (ii) Disposition of an asset. (iii) Cost recovery deductions. (iv) Bad debt expense. (v) Deductions for payments on certain liabilities.

(vi) Deduction for section 382 excess business interest expense.

(A) In general. (B) No adjustment to the NUBIG/NUBIL computation.

(4) Additional recognized built-in gain and loss items.

(5) Section 382 disallowed business interest carryforwards.

(e) General operating rules. (1) Anti-duplication rule. (2) References to the principles of regulations under section 1374.

(f) Examples. (g) Applicability dates. (1) In general. (2) Paragraph (d)(2)(vi) of this section.

Par. 3. Section 1.382-2 is amended by adding reserved paragraphs (a)(7) and (8) and paragraphs (a)(9) through (13) and (b) (4) to read as follows:

§1.382-2 General rules for ownership change.

(a) * * * (7)-(8) [Reserved] (9) Net unrealized built-in gain . The term net unrealized built-in gain means a positive amount determined under §1.3827(c)(3). (10) Net unrealized built-in loss . The term net unrealized built-in loss means a negative amount determined under §1.382-7(c)(3).

(11) Recognized built-in gain . The term recognized built-in gain has the meaning provided in §1.382-7(d)(2).

(12) Recognized built-in loss . The term recognized built-in loss has the meaning provided in §1.382-7(d)(3).

(13) Section 382 regulations . The term section 382 regulations means this section and §§1.382-3 through 1.382-12.

(b) * * * (4) Rules provided in paragraphs (a) (9) through (13) of this section . The rules of paragraphs (a)(9) through (13) of this section apply to any ownership change occurring after date of publication of Treasury decision adopting these proposed regulations as final regulations in the Federal Register . However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may apply the rules of paragraphs (a)(9) through (13) of this section 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 their related parties consistently apply the rules of paragraphs (a)(9) through (13) of this section and §1.382-7 to such ownership change and all ownership changes occurring in subsequent taxable years.

Par. 4. Section 1.382-7 is revised to read as follows:

§1.382-7 Built-in gains and losses. (a) Overview . This section provides rules governing the determination of a loss corporation’s net unrealized built-in gain or net unrealized built-in loss, as well as its recognized built-in gains and recognized built-in losses for purposes of section 382 and the section 382 regulations. Paragraph

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(10) Section 382 asset . The term sec- tion 382 asset means any asset that the loss corporation owns immediately before the ownership change, including goodwill and other intangible assets, but excluding those assets described in section 382(h)(3) (B)(ii). For purposes of this definition, all accounts receivable, other than those that were acquired in the ordinary course of the loss corporation’s business, are treated as items described in section 382(h)(3)(B) (ii).

(11) Section 382 excess business in- terest expense . The term section 382 ex- cess business interest expense means the amount of business interest expense of a partnership for a taxable year that was disallowed under §1.163(j)-2(b) but not suspended under section 704(d).

(12) Taxable income or timing limita- tion . The term taxable income or timing limitation means:

(i) A limitation set forth in the Internal Revenue Code of 1986, as amended (Code), on the amount of a deduction that may otherwise be claimed by a loss corporation, based on, or derived from, any amount of a loss corporation’s taxable income (see, for example, section 170(b)(2) (A)); or

(ii) A limitation set forth in the Code that defers the timing of a deduction that is otherwise allowable under the Code or regulations (see, for example, sections 267(a)(2) and 469). (c) Net unrealized built-in gains and losses —(1) In general . This paragraph (c) provides rules regarding the calculation of a loss corporation’s net unrealized built-in gain or net unrealized built-in loss for purposes of section 382 and the section 382 regulations. See paragraph (e)(1) of this section (regarding anti-duplication).

(2) Consistency rules —(i) In general . No amount is included in the calculation of net unrealized built-in gain or net unrealized built-in loss if the amount is properly allocable to the pre-change period (within the meaning of §1.382-6(g)(2)) pursuant to §1.382-6 and is included in the determination of the loss corporation’s taxable income or net operating loss for the change year.

(ii) Members of consolidated groups . If a loss corporation enters or leaves a consolidated group on the date of an ownership change for purposes of sec

(b) of this section provides definitions of terms used for purposes of this section. Paragraph (c) of this section provides the rules regarding the determination of a loss corporation’s net unrealized built-in gain or net unrealized built-in loss. Paragraph (d) of this section provides the rules regarding the determination of a loss corporation’s recognized built-in gain or recognized built-in loss. Paragraph (e) of this section provides an anti-duplication rule to prevent duplicate inclusion of items in the computation of net unrealized built-in gain or net unrealized built-in loss, or in the computation of recognized built-in gain or recognized built-in loss. Paragraph (f) of this section provides examples illustrating the rules of this section. Paragraph (g) of this section provides applicability dates for the rules of this section.

(b) Definitions . The following definitions apply for purposes of this section.

(1) Change year . The term change year has the meaning provided in §1.382-6(g) (1).

(2) Cost recovery deduction . The term cost recovery deduction means any deduction for depreciation under section 167 or section 168, any deduction for the amortization of intangibles (for example, under section 167 or 197) and amortizable expenditures (for example, under section 195(b)(1)(B), section 248 or section 1245(a)(2)(C)), or any deduction for depletion under section 611.

