The IRS modified the safe harbor approaches for determining recognized built-in gain (RBIG) and recognized built-in loss (RBIL) under Notice 2003-65, 2003-2 CB 747, for corporate reorganizations and ownership changes. The IRS made the modifications in response to amendments made to the Code Sec. 167(k) additional first-year depreciation deduction by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA).
After a reorganization or other change in corporate ownership, the use of certain carryforwards may be limited or prohibited, including net operating loss (NOL) carryforwards. Code Sec. 382 generally provides that, after such an ownership change, the amount of taxable income of a loss corporation for any post-change year that can be offset by pre-change losses cannot exceed the Code Sec. 382 limitation (as defined in Code Sec. 382(b)) for that year.
Under Code Sec. 382(h), if a loss corporation has a net unrealized built-in gain (NUBIG) at the time of an ownership change, any RBIG for a tax year within the five-year recognition period after the ownership change increases the Code Sec. 382 limitation for that year, but not above the NUBIG amount. Similarly, if a loss corporation has a net unrealized built-in loss (NUBIL), any RBIL for a tax year within the five-year recognition period is a pre-change loss subject to the Code Sec. 382 limitation, but not above the NUBIL amount.
Notice 2003-65 provides two alternative safe harbor approaches for determining RBIG and RBIL: the “338 approach” and the “1374 approach.”
Section 338 Approach Safe Harbor
Under the 338 approach safe harbor, RBIG and RBIL items are generally identified by comparing the loss corporation’s actual items of income, gain, deduction, and loss with those that would have resulted if a Code Sec. 338 election had been made for a hypothetical purchase of all of the loss corporation’s outstanding stock on the change date. This approach treats as RBIG or RBIL the difference between the loss corporation’s actual allowable cost recovery deduction for an asset and the hypothetical cost recovery deduction that would have been allowable for the asset had a Code Sec. 338 election been made for a purchase of the loss corporation’s stock.
Section 1374 Approach Safe Harbor
Under the 1374 approach safe harbor, the rules of Code Sec. 1374(d) and its related regulations are generally used for identifying RBIG and RBIL. This safe harbor relies on the accrual method of accounting to determine whether certain items of income or deduction are RBIG or RBIL. However, under Code Sec. 382(h)(2)(B), the 1374 approach treats any allowable deduction for depreciation, amortization, or depletion—collectively, an “amortization deduction”—of a built-in loss asset as RBIL, except to the extent the loss corporation establishes that the amount is not attributable to the excess of an asset’s adjusted basis over its fair market value on the change date, regardless of whether the amount accrued for tax purposes before the change date. An acceptable way to determine the amount of amortization deduction that is not attributable to an asset’s built-in loss on the change date is to compare the deduction amount actually allowed to the deduction amount that would have been allowed had the loss corporation purchased the asset for its fair market value on the change date. The amount by which the actual amortization deduction amount does not exceed the hypothetical amortization deduction amount is not RBIL.
The TCJA amended Code Sec. 168(k) to extend and modify the additional first year depreciation deduction for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2027. TCJA also removed the prior requirement that the original use of the property had to commence with the taxpayer for qualified property to be eligible for additional first year depreciation.
Under the current safe harbors, this means that additional first year depreciation would increase RBIG and reduce RBIL in the first year of the recognition period. In some situations, total RBIG would increase and total RBIL would either increase or decrease over the five-year recognition period. The Treasury Department and the IRS have determined that these changes in RBIG and RBIL amounts are not appropriate.
Modifications to Safe Harbors
The Notice 2003-65 safe harbors are modified to provide as follows:
Under the 338 approach, in determining RBIG or RBIL, the hypothetical cost recovery deductions that would have been allowable had a Code Sec. 338 election been made are determined without regard to Code Sec. 168(k).
Under the 1374 approach, in computing the amount of cost recovery deductions that are not attributable to an asset’s built-in loss on the change date, the hypothetical cost recovery deductions that would have been allowable had the loss corporation purchased the asset for its fair market value on the change date are determined without regard to Code Sec. 168(k).
The modifications are effective for any ownership changes that occur after May 8, 2018. Additionally, the Treasury Department and IRS continue to request comments on the treatment of built-in items under Code Sec. 382(h).
Notice 2003-65, 2003-2 CB 747, is modified.