Alternative approach for calculating loss disallowance on disposition or deconsolidation of subsidiary stock.

• Author: Gordon, Jared H.

In Notice 2004-58, the IRS formalized the availability of an alternative approach for calculating the loss disallowed on a disposition (or the basis reduced on deconsolidation) of a share of a consolidated subsidiary's stock under Temp. Regs. Sec. 1.337(d)-2T. The alternative approach is referred to as the "basis disconformity model."

The notice applies to dispositions and deconsolidations of subsidiary stock occurring on or after March 7, 2002. Additionally, temporary and proposed regulations under Temp. Regs. Sec. 1.1502-20T that were issued concurrently with the notice make the basis disconformity model elective for dispositions and deconsolidations occurring before March 7, 2002. As such, the notice has relevance for the upcoming tax season. Moreover, it may have applicability for some time to come, depending on whether the government proposes to replace Temp. Regs. Sec. 1.337(d)-2T (which is due to sunset on March 7, 2005).

Who Should Use?

Notice 2004-58's new approach provides three alternatives to the classical tracing method (described below), historically thought to be prescribed by Temp. Regs. Sec. 1.337(d)-2T, and adopts instead the mechanical basis disconformity model. It also clarifies that a modified approach to tracing (discussed below) will still be available. Note: The alternative methods for calculating loss disallowance or basis reduction present an opportunity for a taxpayer with one or more of the following circumstances to claim a loss on the disposition or deconsolidation of subsidiary stock:

1. The taxpayer recognized less than 100% of a loss on the disposition of a subsidiary's stock using the classical tracing method. Under the basis disconformity model, the taxpayer may be allowed to maximize its stock loss, particularly if it incurred operating losses that reduce net positive adjustments.

2. The taxpayer recognized a loss using the classical tracing method, but is concerned with the approach and quality of the supporting documentation. The basis disconformity model may yield the same or greater loss, but may be much easier to substantiate.

3. The taxpayer has a refund claim for a recognized stock loss under examination, and part of the loss is being disallowed.

4. Finally, any taxpayer that failed to recognize a loss on the disposition of a subsidiary's stock for transactions going back as tar as 1991 should review its filing position for the loss year and consider whether the basis disconformity model would be more advantageous. Further, a taxpayer that has incurred such a loss in the current tax year (or expects to incur one prior to March 7, 2005), should prospectively consider the most advantageous method to calculate and document the loss to be reported on its current or future return.

   Brief History of the LDRs

   On March 7, 2002, Temp. Regs. Secs. 1.337(d)-2T and 1.1502-20T(i) effectively replaced the loss disallowance rules (LDRs) of Regs. Sec. 1.1502-20 that were invalidated, in part, by Rite Aid Corp., 255 F3d 1357 (Fed. Cir. 2001).

   The temporary regulations, which will sunset on March 7, 2005, apply to dispositions and deconsolidations of subsidiary stock occurring on or after March 7, 2002. In general, Temp. Regs. Sec. 1.337(d)-2T disallows any loss recognized by a consolidated group member on a subsidiary stock disposition, except to the extent the consolidated group establishes that the loss is not attributable to the recognition of built-in gain (BIG). For...