(3) First-year nonrecourse COD in- come . The term first-year non-recourse COD income means any income from discharge of indebtedness that the loss corporation recognizes (including income that is excluded from gross income under section 108(a)(1)) during the first twelve months of the recognition period on inadequately secured nonrecourse liabilities.

(4) First-year recourse COD income . The term first-year recourse COD income means any income from discharge of indebtedness (including from liabilities described in paragraph (c)(3)(i)(C) of this section) that the loss corporation recognizes (including income that is excluded from gross income under section 108(a)(1)) during the first twelve months of the recognition period on all of the loss corporation’s liabilities immediately before the ownership change (excluding nonrecourse liabilities) to the extent of its pre-change excess recourse liabilities.

(5) Inadequately secured nonrecourse liabilities . The term inadequately secured nonrecourse liabilities means any nonrecourse liability of which, immediately before the ownership change:

(i) The adjusted issue price (within the meaning of §1.1275-1(b)) of the nonrecourse liability; exceeds

(ii) The fair market value of the property (determined without regard to section 7701(g) and §1.1001-2(a)(4)(i)) which secures such nonrecourse liability.

(6) Negative section 163(j) expense . The term negative section 163(j) expense has the meaning provided in §1.163(j)6(h)(1). (7) Nonrecourse liabilities . The term nonrecourse liabilities has the same meaning as the term nonrecourse liability has in §1.1001-2(a)(4)(i).

(8) Pre-change excess recourse liabili- ties . The term pre-change excess recourse liabilities means:

(i) If the loss corporation is under the jurisdiction of a court under title 11 of the United States Code on the change date, in an action that results in a discharge of recourse liabilities of the loss corporation, then the amount of all of the loss corporation’s liabilities immediately before the ownership change (excluding nonrecourse liabilities) that are discharged by order of the court in that action; or

(ii) In all other cases, an amount equal to the excess, if any, of:

(A) The aggregate adjusted issue price (within the meaning of §1.1275-1(b)) of the loss corporation’s liabilities immediately before the ownership change, excluding—

( 1 ) Recourse liabilities to the extent that they would not be included in the determination of whether the loss corporation is insolvent within the meaning of section 108(d)(3), and

( 2 ) Nonrecourse liabilities; over (B) The sum of the fair market value of the assets that the loss corporation owns immediately before the ownership change, reduced, but not below zero, by the amount of nonrecourse liabilities that is secured by such assets immediately before the ownership change.

(9) Recognition period . The term rec- ognition period has the meaning provided in section 382(h)(7)(A).

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tion 382, the principles of §1.1502-76(b) apply in determining the treatment of any taxable item for purposes of this section. Accordingly, items that are includible (under the end of the day rule (within the meaning of §1.1502-76(b)(1)(ii)(A)) or otherwise) in the taxable year that ends as a result of the change in status of a loss corporation (S) are not treated as recognized or taken into account during the recognition period for purposes of section 382 and the section 382 regulations. See §1.1502-28(b)(11) (regarding allocation of excluded COD income under end of the day rule principles). Moreover, no such item is included in the determination of net unrealized built-in gain or net unrealized built-in loss. For example, if income from the discharge of indebtedness is includable in the taxable year that ends as a result of S’s change in status, that income is neither treated as taken into account during the recognition period nor included in the determination of net unrealized built-in gain or net unrealized built-in loss. Further, the determination of net unrealized built-in gain or net unrealized built-in loss excludes the fair market value and basis of any asset that is disposed of on the change date if the gain or loss from that asset is includible in the taxable year that ends as a result of S’s change in status. In contrast, items that are includible (under the next day rule (within the meaning of §1.1502-76(b)(1) (ii)(B)) or otherwise) in the taxable year that begins as a result of S’s change in status are treated as occurring in the recognition period, and those items (and the basis and fair market value of any assets that generate those items) are among the amounts included in the determination of net unrealized built-in gain or loss.

(3) Computation of net unrealized built-in gain and net unrealized built-in loss —(i) In general . A loss corporation’s net unrealized built-in gain, if positive, or net unrealized built-in loss, if negative, is the amount equal to—

(A) The sum of the amount that would be realized (taking into account section 382(h)(8)) if, immediately before the ownership change, the loss corporation—

( 1 ) Had satisfied each inadequately secured nonrecourse liability by surrendering to the creditor all of the assets securing that debt; and

( 2 ) Had sold all of its section 382 assets (other than those assets described in paragraph (c)(3)(i)(A)( 1 ) of this section) at fair market value to an unrelated third party with the hypothetical buyer assuming no liabilities; decreased by

(B) The aggregate adjusted basis of the loss corporation’s section 382 assets immediately before the ownership change; decreased by

(C) The amount of any non-contingent liability of the loss corporation immediately before the ownership change for which the loss corporation would be allowed a deduction (including a deduction for a capital loss) on payment of the liability (determined without regard to any taxable income or timing limitation); decreased by

(D) The estimated value of any liability of the loss corporation that is contingent immediately before the ownership change, for which, upon the removal of the contingency, the loss corporation would be allowed a deduction (including a deduction for a capital loss) on payment or accrual (determined without regard to any taxable income or timing limitation); increased or decreased by

(E) The loss corporation’s section 481 adjustments that would be taken into account on the sale referred to in paragraph (c)(3)(i)(A) of this section; increased by

(F) The amount that would be treated as recognized built-in gain under paragraph (d)(2) of this section if all amounts (except for amounts described in paragraph (d)(2) (ii) of this section) were properly taken into account during the recognition period; decreased by

(G) The amount that would be treated as recognized built-in loss under paragraph (d)(3) of this section if all amounts (except for amounts described in paragraph (d)(3)(ii) of this section) were properly taken into account during the recognition period.

