Consolidated returns and E&P - application of Sec. 1503(e) to preaffiliation property.

• Author: Blair, David W.
• Position: Earnings and profits

Legislation enacted after the decision in Woods Investment Co., 85 TC 274 11985L eliminates the so-called "Woods benefit" and requires that tax depreciation, instead of earnings and profits (E&PJ depreciation, be used to calculate the basis of stock on a disposition of a subsidiary in a consolidated group. The application of this rule, however, is unclear when the subsidiary owns property that was acquired before the subsidiary became a member of the consolidated group (preaffiliation property). In many cases, significant adjustments may be necessary to correctly compute gain or loss on disposition.

Sec. 15031e)provides for adjustment to the basis of stock of a consolidated group member to reverse any "Woods effect" on a disposition (e.g., sale or exchange, loss from worthlessness) of the stock. It is unclear how this provision applies to property acquired by a group member before it joined the consolidated group ("preaffiliation property"), and the only IRS guidance (Letter Ruling 9039003) further adds to the confusion. The potential application of Sec. 15031e1 to preaffiliation property can be significant, particularly in capital-intensive industries that are supporting their business operations through divestiture of subsidiaries in stock sales without Sec. 338 elections.

Taxpayers who have made for are contemplating) dispositions of a subsidiary owning preaffiliation property should verify whether they have properly considered the application of Sec. 1503(e), particularly in the situation illustrated below. Identification of this issue may uncover potential refund claims and other unusual or technical applications of the law and regulations that influence the proper determination of the subsidiary's stock basis.

Sec. 1503(e) was added by the Revenue Act of 1987 and modified by the Technical and Miscellaneous Revenue Act of 1988 ITAMRA), the Omnibus Budget Reconciliation Act of 1989 and the Revenue Reconciliation Act of 1990. Sec. 1503(e)(1) provides that in determining gain (including any excess loss account recapture) or loss on the disposition of stock of a consolidated group member, the E&P used to calculate the stock's basis under Regs. Sec. 1.1502-32 is determined as though Sec. 312 were applied for the tax year (and all preceding consolidated years of the member with respect to such group) without regard to Sec. 312(k)and (n). Thus, for depreciation purposes, Sec. 3121k) is disregarded and actual tax depreciation is used in making...