United States: Proposed Regulations May Significantly Reduce The Value Of Net Operating Loss Carryforwards And The Value Of Companies With Net Operating Losses

On September 9, 2019, the Treasury Department and IRS issued new proposed regulations (REG-125710-18) (the “Proposed Regulations”) affecting how companies with net operating losses (“NOLs” and such entities, “Loss Companies”) will calculate the ability to use such losses following an ownership change in the wake of the Tax Cuts and Jobs Act, P.L. 115-97 (2017) (TCJA).

The Proposed Regulations represent a significant departure from current law and abandon the method most commonly used by Loss Companies to calculate the annual limitation on the use of NOLs under Section 382.1


  • The Proposed Regulations eliminate a Loss Company’s ability to utilize the so-called “Section 338 approach” for purposes of determining the Loss Company’s annual Section 382 limitation. The Section 338 approach was sanctioned in guidance from the IRS in 2003 and, notwithstanding commentary in the preamble to the Proposed Regulations regarding the difficulty of applying the Section 338 approach, has been widely adopted and implemented by Loss Companies with net unrealized built-in gains since its introduction.
  • The Proposed Regulations modify the method by which a Loss Company’s assets are valued for purposes of determining the potential increase to a Loss Company’s Section 382 limitation by excluding recourse liabilities. In addition, the Proposed Regulations clarify that cancellation of indebtedness income (CODI) recognized during the first year of the ownership change is generally not treated as a recognized built-in gain for purposes of determining the increase in the Section 382 limitation unless it is included in income or used to reduce asset basis.

If enacted in their current form, the Proposed Regulations will have a significant, detrimental impact on the ability of Loss Companies to offset future income with their pre-acquisition losses and may result in substantial diminution of the value of NOL carryforwards and the equity value of Loss Companies. The Proposed Regulations may also have a chilling effect on M&A activity and influence parties to favor asset acquisitions over stock purchases.

It is important to note that the impact of the Proposed Regulations is not limited to financially-troubled companies; an otherwise healthy company may constitute a Loss Company for any number of reasons, including its decision to take advantage of bonus depreciation for capital expenditures or expensing, rather than capitalizing, R&D costs.

Although the Proposed Regulations do not apply to ownership changes that take place prior to the issuance of final regulations, Loss Companies, acquirers, and investors are advised to consider the Proposed Regulations:

  • when making decisions regarding depreciation and amortization methods;
  • when making investment and pricing decisions;
  • for purposes of drafting acquisition agreements relating to Loss Companies;
  • for purposes of analyzing the value of adopting a so-called “NOL poison pill;” and
  • for purposes of structuring new debt obligations and whether non-recourse debt (including recourse debt of a disregarded subsidiary of the issuer) may be utilized to protect the value of NOLs.


Section 382 was implemented to prevent the acquisition of Loss Companies for the sole purpose of utilizing the acquired company’s NOLs post-acquisition to offset income generated by the acquired company. Very generally, when a Loss Company undergoes an ownership change,2 Section 382 limits the annual use of the Loss Company’s NOLs and certain other tax attributes after the ownership change. The Section 382 “base” limitation is measured by the value of the Loss Company on the change of control date multiplied by the then-prevailing federal long-term tax-exempt rate (1.89% for September 2019). The base limitation alone generally is low, particularly in the relatively low interest rate environment of recent years. However, the Section 382 base limitation is increased by the amount of any recognized built-in gain (RBIG) or reduced by the amount of any recognized built-in loss (RBIL) during the five-year period following the ownership change date (the “Recognition Period”). The purpose of this adjustment to the base limitation is to provide neutrality between the tax result that would have been obtained for a Loss Company if the assets giving rise to a net unrealized built-in gain (i.e., the amount by which the fair market value of those assets exceeds the Loss Company’s adjusted basis in such assets) (NUBIG) or a net unrealized built-in loss (i.e., the amount by which the Loss Company’s adjusted tax basis in its assets exceeds their fair market value) (NUBIL) had been sold shortly prior to the ownership change and the result that would obtain if the assets in question were sold during the Recognition Period.