(ii) Adjustments related to discharge of indebtedness —(A) In general . Except as provided in paragraph (c)(3)(ii)(B) of this section, no amount of discharge of indebtedness income recognized during the recognition period that is included in gross income under section 61(a)(12) or excluded under section 108(a) is added to the computation of the loss corporation’s net unrealized built-in gain or net unreal

ized built-in loss. See paragraphs (c)(2) and (c)(3)(iii)(C) of this section for limitations on amounts that can be included in the computation of net unrealized built-in gain and net unrealized built-in loss.

(B) Exception for first-year recourse COD income . A loss corporation may apply the provisions of this paragraph (c) (3)(ii)(B) to all of its first-year recourse COD income, subject to the timing rules of paragraphs (c)(3)(iii)(D) of this section. An adjustment that is made pursuant to this paragraph (c)(3)(ii)(B) can cause a loss corporation that would otherwise have a net unrealized built-in loss to have a net unrealized built-in gain or to meet the requirements of section 382(h)(3)(B) such that the loss corporation’s net unrealized built-in gain or net unrealized built-in loss is zero. See paragraphs (c)(2) and (c) (3)(iii)(C) of this section for limitations on amounts that can be included in the computation of net unrealized built-in gain and net unrealized built-in loss.

( 1 ) Discharge of indebtedness income included in gross income . The amount calculated under paragraph (c)(3)(i) of this section is increased by the amount of all first-year recourse COD income that is included in gross income under section 61(a)(12). This amount of first-year recourse COD income is treated as recognized built-in gain. See paragraph (d)(2) (iii) of this section.

( 2 ) Excluded discharge of indebtedness income reducing post-ownership change attributes . The amount calculated under paragraph (c)(3)(i) of this section is increased by the amount of all first-year recourse COD income that is excluded under section 108(a), to the extent section 108(b) reduces attributes that are not prechange losses, as defined in §1.382-2(a) (2), including reduction under section 1017(a) of the basis of the loss corporation’s assets that were not held at the time of the ownership change. This amount of first-year recourse COD income is treated as recognized built-in gain. See paragraph (d)(2)(iii) of this section. This paragraph (c)(3)(ii)(B)( 2 ) does not apply to amounts of first-year recourse COD income corresponding to debt whose discharge results in reduction under section 1017(a) of the basis of the loss corporation’s assets that were held at the time of the ownership change.

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( 3 ) Excluded discharge of indebtedness income reducing basis . A loss corporation decreases the amount of basis that is described in paragraph (c)(3)(i)(B) of this section by the amount of first-year recourse COD income that is excluded under section 108(a), to the extent that section 1017(a) reduces the basis of the loss corporation’s section 382 assets. No other adjustment to the computation in paragraph (c)(3)(i) of this section is made with respect to the first-year recourse COD income described in this paragraph (c)(3)(ii)(B)( 3 ), and this amount of firstyear recourse COD income is not treated as recognized built-in gain.

(iii) Additional operating rules —(A) Value of contingent liabilities . If any liability described in paragraph (c)(3)(i)(C) of this section is reflected on the face of the most recently issued applicable financial statement, within the meaning of section 451(b)(3) and the regulations in this part under section 451 of the Internal Revenue Code (determined without regard to whether the taxpayer has another statement described in section 451(b) (3) and the regulations in this part under section 451 of the Inernal Revenue Code), then the estimated value of a liability is the amount of such liability reflected on the most current applicable financial statement as of the change date. The estimated value of any liability described in paragraph (c)(3)(i)(C) of this section is not adjusted to reflect the actual amount of liability that is established on removal of the contingency.

(B) Inventory . The principles of §1.1374-7 apply to determine the amount realized under paragraph (c)(3)(i)(A) of this section with regard to inventory.

(C) Limitation on total amount of ad- justment to NUBIL/NUBIG regarding re- course COD income . The total amount of increases in the calculation of net unrealized built-in gain or loss under paragraph (c)(3)(i) of this section related to first-year recourse COD income under paragraph (c) (3)(ii)(B) of this section is limited to the loss corporation’s liabilities immediately before the ownership change (excluding nonrecourse liabilities) to the extent of its pre-change excess recourse liabilities defined in paragraph (b)(8)(i) or (ii) of this section, as applicable.

