Interim Loss-Disallowance Regulations

In Jan. 31, 2002, the Treasury issued Notice 2002-11, stating that it will issue interim guidance that will require consolidated groups to determine the allowable loss on a sale or disposition of subsidiary stock under an amended Regs. Sec. 1.337(d)-2, instead of under Regs. Sec. 1.1502-20 (see "Notice 2002-11: IRS Reversal on Rite Aid," p. 280, this issue).

On March 7, 2002, the Service issued new temporary and proposed regulations under Secs. 337(d) and 1502 as a stopgap measure to provide immediate guidance on calculating the allowable loss and basis reductions for dispositions and deconsolidations of subsidiary stock. For dispositions and deconsolidations before March 7, 2002, a consolidated group can determine the amount of a member's allowable loss or basis reduction under any one of three methods. The first method is essentially the same as the old rules under Regs. Sec. 1.1502-20. It allows a loss to the extent that the loss exceeds the sum of (1) positive investment adjustments, (2) extraordinary gain items and (3) duplicated losses. It does not employ a tracing methodology. The second method is an elective provision that uses the old rules under Regs. Sec. 1.1502-20 without regard to duplicated losses. The third method is also an elective provision that uses new Temp. Regs. Sec. 1.337(d)-2T. For dispositions and deconsolidations after March 6, 2002, the use of the third method is mandatory.

Temp. Regs. Sec. 1.337(d)-2T closely follows the approach announced in Notice 2002-11. This regulation allows a taxpayer to realize a loss on the disposition or deconsolidation of a subsidiary member when the taxpayer establishes that the loss or basis is not attributable to the recognition of built-in gain on an asset's disposition. Treasury seems to have instituted a tracing regime without providing much guidance on implementation, which raises numerous technical and practical issues.

A significant portion of the new regulation deals with the complexity of determining a member's allowable loss or basis reduction for prior transactions for which the three alternative regimes may apply. Treasury paid particular attention to the difficulties involving loss-reattribution elections and a departed member's loss carryforward amounts. These regulations provide refund opportunities for consolidated groups that have re-alized a stock loss on a subsidiary's prior disposition or deconsolidation.

The ability to elect the new Temp. Regs. Sec. 1.337(d)-2T methodology for prior dispositions and deconsolidations should generally be favorable to most taxpayers, as it does not have the duplicated-loss and positive-adjustment factors. However, if a loss-reattribution election was made under Regs. Sec. 1.1502-20(g), the other options should be considered. These regulations contain rules to protect both the buyer and seller in situations involving the loss-reattribution election when the taxpayer files an amended return.

The temporary regulations appear to be a stopgap measure. The Service recently indicated that it will start to look at all options and policy issues raised by the rules, and not rush to issue final regulations.

From Randy A. Schwartzman, CPA, MST, Melville, NY