Rite Aid precipitates issuance of prop. and temp. regs.

• Author: Hayes, Thomas
• Position: Disposition of a loss subsidiary by a consolidated group

Tax law on the disposition of a loss subsidiary by a consolidated group has remained relatively unchanged during the past 10 years. Promulgated in early 1991, under Regs. Sec. 1.1502-20, the loss disallowance rule (LDR) disallows certain losses recognized by a consolidated group member on the disposition of its stock. In theory (and somewhat in practice), the LDR was designed to allow nonduplicated deductions for actual economic losses, while prohibiting duplicated losses and losses attributable solely to basis adjustments made pursuant to the consolidated return regulations. With the Federal Circuit's recent decision in Rite Aid, 255 F3d 1357 (2001), the LDR has become obsolete and newly issued temporary regulations have taken its place.

LDR and the Rite Aid Decision

The LDR generally applies to all dispositions and deconsolidations of subsidiary stock at a loss, occurring between Feb. 1, 1991 and March 7, 2002. Regs. Sec. 1.1502-20(a)(1) states that "no deduction is allowed for any loss recognized by a member [of a consolidated group] with respect to the disposition of stock of a subsidiary." However, losses are disallowed only to the extent of the sum of three "factors": (1) extraordinary gain dispositions, (2) positive investment adjustments and (3) duplicated losses.

For purposes of this item, only the duplicated loss factor (DLF) will be considered, because this was the factor invalidated by the Federal Circuit in Rite Aid. The DLF prevents taxpayers from recognizing the same economic loss twice--first as a loss on the sale of a subsidiary's stock (by a consolidated group member) and second as a loss on the disposition of the subsidiary's assets.

Generally, the DLF can be expressed as the excess of a subsidiary's loss carry-overs and aggregate adjusted basis in its assets, over the value of its stock (plus any liabilities) immediately after the disposition of its stock by a consolidated group member (Regs. Sec. 1.1502-20(c)(2)(vi)). The facts of Rite Aid provide a quick illustration of the application of the now-defunct DLF.

In 1984, Rite Aid purchased the stock of Penn Encore (Encore), a small discount bookstore chain. For approximately a decade, Rite Aid included Encore in its consolidated group. During this time, Encore experienced significant losses that were funded by loans from Rite Aid. In 1994, Rite Aid contributed the Encore debt to Encore's capital and sold the Encore stock to an unrelated company. Rite Aid determined that...