(D) Timing of adjustments described in paragraphs (c)(3)(ii)(B)(1) through (3) of this section . If a loss corporation chooses to apply the provisions of this paragraph (c)(3)(iii)(D) to all of its first-year recourse COD income, then it must make the adjustments described in paragraphs (c)(3)(ii)(B)( 1 ) through ( 3 ) of this section, in their entirety as of the change date. However, a loss corporation may make these adjustments only if—

( 1 ) The statement described in §1.38211 reflects such adjustments or; ( 2 ) The loss corporation files an amended return for the taxable year that includes the change date and includes an amended §1.382-11 statement (entitled “AMENDED STATEMENT PURSUANT TO §1.382-11(a) BY [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF TAXPAYER], A LOSS CORPORATION,”) to reflect such adjustments.

(E) Adjusted basis of the loss corpora- tion’s section 382 assets . The adjustments of this paragraph (c)(3)(iii)(E) apply for purposes of determining the adjusted basis of loss corporation’s assets under section 382(h)(2)(A)(ii)(II) and (B)(ii)(I) and the computation of net unrealized built-in gain and loss under section 382(h)(6)(C) and paragraph (c)(3)(i)(B) of this section. The loss corporation’s basis in its section 382 assets is adjusted immediately before the ownership change by the amount of any adjustment that would apply if the section 382 asset were sold immediately before the ownership change. For example, the loss corporation’s basis in a partnership interest is adjusted to the extent §1.163(j)-6(h)(3)(i) would have required an adjustment if the loss corporation had disposed of all or substantially all of its partnership interest immediately before the ownership change.

(F) [Reserved] (d) Recognized built-in gain and loss (1) In general . This paragraph (d) provides rules for determining whether an item is recognized built-in gain or recognized built-in loss for purposes of section 382(h) and the section 382 regulations. Except as expressly provided in this paragraph (d), no amount is treated as recognized builtin gain or recognized built-in loss if that amount was not properly included in the computation of the loss corporation’s net unrealized built-in gain or net unrealized

built-in loss pursuant to paragraph (c)(3) of this section.

(2) Recognized built-in gain —(i) In general . Except as otherwise provided in this paragraph (d)(2) and in paragraph (d)(4) of this section, subject to section 382(h)(1)(A)(ii), an item of income that is properly taken into account during the recognition period is a recognized builtin gain only if the item would have been properly included in gross income before the change date by an accrual method taxpayer (disregarding any method of accounting for which an election by the taxpayer must be made unless the taxpayer actually elected that method). As a result, for example, cost recovery deductions on an appreciated asset claimed during the recognition period are not treated as generating recognized built-in gain.

(ii) Disposition of an asset . The gain recognized on the disposition of an asset during the recognition period is recognized built-in gain to the extent provided in section 382(h)(2)(A). Income included as a dividend under section 61(a)(7) (including amounts treated as dividends under section 1248) and inclusions of income with respect to stock (excluding gain recognized on the disposition of stock), for example under section 951(a) and 951A(a), are not treated as recognized built-in gain.

(iii) Income from discharge of indebt- edness attributable to certain recourse li- abilities . If a loss corporation chooses to apply the provisions of paragraph (c)(3) (ii)(B) of this section, then the amounts described in paragraphs (c)(3)(ii)(B)( 1 ) and ( 2 ) of this section are treated as recognized built-in gain on the date recognized. Otherwise, no income from the discharge of indebtedness attributable to recourse liabilities is recognized built-in gain.

(iv) Income from discharge of indebt- edness attributable to certain nonrecourse liabilities . Except as provided in this paragraph (d)(2)(iv), no income from the discharge of indebtedness attributable to nonrecourse liabilities is recognized builtin gain.

(A) Treatment as RBIG . Notwithstanding paragraph (d)(2)(i) of this section, the amount of all first-year nonrecourse COD income that is included in gross income under section 61(a)(12) or first-year nonrecourse COD income that is excluded

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under section 108(a), to the extent section 108(b) reduces attributes that are not prechange losses, as defined in §1.382-2(a) (2), is recognized built-in gain on the date recognized. This paragraph (d)(2)(iv)(A) does not apply to amounts of first-year nonrecourse COD income corresponding to debt whose discharge results in reduction of basis described in section 1017(a).

(B) Adjustment to basis . First-year nonrecourse COD income that is excluded under section 108(a) and reduces the basis of the loss corporation’s assets that the loss corporation owned immediately before the ownership change is not recognized built-in gain. However, first-year nonrecourse COD income that is excluded under section 108(a) and reduces the basis of assets that the loss corporation did not own immediately before the ownership change is recognized built-in gain.

(C) Limitation on total amount of RBIG regarding nonrecourse COD income . The amount of first-year non-recourse COD income treated as recognized built-in gain under this paragraph (d)(2)(iv) is limited to the excess of adjusted issue price of debt over fair market value of property measured under paragraph (e)(5) of this section.

(D) No adjustment to the NUBIG/ NUBIL computation . The computation under paragraph (c)(3)(i) of this section is not adjusted to reflect recognized builtin gain amounts related to this paragraph (d)(2)(iv). Nonetheless, for purposes of determining the limitations on amounts of recognized built-in gain or loss under section 382(h)(2)(A)(ii)(II) and (B)(ii)(I), the adjusted basis of the loss corporation’s section 382 assets reflects the reduction, if any, described in paragraph (d)(2)(iv)(B) of this section.

