Understanding the Built-in Gain and Loss Rules of Section 382 - and Possible Significant Changes on the Horizon: Unprecedented NOLs have accompanied unprecedented times.

• Date: 01 January 2021
• Author: Jacobs, Kevin M.

As we all welcome the new year, companies look forward to the future and hope to leave 2020 to the history books. Because of the lingering economic effects of COVID-19 and the expansion by the Tax Cuts and Jobs Act (TCJA) of the application of the Section 168(k) first-year bonus depreciation,(1) corporations have to carry forward an unprecedented number of federal income tax losses (net operating losses, or NOLs). (2) The increase in NOLs, coupled with the TCJA's inclusion of disallowed business interest expense carryforwards under Section 163(j) as an attribute subject to Section 382, the universe of "loss corporations" for purposes of Sections 382 and 383, and understanding the limitations of having an "ownership change," are particularly important.

An ownership change occurs if a corporation has a greater than fifty percent increase in stock ownership over, generally, a three-year period and is, at the time of that change, a "loss corporation." (3) The amount of the loss corporation's pre-change attributes (including recognized built-in losses, or RBILs) that can be used after an ownership change is generally limited to the value of the corporation immediately before the ownership change multiplied by the current "long-term tax-exempt rate." (4) This limit is increased by any recognized built-in gain (RBIG) that the corporation recognizes during the five-year recognition period. (5) As discussed below, on September 10, 2019, the Treasury Department and the Internal Revenue Service published proposed regulations that would significantly change the built-in gain and loss rules (to the detriment of taxpayers). Fortunately, these proposed 2019 regulations were subsequently modified to provide limited transition relief and an opportunity to extend the availability of the pro-taxpayer methodology in Notice 2003-65.

The Neutrality Principle

Congress designed the Section 382 rules to embody the "neutrality principle," with the idea that NOLs (and certain other tax attributes) should be no more or less valuable in the hands of a corporations new owners than they were in the hands of the old owners. Extending the neutrality principle, Section 382 (to a degree) treats built-in gains and losses and items of income and deduction recognized after the ownership change the same as if they had been recognized before the ownership change. This treatment prevents timing differences from affecting outcomes following an ownership change.

Notice 2003-65

To help address what items of income and deduction to consider when calculating net unrealized built-in gain (NUBIG) and net unrealized built-in loss (NUBIL) and when determining whether they constitute RBIG or RBIL, the IRS issued Notice 2003-65 to provide a single methodology to calculate a loss corporations NUBIG or NUBIL, which is based on a hypothetical sale of all the corporations assets to an unrelated buyer that assumed all the corporation's...