Wasting Assets Do Not Generate BIG under Sec. 382

In Technical Advice Memorandum (TAM) 200217009, the IRS ruled that income earned from a taxpayer’s "existing patient base" following a Sec. 382 ownership change cannot be treated as a recognized built-in gain (RBIG) for Sec. 382(h)(6) purposes. In so holding, it rejected the taxpayer’s argument that the income generated was the economic equivalent of income realized on an asset’s disposition, because both types of income reflected a realization of the asset’s fair market value (FMV) on the date of the ownership change.

In the TAM, a corporation underwent a Sec. 382(g) ownership change when it had unused net operating loss carryovers. Following the change and before the expiration limit, the corporation filed three years of refund claims. It claimed that for the refund years, its Sec. 382 limit should be increased to take into account income generated from an "existing patient base" (i.e., patients for whom the corporation supplied products and services at the time of the ownership change).

In support of its claim, the taxpayer pointed to the Technical and Miscellaneous Revenue Act of 1988 amendment to Sec. 382 that allows any income item properly taken into account during the recognition period but attributable to periods before an ownership change date, to be treated as an RBIG for the tax year in which it is properly taken into account. The taxpayer argued that the income generated from a "wasting asset" (such as its patient base) was the logical extension of the economic accrual model that allows gain or loss on an asset’s disposition during the recognition period to be an RBIG.

The Service noted that the legislative history provided examples of post-ownership change income attributable to a pre-change period and treated as RBIG. However, these examples (in-cluding a cash-basis taxpayer’s collection of accounts receivable and Sec. 481(a) income adjustments) were distinguishable from income from wasting assets such as the taxpayer’s patient base. In the IRS’s view, all of the examples dealt with income deferral attributable to a taxpayer’s accounting method. A wasting asset with BIG, however, merely has a FMV that exceeds its basis in the pre-change period; it does not have a fixed right to income taken into account in the post-change period.

The Service also noted that Congress nowhere indicated in the legislative history that the income from a wasting asset should mirror the treatment of the deductions enumerated in Sec. 382(h)(2)(B) (i.e., amounts allowable as depreciation, amortization or depletion in the post-change period for built-in-loss assets). Thus, it concluded that post-change income generated from a wasting asset that has a BIG on the change date is not the "flip side" of treating depreciation, amortization and depletion deductions as recognized built-in losses.

The taxpayer’s position in the TAM arguably can apply to a wide range of BIG assets that generate income in the post-change period. Intangible assets (such as the taxpayer’s patient base) best accommodate this position, because they are expensed as developed and, as a result, generally have significant BIG on a change date. Following the TAM, it will be interesting to see if this issue is addressed by the courts in the future.

From Joseph Quinn, CPA, Oak Brook, IL