In PLR 201051019 (12/23/2010), the Service ruled that in computing a consolidated group’s §382 limitation after filing for bankruptcy relief, all of its outstanding liabilities before the ownership change should be taken into account at the adjusted issue price, regardless of whether the obligations were subsequently discharged in whole or in part during the recognition period. Accordingly, unless the parent of the consolidated group of corporations elected application of §382(l)(6), then under §382(l)(5), there is no §382 limitation on pre-change losses or built-in losses of the parent consolidated group and each of its members as a result of the ownership change that took place under the facts.

Facts. Parent (P) is the common parent of a consolidated group (Parent Consolidated Group) engaged in Business A. On Date 1, P and X, a disregarded entity of Subsidiary Y, filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code. The subsidiaries of Parent (other than X), including Subsidiary Y, did not file for bankruptcy protection. Later, under a plan or reorganization approved by the Bankruptcy Court: (i) each electing holder of an allowed claim arising under a Note 1 or any holder of an allowed claim arising under a Note 2 received its pro rata share of New Notes 1 and a specified percentage of P's new common stock; (ii) each non-electing holder of a claim under Note 1 had its current claim reinstated and retained the Note; (iii) each holder of a claim under Loan 1 or 2 received its pro rata share of New Notes 1 and specified percentage of P’s new common stock; (iv) each holder of an allowed claim under Note 3 or 4 received its pro rata share of a specified percentage of P’s new common stock plus contingent value righs; (v) each holder of certain notes issued by X received its pro rata share of New Notes 2 issued by X and guaranteed by P; (vi) the holders of equity interests in P cancelled those interests however preferred stock holders of P received contingent value rights. The only debt of P debt that was exchanged for stock was debt of P. Under the plan or reorganization approved by the Bankruptcy Court in a Title 11 case, P would experience an ownership change under §382, immediately after the ownership change at least 50% of the value and voting power of the common stock of P would become owned by “qualified creditors” per §382(l)(5)(3) and Treas. Reg. §1.382-9(d)(1).

The affiliated group of corporations, of which P is the common parent, is a “loss group” per Treas. Reg. §1.1502-91(c). All members of the consolidated group were eligible to be included in the determination of whether the loss group were eligible to be included in determining whether the loss group had a net unrealized build in loss per Treas. Reg. §1.1502-91(g)(2)(ii).

The ruling identified two alternative methods by which to calculate the §382 limitation Where §382(l)(5) applies, the amount of pre-change losses or built-in losses of the taxpayer to be used to offset taxable income of any new loss corporation for any post-change year would not be limited by §382 as a result of an ownership change. Conversely, if §382(l)(6) was applied, the value of the old loss corporation would reflect the increase in value resulting from any surrender or cancellation of creditors' claims in the transaction, pursuant to Treas. Reg. 1.382-9 .

If Section 382(l)(6) were elected, the consolidated group would calculate its net unrealized built-in gain or loss, pursuant to Section 382(h) and in conjunction with the guidance provided in Notice 2003-65 , under the deemed Section 338 approach. In holding that all liabilities should be considered, the Service specified that amounts realized should be allocated to the stock and obligations of the group notwithstanding that gain or loss might not be taken into account under Reg. 1.1502-91 .

In this situation since no election was made under §382(l)(6), then under §382(l)(5) the Service ruled that no §382 limitation on pre-change losses or built-in losses of the P consolidated group and each member resulted as a result of the ownership change. See §382(h). Notice 2003-65, 2003-2 CB 747 , provides two alternative approaches—the §338 approach and the §1374 approach—to applying §382(h) that should be considered when calculating recognized built-in gain and recognized built-in loss. P also takes into account the increase in the value of P resulting from the surrender of certain creditor claims per Treas. Reg. §1.382-9. On the other hand, were the P consolidated group to apply §382(l))(6) to the change in ownership, then in applying Notice 2003-65 to the calculation of net unrealized built-in gain or loss, as modified by Notice 2003-65, the P consolidated group may compute the deemed sale and allocation rule for determining the aggregate deemed sale price under Treas. Regs. §§ 1.338-4 and 1.338-6. Amounts realized should be allocated to the stock and obligations of members of the P consolidated group regardless of whether such gain or loss might not be taken into account under Treas. Reg. §1.1502-91.

Liabilities often are discharged coincident with an ownership change, resulting in cancellation of indebtedness income. PLR 201051019 is helpful in clarifying how to apply the §382 limitation in this situation by clarifying that, under the described fact pattern, all liabilities—including those discharged as part of a bankruptcy filing—should be included in any net unrealized built-in gain or loss calculation.