(v) Installment method . The amount of income reported under the installment method (see section 453) that is treated as recognized built-in gain is determined under the principles of §1.1374-4(h) (determined without regard to §1.1374-2(a) (2)). Further, if a loss corporation that is a member (selling or distributing member) of a consolidated group (as defined in §1.1502-1(h)) transfers a built-in gain asset to a member of the same consolidated group (transferee member) before or during the recognition period, the gain is deferred under §1.1502-13, and before the

close of the recognition period, the transferee member sells the built-in gain asset in a sale reportable under the installment method, then any deferred gain is RBIG when taken into account by the selling or distributing member, even if the gain is taken into account after the close of the recognition period.

(vi) Prepaid income . Any amount received prior to the change date that is attributable to performance occurring on or after the change date is not recognized built-in gain. Examples to which this paragraph (c)(2)(vi) applies include income received prior to the change date that is deferred under sections 451(c) or 455.

(3) Recognized built-in loss —(i) In general . Except as otherwise provided in paragraphs (d)(3) and (4) of this section, subject to section 382(h)(1)(B)(ii), any deduction properly allowed during the recognition period is treated as recognized built-in loss if an accrual-method taxpayer would have been allowed a deduction for the item against gross income before the change date (taking into account any additional methods of accounting actually used by the loss corporation). For purposes of this paragraph (d)(3), in determining whether an accrual-method taxpayer would have been allowed a deduction before the change date, no taxable income or timing limitation applies. See paragraph (e) of this section for an anti-duplication rule.

(ii) Disposition of an asset . The loss recognized on the disposition of an asset during the recognition period is treated as a recognized built-in loss to the extent provided in section 382(h)(2)(B).

(iii) Cost recovery deductions . The amount of cost recovery deductions with respect to any section 382 asset for any taxable year during the recognition period is treated as recognized built-in loss to the extent of the excess, if any, of—

(A) The greater of the amount of cost recovery deductions allowed or allowable with respect to the period; over

(B) The amount of cost recovery deductions that would have been allowable if the adjusted basis on the change date equaled the fair market value of the section 382 asset, taking into account the depreciation or amortization method, as applicable; the useful life; the recovery period or amortization period, as appli

cable; and the convention (cost recovery schedule) actually used by the loss corporation.

(iv) Bad debt expense . Any bad debt deduction under section 166 that arises during the recognition period from debt owed to the loss corporation immediately before the ownership change is a recognized built-in loss to the extent it does not exceed the amount described in section 382(h)(2)(B)(ii). (v) Deductions for payments on certain liabilities . A deduction for the payment of a liability that is described in paragraph (c)(3)(i)(C) or (D) of this section is a recognized built-in loss to the extent of the amount or the estimated amount of the liability, as applicable, immediately before the ownership change, that was included in the loss corporation’s computation of net unrealized built-in loss or net unrealized built-in gain under paragraph (c)(3) of this section.

(vi) Deduction for section 382 excess business interest expense —(A) In gener- al . A deduction attributable to section 382 excess business interest expense during the recognition period is recognized builtin loss to the extent the section 382 excess business interest expense is allocated to the loss corporation pursuant to §1.163(j)6(f)(2) and is attributable to either a prechange period (within the meaning of §1.382-6(g)(2)) or a taxable year prior to the ownership change. Solely for purposes of determining whether this paragraph (d) (3)(vi) applies;

( 1 ) The principles of §1.382-6(a) apply (unless the taxpayer made an election pursuant to §1.382-6(b), in which case the principles of §1.382-6(b) apply) to determine the extent the section 382 excess business interest expense is attributable to a pre-change period and

( 2 ) Section 1.163(j)-6(g)(2)(i) applies to section 382 excess business interest expense that was allocated to the loss corporation in the order of the taxable years in which the section 382 excess business interest expense was allocated to the loss corporation pursuant to §1.163(j)-6(f)(2), beginning with the earliest taxable year.

(B) No adjustment to the NUBIG/NU- BIL computation . The computation of a loss corporation’s net unrealized built-in gain or net unrealized built-in loss is not adjusted to reflect recognized built-in loss

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amounts related to this paragraph (d)(3) (vi).

(4) Additional recognized built-in gain and loss items . The following additional items of income, gain, deduction, or loss are treated as recognized built-in gain or recognized built-in loss, as applicable:

(i) Positive and negative section 481(a) adjustments, to the extent provided in §1.1374-4(d)(1);

(ii) Any item of income properly taken into account during the recognition period under the completed contract method (as described in §1.460-4(d)) and similar items of deduction, to the extent provided in §1.1374-4(g); and

(iii) The distributive share of a partnership item to the extent provided by the principles of §1.1374-4(i).

(5) Section 382 disallowed business interest carryforwards . Section 382 disallowed business interest carryforwards are not treated as recognized built-in losses.

