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

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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 corporation’s 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 corporation’s NUBIG or NUBIL, which is based on a hypothetical sale of all the corporation’s assets to an unrelated buyer that assumed all the corporation’s liabilities. Notice 2003-65 provides two safe harbor approaches to determine whether an item of income or gain is characterized as RBIG or whether an item of deduction or loss is characterized as RBIL: the Section 338 approach and the Section 1374 approach.

The Section 338 approach is generally advantageous for loss corporations with a NUBIG, because it treats certain built-in gain assets as generating RBIG even if the assets are not actually disposed of. The Section 338 approach assumes that, for any taxable year, an asset that had a built-in gain on the change date generates income, which in turn is treated as RBIG, equal to the excess of the cost recovery deduction that would have been allowed for that asset if the asset was newly purchased on the change date over the loss corporation’s actual allowable cost recovery deduction for the asset.

For example, consider the assets of a loss corporation that undergoes an ownership change that has an aggregate fair market value (FMV) of $120 million greater than its aggregate basis (with all of the recorded tangible and intangible property having a FMV equal to its tax basis) and thus has a $120 million NUBIG. If the loss corporation applied the Section 338 approach, then the entire $120 million would be allocated to hypothetical goodwill and would be deemed amortized over a fifteen-year period (or $8 million a year). The annual RBIG adjustment for the recognition period would be $8 million ($8 million of deemed cost recovery deductions for the newly purchased asset, $0 actual cost recovery deductions), for a total increase in the Section 382 limitation of $40 million over the five-year recognition period.

The Section 1374 approach may help loss corporations with a NUBIL, because it generally treats only built-in items of deduction as RBIL if an accrual-method taxpayer would have deducted the expense prior to the change date.

2019 Regulations

Over the years, the Treasury Department and the IRS have voiced concerns regarding Notice 2003-65, including the view that the Section 338 approach violated the neutrality principle by overstating RBIG (attributable to the hypothetical cost recovery deductions) and have felt that taxpayers should have only one method to determine whether an item of income or deduction is RBIG or RBIL. The TCJA complicated the use of the Section 338 approach, because taxpayers could choose whether the deemed Section 338 election applied only to the loss corporation or whether the loss corporation could in turn have its nonconsolidated subsidiaries make deemed Section 338 elections as well. To address these concerns, the Treasury Department and the IRS proposed the September 10, 2019, regulations, which would render Notice 2003-65 obsolete and substantially modify the calculation of both NUBIG and NUBIL as well as change the determination of whether an item of income, gain, deduction, or loss is RBIG or RBIL.6

With respect to calculating NUBIG and NUBIL, the proposed 2019 regulations deviate from the Notice 2003-65 approach. First, the loss corporation will need to estimate the amount of its contingent deductible liabilities as of the time of the ownership change.7 Second, the loss corporation has to characterize its liabilities as recourse and nonrecourse, and only the nonrecourse liabilities that are inadequately secured are considered satisfied in a separate transaction. As a result, all other liabilities are disregarded in the hypothetical sale to determine the gross asset value. This alone has the potential to reduce the amount of NUBIG or increase the amount of NUBIL.

However, the most significant change is with respect to determining whether an item of income or deduction is RBIG or RBIL: the 2019 regulations reject the Section 338 approach and adopt a modified version of the Section 1374 approach. As highlighted above, this change would significantly affect loss corporations that have a NUBIG, because loss corporations would not be treated as having an RBIG equal to the cost recovery deductions for built-in gain assets. In the example above, the $40 million cumulative limitation increase would be lost. The 2019 regulations also exclude dividend income (including amounts treated as dividend income)8 and global intangible low-taxed income (GILTI) or Subpart F income inclusions as RBIG, even if at the time of the ownership change, the loss corporation had a built-in gain on the stock and the underlying corporation has earnings and profits or Subpart F or tested income.

2019 Regulations Transition Relief

The 2019 regulations were proposed to apply to any ownership changes that occurred after the date the regulations were finalized. This raised a concern about which rules would apply to a transaction that was signed with a delayed closing date, because the regulations could be finalized at any time.

Fortunately, on January 14, 2020, the Treasury Department and the IRS modified the applicability date of the 2019 regulations. The 2019 regulations are now proposed to have a thirty-day delayed applicability date and include transaction relief.

