PRACTISING LAW INSTITUTE TAX STRATEGIES FOR CORPORATE ACQUISITIONS, DISPOSITIONS, SPIN-OFFS, JOINT VENTURES, FINANCINGS, REORGANIZATIONS AND RESTRUCTURINGS 2014 The Consolidated Unified Loss Rules June 2014 By Mark J. Silverman Steptoe & Johnson LLP Washington, D.C. Copyright © 2014 Mark J. Silverman, All Rights Reserved. - i - TABLE OF CONTENTS Internal Revenue Service Circular 230 Disclosure: As provided for in IRS regulations, advice (if any) relating to federal taxes that is contained in this document (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein. Page I. BACKGROUND AND HISTORY OF LOSS DISALLOWANCE AND LOSS DUPLICATION RULES .....................................................................................................1 A. Investment Adjustment Rules ..................................................................................1 B. Targeted Problems ...................................................................................................2 C. Loss Disallowance Regulations for Dispositions Between 1/31/91 and 3/7/02 – History of Treasury Regulation Section 1.1502-20 ...................................9 D. Rite Aid Case .........................................................................................................13 E. Loss Disallowance Regulations for Dispositions Between 3/7/02 and 9/17/08 – Treasury Regulation Section 1.337(d)-2................................................17 F. Loss Duplication Regulations for Dispositions Between 3/7/02 and 9/17/08 – Treasury Regulation Section 1.1502-35 ................................................18 G. Current Unified Loss Rules for Dispositions After 9/17/08 – Treasury Regulation Section 1.1502-36 ................................................................................20 H. Avoiding the Unified Loss Rules or Prior Loss Disallowance and Duplication Rules...................................................................................................21 II. CURRENT UNIFIED LOSS RULES FOR LOSS ON SUBSIDIARY STOCK ..............22 A. Background ............................................................................................................22 B. General Rule: Reg. § 1.1502-36 ............................................................................25 C. Basis Redetermination to Reduce Disparity ..........................................................29 D. Stock Basis Reduction to Prevent Non-Economic Loss ........................................33 E. Attribute Reduction to Prevent Duplication of Loss..............................................37 F. Coordination with Loss Deferral and Other Loss Disallowance Rules .................45 G. Anti-Abuse Rule - Reg. § 1.1502-36(g).................................................................46 III. OLD LOSS DISALLOWANCE RULES – ADDRESSING CONCERNS RELATING TO THE REPEAL OF GENERAL UTILITIES ...........................................47 A. General Rule ..........................................................................................................47 B. Deconsolidations ....................................................................................................48 B. Allowable Loss ......................................................................................................52 C. Netting Rule ...........................................................................................................64 - ii - Page D. Coordination with Loss Deferral and Other Loss Disallowance Rules .................68 E. Successor Rule .......................................................................................................71 F. Anti-Avoidance Rules ............................................................................................72 G. No Tiering Up of Certain Adjustments ..................................................................75 H. Prior Reg. § 1.1502-20(i) – Transition Rules ........................................................77 IV. OLD LOSS DISALLOWANCE RULES – ADDRESSING CONCERNS RELATING TO LOSS DUPLICATION...........................................................................90 A. Background ............................................................................................................90 B. Basis Redetermination Rule ...................................................................................92 C. Loss Suspension Rule ............................................................................................97 D. Worthlessness and Dispositions Not Followed by Separate Return Years..........100 E. Anti-Avoidance Rules ..........................................................................................104 V. EXAMPLES APPLYING THE UNIFIED LOSS RULES AND LOSS DISALLOWANCE AND DUPLICATION RULES.......................................................112 A. Basis Redetermination Examples ........................................................................112 B. Basis Reduction Examples ...................................................................................124 C. Duplicated Loss Examples ...................................................................................144 D. Intercompany Transfers of Subsidiary Stock Examples ......................................154 - iii - TABLE OF EXAMPLES Page Example 1 – Basic Investment Adjustment Rules ........................................................................2 Example 2 – Basic Son of Mirrors Transaction ............................................................................3 Example 3 – Son of Mirrors Transaction – “Bust Up” .................................................................4 Example 4 – Wasting Assets .........................................................................................................5 Example 5 – Loss Duplication: Unrelated Taxpayers..................................................................6 Example 6 – Loss Duplication: Stuffing/Outside Loss Recognized Before Inside Loss ...............................................................................................................7 Example 7 – Loss Duplication: Stuffing/Inside Loss Recognized Before Outside Loss.............................................................................................................8 Example 8 – Overview of Unified Loss Rule .............................................................................27 Example 9 – Netting Rule Application (Allocation of Gain Amount to Determine Net Loss) ..36 Example 10 – Worthlessness Where S Continues as a Member ...................................................45 Example 11 – Definition of Deconsolidation................................................................................49 Example 12 – Using the Deconsolidation Rule to Avoid Gain Recognition ................................51 Example 13 – Built-In Loss Offsets Built-In Gain .......................................................................58 Example 14 – Netting Gains and Losses.......................................................................................66 Example 15 – Netting Under the Deconsolidation Rule ...............................................................67 Example 16 – Coordination With Loss Deferral Rules ................................................................70 Example 17 – Successor Rule .......................................................................................................71 Example 18 – Shifting of Value ....................................................................................................72 Example 19 – Basic Stuffing Case ................................................................................................74 Example 20 – Deconsolidation of Parent in Same Transaction as Subsidiary .............................76 Example 21 – Reattribution Rule ..................................................................................................81 Example 22 – Worthless Stock Deduction..................................................................................101 Example 23 – Transfer of Property to Avoid Basis Redetermination Rule ................................104 Example 24 – Loss Reimportation ..............................................................................................107 Example 25 – Transfers to Avoid Gain Recognition ..................................................................110 Example 26 – Basis Redetermination To Prevent Non-Economic Loss .....................................112 Example 27 – Basis Redetermination To Prevent Duplicated Loss ...........................................114 Example 28 – Increase In Basis of Transferred Loss Share ........................................................115 Example 29 – No Investment Adjustments; Basis Redetermination Under Prior Rules But Not Unified Loss Rules ........................................................................................117 Example 30 – Partial Duplicated Loss Allowed Under Prior Rules But Not Unified Loss Rules ...............................................................................................120 Example 31 – No Deconsolidation; Economic Loss Disallowed Under Prior Rules But Not Under Unified Loss Rules .............................................................................121