(e) General operating rules —(1) An- ti-duplication rule . Appropriate adjustments must be made in applying the provisions of this section to ensure that no item of economic gain or loss is duplicated in the computation of net unrealized builtin gain or net unrealized built-in loss, or in the computation of recognized built-in gain or recognized built-in loss. Additionally, appropriate adjustments must be made in applying the provisions of this section to ensure that no amount of net unrealized built-in gain or net unrealized built-in loss is utilized in a duplicative manner, and that the limitations on the total amount of adjustment to net unrealized built-in loss and net unrealized built-in gain take into account amounts of income from discharge of indebtedness that are excluded under section 108(a) and reduce the basis of the loss corporation’s assets.

(2) References to the principles of reg- ulations under section 1374 . All references in this section to the principles of a regulation in this part under section 1374 of the Internal Revenue Code must be interpreted, as necessary, to be consistent with the rules and principles of this section.

(f) Examples . The examples in this paragraph (f) illustrate the application of the provisions of this section. For purposes of the examples in this paragraph (f), LossCo is a loss corporation that files its return on a calendar year basis, that uses

the accrual method of accounting, and that has an ownership change on the last day of the taxable year (Year 0). Further, LossCo satisfies the threshold requirement of section 382(h)(3)(B)(i). Additionally, the stated facts of the example include all relevant corporate activity, property, and taxable items.

(1) Example 1. Impact of certain liabilities on computation of net unrealized built-in loss and amount treated as recognized built-in loss (i) Facts . Immediately before the ownership change, LossCo has a section 382 asset with a fair market value of $100 and an adjusted basis of $90, a liability of $30 for which LossCo will be allowed a deduction upon payment (fixed liability), and an estimated contingent liability of $20, for which, upon removal of the contingency and payment, LossCo will be allowed a deduction (contingent liability). In Year 1, LossCo settles and pays off the contingent liability for $25. In Year 2, LossCo pays off the fixed liability for $30.

(ii) Analysis —(A) Computation of net unrealized built-in loss . Under paragraph (c)(3)(i) of this section, LossCo has a net unrealized built-in loss of $40 ($100, the amount LossCo would realize if it sold all its assets to an unrelated third party (paragraph (c)(i)(A)( 2 ) of this section), decreased by $140 (the sum of the fixed liability ($30) (paragraph (c)(i)(B) of this section), the estimated value of the contingent liability ($20) (paragraph (c)(i)(C) of this section) and the aggregate adjusted basis in the asset ($90) (paragraph (c)(i)(D) of this section)).

(B) Settlement of the contingent liability . Upon settlement and payment of the contingent liability in Year 1, LossCo is entitled to a deduction of $25 (disregarding application of any limitation). Under paragraph (d)(3)(vi) of this section, $20 of the deduction (the estimated value of the liability at the time of the ownership change) is recognized built-in loss and $5 is not subject to section 382. After Year 1, pursuant to section 382(h)(1)(B)(ii), the maximum amount of recognized built-in loss that LossCo can have is $20 ($40 net unrealized built-in loss, less the $20 recognized built-in loss in Year 1).

(C) Payment of the fixed liability . Upon paying the fixed liability in Year 2, LossCo is entitled to a deduction of $30 (disregarding application of any limitation). Under paragraph (d)(3)(vi) of this section, $30 of the deduction would have been recognized built-in loss, but the amount of recognized built-in loss is limited by section 382(h)(1)(B)(ii). As a result, of the $30 deduction, $20 is a recognized built-in loss and $10 is not subject to section 382.

(2) Example 2. Cost recovery deductions (i) Facts . Immediately before the ownership change, LossCo has a net unrealized built-in loss of $300 that is attributable to a non-depreciable asset with a fair market value of $500 and an adjusted basis of $650, and a patent with a fair market value of $125 and an adjusted basis of $275. The patent is an “amortizable section 197 intangible” as defined in section 197(c) and has a 15-year amortization period. As of the change date in Year 0, the patent has a remaining amortization period under section 197 of 5 years. For Year 1, LossCo calculates a $55 amortization deduction for the patent.

(ii) Analysis . Under paragraph (d)(3)(iii) of this section, the amount of cost recovery deduction on the patent that is a recognized built-in loss is the excess, if any, of the amount of cost recovery deductions allowed or allowable over the amount of cost recovery deductions that would have been allowable if the adjusted basis on the change date had equaled the fair market value of the patent, taking into account the amortization method, amortization period, and convention (cost recovery schedule) actually used by the loss corporation. LossCo would have been allowed a cost recovery deduction of $25 if the adjusted basis of the patent on the change date had equaled its fair market value taking into account the cost recovery schedule actually used by LossCo, ($125 fair market value divided by remaining amortization period of 5 years). Accordingly, $30 of the Year 1 cost recovery deduction is recognized built-in loss ($55 allowed and allowable cost recovery deduction, less the $25 cost recovery deduction that would have been allowable if the adjusted basis on the change date equaled the fair market value of the patent). The remaining $25 is not subject to section 382.