The thirty-day delayed applicability date allows taxpayers that have an ownership change within thirty days of the finalization of the 2019 regulations and still have the ability to apply Notice 2003-65. This provides a planning opportunity for taxpayers that actively manage their tax attributes, because once the regulations are finalized, taxpayers can ascertain how close they are to incurring an ownership change and try to structure a transaction within the thirty-day period to trigger an ownership change. Although triggering an ownership change is not something most taxpayers have historically done intentionally, in this case doing so could significantly increase their ability to use their attributes going forward (because of the potential higher RBIG amounts under Notice 2003-65, unlike under the final 2019 regulations).

Similar relief, with a much longer time window, is available for ownership changes that occur pursuant to a transaction that qualifies for transaction relief. To qualify for transaction relief, the ownership change must result from a specific transaction, in which on or before the applicability date (taking into account the thirty-day delayed applicability date):

  • a binding agreement is in effect, or a public announcement is made or is described in a submitted filing with the SEC;
  • the taxpayer is a debtor in a bankruptcy case and the transaction occurs pursuant to an order of a court (or pursuant to a plan confirmed, or a sale approved, by order of a court) in a bankruptcy case; or
  • a ruling request with respect to the transaction has been submitted to the IRS.

Because the key date in applying the transaction relief is the applicability date and not the date the final regulations are published, taxpayers will have greater flexibility and the ability to apply the rules in Notice 2003-65. The transaction relief, however, applies only to an ownership change that occurs as a result of the transaction that is eligible for the relief and not to any other ownership changes. This can pose a great trap for the unwary. For example, assume the regulations are finalized on January 31. On February 15, X, a loss corporation, enters into a binding agreement to engage in a transaction that will close on March 31. On March 10, X experiences an ownership change, unrelated to the March 31 transaction. The March 10 ownership change would be subject to the final regulations, whereas X could apply Notice 2003-65 to the March 31 ownership change. To avoid this potential result, X could have triggered an ownership change during the thirty-day delayed applicability date. As a result, both the ownership change that occurred during the delayed applicability date period and the ownership change on March 31 would qualify for Notice 2003-65 treatment.


In the current economic climate and with the great number of comments that the Treasury Department and the IRS have received, it is unclear whether the 2019 regulations will be finalized and, if so, in what form. It does seem certain that if they are finalized, they will likely reduce a corporation’s ability to use its attributes to offset taxable income than it would be able to under Notice 2003-65. As a result, corporations should be able to sigh with relief, knowing that deals currently being negotiated should not be subject to the regulations, when finalized.

Loss corporations with significant NOLs should consider whether to trigger an ownership change or to perform a specified action that would qualify for transaction relief, once the final regulations are published and depending on whether they are in the same form as the 2019 regulations, so as to take advantage of the favorable rules of Notice 2003-65.

Kevin M. Jacobs is a managing director and the national tax office practice leader of Alvarez & Marsal Taxand in Washington, D.C., and Todd Reinstein is a partner in the Washington, D.C., office of Troutman Pepper. The opinions expressed in this article are those of the authors and not necessarily those of Alvarez & Marsal Taxand, Troutman Pepper, or their clients.

Kevin M. Jacobs
Todd Reinstein








  1. Unless otherwise stated, all references to “Section” are to the Internal Revenue Code of 1986, and all references to “Regulation” are to the Treasury Regulations promulgated under it.
  2. Although the CARES Act has allowed taxpayers to carry back their NOLs that arose in taxable years beginning after December 31, 2018, and before January 1, 2021, for five taxable years, there may be reasons for which taxpayers still currently have NOLs. For example, the carryback of an NOL may offset the benefit of certain nonrefundable credits or deductions, or the taxpayer may have to carry back its NOL to a previously closed taxable year in which there is potential tax liability.
  3. As defined under Section 382(g).
  4. Section 382(b). For December 2020, the long-term tax-exempt rate was 0.99% (Revenue Ruling 2020-26). Therefore, if a loss corporation had an ownership change on December 31, 2020, and its value immediately before the ownership change was $100 million, it would then have a base limitation of $990,000.
  5. Section 382(h)(1)(A)(i).
  6. REG-124710-18 (September 10, 2019).
  7. The 2019 regulations require that liabilities reflected on the loss corporation’s most recently issued applicable financial statement will be deemed liabilities for the calculation of NUBIG or NUBIL (Proposed Regulation 1.382-7(c)(3)(iii)(A)).
  8. Several provisions cause dispositions of stock to be characterized as a dividend (for example, Sections 304, 356(a)(2), and 1248). In each case, the stock is being disposed of, but the amount characterized as a dividend is not treated as RBIG. As a result, the unrealized built-in gain in the stock will never be able to be characterized as RBIG.

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