In order to compute the potential adjustment to the base limitation under Section 382, a Loss Company must determine the amount of its NUBIG or NUBIL as of the ownership change date. This computation is made by postulating that the acquirer assumed all of the Loss Company’s indebtedness, including recourse indebtedness that was cancelled or discharged in the transaction. Loss Companies very often have a NUBIG due to historic depreciation deductions (which in many cases constituted a substantial contributing factor in generating the NOLs in question) and the indebtedness taken into account for purposes of measuring the hypothetical gain. This NUBIG may result in a Section 382 limitation that is substantially greater than the base limitation.

Notice 2003-65

Prior to issuance of the Proposed Regulations, IRS Notice 2003-65 provided a safe harbor for purposes of measuring a Loss Company’s RBIG, RBIL, NUBIG, and NUBIL for purposes of determining the Section 382 limitation (the “Safe Harbor”). Under the Safe Harbor, the NUBIG or NUBIL is calculated based on the net amount of gain or loss that would have been recognized if the Loss Company sold all of its assets (including goodwill) immediately before the ownership change to a third party for an amount of cash equal to the assets’ fair market value. This can be done electively by application of one of two approaches: (i) the Section 1374 approach and (ii) the Section 338 approach.

The Section 1374 approach

Under the Section 1374 approach, only the amount of gain or loss actually recognized during the recognition period on an actual sale or exchange of an asset is an RBIG or RBIL, respectively, and such amount is limited to the unrealized built-in gain or loss in that asset as of the ownership change date, subject to certain adjustments.

The Section 338 approach

By contrast, under the Section 338 approach, the Loss Company measures its RBIG or RBIL by calculating the items of income, gain, deduction, and loss that would have resulted if a Section 338 election had triggered a hypothetical sale of its assets. The Loss Company then treats as additional RBIG or RBIL the positive or negative difference between the depreciation or amortization deductions that would be generated during the Recognition Period with or without giving effect to the hypothetical asset sale. In the case of a Loss Company with a NUBIG, which as mentioned above, is a common fact pattern, this generates additional Section 382 limitation (and thus enhances the ability to offset post-ownership change income with pre-acquisition losses) without regard to whether the Loss Company actually sells its assets during the Recognition Period.3

Proposed Regulations

The Proposed Regulations would eliminate the Section 338 approach and make the use of the Section 1374 approach mandatory for purposes of computing NUBIGs and NUBILs. This change is anticipated to significantly reduce the value of the NOLS of Loss Companies in most circumstances by limiting the annual increase to the base limitation to only those built-in gains recognized from actual asset dispositions.

Furthermore, the Proposed Regulations exclude recourse liabilities when determining gain or loss from the hypothetical sale of assets for purposes of calculating NUBIGs and NUBILs. This exclusion is expected to substantially reduce the NUBIG ceiling to which the base limitation can be increased for Loss Companies with significant leverage.

The Proposed Regulations also provide that CODI is not treated as an RBIG for purposes of applying the Section 1374 approach. This could have a significant detrimental effect on the ability of Loss Companies emerging from Chapter 11 or other insolvency transactions to offset future income with NOLs generated before an ownership change.

The Proposed Regulations are effective only for Loss Companies undergoing ownership changes after the date on which they are finalized, although taxpayers may elect to apply them to any transaction prior to the finalization date and any ownership change for an open tax year including ownership changes.

The Treasury Department and IRS have requested comments on the Proposed Regulations by November 12, 2019, with a specific interest in comments regarding the impact on insolvent companies and companies in bankruptcy. Based on the initial negative reaction to the Proposed Regulations, we anticipate that practitioners and interested parties will have numerous comments. It is impossible to predict whether the government will be receptive to such comments, particularly in light of the rapidly-expanding budget deficit, or what form final regulations may take. In the interim, taxpayers are encouraged to consult with their tax advisors regarding the potential impact of the Proposed Regulations to them.


1 All Section references contained herein are to the Internal Revenue Code of 1986, as amended.

2 An ownership change refers to any acquisition of more than 50% of a corporation’s equity by certain “5 percent shareholders” during a three-year testing period. Such an ownership change may occur pursuant to a restructuring in bankruptcy, an M&A transaction, or the accumulation of shares by significant holders.

3 Bonus depreciation under Section 168(k) added by the TCJA allows companies to immediately deduct certain capital expenditures. It was not clear upon enactment whether this new bonus depreciation would be permitted for purposes of determining a Loss Company’s RBIG or RBIL under the Section 338 approach. The IRS answered this question in the negative in Notice 2018-30.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions