After a change in IRS personnel and three years of relentless taxpayer complaints, the IRS made a welcome announcement last week. At the ABA Tax Section meeting, an IRS spokesperson confirmed that they will not finalize the 2019 proposed section 382 regulations that would have eliminated the ability to increase net operating loss (“NOL”) usage for a post-change loss of tax value in amortizable and depreciable “wasting” assets. For more details regarding the proposed regulations and their significance, please refer to our prior articles, here and here.
Historically, loss corporations were permitted to increase their NOL limitation by applying a hypothetical section 338 election on the change date with respect to a hypothetical purchase of its stock. This approach created additional “recognized built in gain” assets in respect of certain cost recovery deductions for amortizable assets and in respect of cancellation of debt income (“COD”), each of which would increase the overall NOL limitation. The 2019 proposed regulations sought to eliminate this approach. Acknowledging the criticism leveled at the draconian approach of the proposed regulations, the IRS stated that it is considering different approaches to address the use of additional post-ownership change NOLs to reflect the loss in value of amortized or depreciated loss corporation assets. Any newly proposed rules will also need to allocate items of income and loss on the ownership change date to either pre-change or post-change periods and then ensure that they are not double counted in a manner that distorts either unrealized built-in gain or loss at the time of an ownership change. The IRS spokesperson indicated that different items of income or deduction may be differently allocated or treated to best fit section 382 NOL principles. In particular, the treatment of COD that is realized and excluded on an ownership change on the date the borrower emergences from bankruptcy raises important policy questions. The bankruptcy tax policy of a fresh start for debtors may prevail, but many options are on the table.
As the new proposed regulations take shape, we are optimistic that their content will place less emphasis on the exact date on which an ownership change occurs and more emphasis on preserving the debtor’s ability to avoid future encounters with Chapter 11.