(3) Example 3. Forgiveness of pre-change ex- cess recourse liabilities —(i) Facts . On Date 1, immediately before the ownership change, LossCo has two assets: Asset 1, which has a fair market value of $100, an adjusted basis of $80, and is subject to a nonrecourse liability with an adjusted issue price of $120 (Liability 1); and Asset 2, which has a fair market value of $100, an adjusted basis of $90, and is subject to a nonrecourse liability with an adjusted issue price of $60 (Liability 2). Additionally, LossCo has a recourse liability with an adjusted issue price of $60. On Date 2, eleven months after the change date, the creditor forgives $20 of the recourse liability, which gives rise to discharge of indebtedness income that is excluded under 108(a), and for which LossCo elects to reduce the basis of Asset 1 and Asset 2 pursuant to section 108(b)(5).

(ii) Analysis —(A) Calculation of net unrealized built-in gain . The nonrecourse liability to which Asset 1 is subject is an inadequately secured nonrecourse liability, because the adjusted issue price of the liability ($120) exceeds the fair market value of the property securing the liability ($100). As a result, pursuant to paragraph (c)(3)(i)(A)( 1 ) of this section, in determining its net unrealized built-in gain, LossCo is treated as satisfying Liability 1 by surrendering to the creditor Asset 1, resulting in an amount realized of $120. Additionally, pursuant to paragraph (c)(3)(i)(A)( 2 ) of this section, LossCo is treated as selling Asset 2 and having an amount realized of $100. As a result, LossCo has a net unrealized built-in gain of $50 ($120 amount realized on Asset 1, plus the $100 amount realized on Asset 2, less the $170 aggregate adjusted basis of LossCo’s section 382 assets). See paragraph (c)(3)(i) of this section. (B) Forgiveness of the recourse liability . Pursuant to paragraph (c)(3)(ii)(A) of this section, the forgiveness of the recourse liability will not impact the calculation of LossCo’s net unrealized built-in gain, unless it chooses to apply the provisions of paragraph (c)(3)(ii)(B) of this section to all of its firstyear recourse COD income. The recourse liability is a pre-change excess recourse liability to the extent its adjusted issue price ($60) exceeds the fair market value of LossCo’s section 382 assets, reduced, but

September 30, 2019 804 Bulletin No. 2019–40

not below zero, by the amount of nonrecourse liability that is secured by such assets immediately before the ownership change ($0 for Asset 1 and $40 for Asset 2), or $20. As a result, the first-year recourse COD income is $20 (the $20 income to the extent of the pre-change excess recourse liability). If LossCo chooses to apply the provisions of (c)(3)(ii)(B) of this section, then, pursuant to paragraph (c)(3)(ii) (B)( 3 ) of this section, LossCo decreases by $20 the amount of basis it uses to compute its net unrealized built-in gain. As a result, LossCo has a net unrealized built-in gain of $70 ($120 amount realized on Asset 1, plus $100 amount realized on Asset 2, less $150 aggregate adjusted basis of LossCo’s section 382 assets. See paragraph (c)(3)(i)(D) of this section. The first-year recourse COD income is not recognized built-in gain.

(4) Example 4. Forgiveness of a recourse liabili- ty that is not a pre-change excess recourse liability (i) Facts . The facts are the same as in paragraph (f) (3)(i) ( Example 3) of this section, except that, as of the date of the ownership change, LossCo also owns Asset 3, which has a fair market value of $80 and an adjusted basis of $50. Additionally, LossCo includes the $20 of cancellation of indebtedness income in gross income that was recognized on Date 2 under section 61(a)(12).

(ii) Analysis —(A) Calculation of net unrealized built-in gain . As in paragraph (f)(3)(ii)(A) ( Example 3) of this section, the nonrecourse liability on Asset 1 is an inadequately secured nonrecourse liability, and as a result, pursuant to paragraph (c)(3)(i)(A)( 1 ) of this section, the amount realized with respect to Asset 1 is $120. Additionally, pursuant to paragraph (c)(3)(i)(A)( 2 ) of this section, LossCo is treated as selling Asset 2 and Asset 3 for an amount realized of $180 ($100, plus $80). As a result, LossCo has a net unrealized built-in gain of $80 ($120 amount realized on Asset 1, plus $100 amount realized on Asset 2, plus $80 amount realized on Asset 3, less $220 aggregate adjusted basis of LossCo’s section 382 assets. See paragraph (c)(3)(i)(D) of this section. (B) Forgiveness of the recourse liability . The forgiveness of the recourse liability will not impact the calculation of LossCo’s net unrealized built-in gain under paragraph (c)(3)(ii)(A) of this section. The adjustment provided under paragraph (c)(3)(ii) (B) of this section for certain recourse liabilities is not available (and the cancellation of indebtedness is not recognized built-in loss) because the recourse liability does not constitute a pre-change excess recourse liability. See paragraph (b)(4) and (8) of this section. The recourse liability is not a pre-change excess recourse liability because its adjusted issue price ($60) does not exceed the fair market value of the LossCo’s section 382 assets, reduced, but not below zero, by the amount of nonrecourse liability that is secured by such assets immediately before the ownership change ($0 for Asset 1, $40 for Asset 2, and $80 for Asset 3).

