The IRS modified the safe harbor approaches for determining recognized built-in gain (RBIG) and recognized built-in loss (RBIL) for corporate reorganizations and ownership changes. The IRS made the modifications because of changes 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, certain carryforwards may be limited or prohibited, including net operating loss (NOL) carryforwards. Generally, Code Sec. 382 provides that after an ownership change, pre-change losses cannot offset more of a corporation’s taxable income than the amount allowed by the Code Sec. 382 limitation 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 provided two alternative safe harbor approaches for determining RBIG and RBIL: the “338 approach” and the “1374 approach.”
Section 338 Approach Safe Harbor
Generally, under the 338 approach safe harbor, RBIG and RBIL items are 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. The 338 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 the related regulations are generally used 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, “amortization deduction”) of a built-in loss asset as RBIL. There is an exception when the loss corporation establishes that the amount is not due 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 due to an asset’s built-in loss on the change date is
- to compare the amount of the deduction actually allowed
- to the amount of the deduction 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) by extending and modifying the additional first year depreciation deduction for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2027. In addition, the TCJA removed the requirement that the property ‘s original use was 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. Moreover, 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.
Safe Harbor Modifications
Therefore, the IRS modified the Notice 2003-65 safe harbors 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 2018-30, modifying Notice 2003-65, 2003-2 CB 747