(5) Example 5. Computing net unrealized built- in gain or loss of a partner that is allocated section 382 excess business interest expense —(i) Facts . LossCo and unrelated Corp A are equal partners in

partnership PRS. LossCo has a basis of $100 in its PRS interest, which has a fair market value of $90. In Year 1, PRS pays or accrues $100 of section 382 excess business interest expense, which is allocated equally to LossCo and Corp A. At the end of Year 1, LossCo has an ownership change. In Year 2, PRS has $80 of excess taxable income (within the meaning of §1.163(j)-1(b)(15)), of which $40 is allocated to LossCo pursuant to §1.163(j)-6(f)(2). LossCo’s section 163(j) limitation (within the meaning of §1.163(j)-1(b)(31)) for Year 2 is $25, and LossCo pays or accrues $60 of other business interest expense in Year 2. LossCo’s section 382 limitation for Year 2 is $30.

(ii) Analysis —(A) Year 1 —( 1 ) Basis reduction to reflect allocation of excess business interest expense . Pursuant to section 163(j)(4) and §1.163(j)-6, a partner in a partnership reduces its adjusted basis in its partnership interest by the amount of excess business interest expense allocated to that partner. As a result, LossCo’s basis in its PRS interest is reduced from $100 to $50 in Year 1.

( 2 ) Calculation of net unrealized built-in gain or loss . LossCo experiences an ownership change at the end of Year 1. Paragraph (c)(3)(iii)(E) of this section provides that, in computing a loss corporation’s net unrealized built-in gain or loss, the amount of the corporation’s basis in its section 382 assets is adjusted immediately before the ownership change by the amount of any adjustment that would apply if the section 382 asset were sold immediately before the ownership change. If LossCo had sold its PRS interest immediately before the ownership change, §1.163(j)-6(h)(3)(i) would have required LossCo to increase its basis in the PRS interest by $50, the amount of its remaining excess business interest expense. As a result, for purposes of section 382(h)(6) (C) and paragraph (c)(3)(i)(B) of this section, LossCo’s basis in its PRS interest is adjusted by the same amount. Thus, for purposes of computing LossCo’s net unrealized gain or loss, LossCo’s basis in its PRS interest is increased to $100 immediately before the ownership change.

(B) Year 2 —( 1 ) Treatment of excess business interest expense as paid or accrued . Pursuant to §1.163(j)-6(g)(2)(i), because LossCo is allocated $40 of excess taxable income from PRS in Year 2, LossCo treats $40 of its excess business interest expense (from Year 1) as paid or accrued in Year 2. LossCo’s remaining $10 of excess business interest expense from Year 1 continues to be characterized as excess business interest expense in succeeding years. See §1.163(j)-6(g)(2)(ii).

( 2 ) Section 163(j) deduction . In Year 2, LossCo is treated as having paid or accrued $100 of business interest expense ($40 of excess business interest expense that is treated as business interest expense under §1.163(j)-6(g)(2)(i), and $60 of business interest expense that LossCo actually paid or accrued in Year 2). Because LossCo has a section 163(j) limitation of $25, LossCo can deduct only $25 of its $100 Year 2 business interest expense (see §1.163(j)-2(b)). Pursuant to §1.383-1(d)(1)(ii), LossCo is treated as deducting $25 of its section 382 excess business interest

expense that is treated as business interest expense in Year 2, because this amount is a recognized built-in loss. No adjustment is made to the computation of LossCo’s net unrealized built-in gain or loss to reflect the $25 of LossCo’s recognized built-in loss. See paragraph (c)(3)(vi) of this section. Both LossCo’s $15 of Year 1 excess business interest expense that was treated as business interest expense in Year 2 and the $60 of other business interest expense that was paid or accrued in Year 2 is disallowed in Year 2 under §1.163(j)-2(b). These amounts are treated as disallowed business interest expense carryforwards into Year 3 under §1.163(j)-2(c), with the $15 carryforward being subject to section 382 limitation. See paragraph (d)(3)(vi) of this section.

(g) Applicability dates —(1) In gener- al . This section applies to any ownership change occurring after date of publication of Treasury decision adopting these proposed regulations as final regulations in the Federal Register . For ownership changes occurring on or before the date the Treasury decision adopting these proposed regulations as final regulations is published in the Federal Register, see §1.382-7 as contained in 26 CFR part 1, revised April 1, 2009. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may apply the rules of this section to any ownership change occurring during a taxable year with respect to which the period described in section 6511(a) has not expired, as long as the taxpayers and their related parties consistently apply the rules of this section and §1.382-7(a)(9) through (13) to such ownership change and all subsequent ownership changes that occur before the applicability date of final regulations.

(2) Paragraph (d)(2)(vi) of this section . Paragraph (d)(2)(vi) of this section applies to loss corporations that have undergone an ownership change on or after June 11, 2010. For loss corporations that have undergone an ownership change before June 11, 2010, see §1.382-7T as contained in 26 CFR part 1, revised April 1, 2009.

Kirsten Wielobob, Deputy Commissioner for Services

and Enforcement.

(Filed by the Office of the Federal Register on September 9, 2019, 8:45 a.m., and published in the issue of the Federal Register for September 10, 2019, 84 F.R. 47455)

Bulletin No. 2019–40 805 September 30, 2019