36 Loss Disallowance

PRACTISING LAW INSTITUTE
TAX STRATEGIES FOR CORPORATE ACQUISITIONS,

DISPOSITIONS, SPIN-OFFS, JOINT VENTURES,
FINANCINGS, REORGANIZATIONS AND
RESTRUCTURINGS 2013
The Consolidated Unified Loss Rules
May 2013
By
Mark J. Silverman
Steptoe & Johnson LLP
Washington, D.C.
Copyright 2013 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.....................................................................................................
A. Investment Adjustment Rules..................................................................................
B. Targeted Problems....................................................................................................
C. Loss Disallowance Regulations for Dispositions Between 1/31/91 and
3/7/02 History of Treasury Regulation Section 1.1502-20...................................
D. Rite Aid Case.........................................................................................................
E. Loss Disallowance Regulations for Dispositions Between 3/7/02 and
9/17/08 Treasury Regulation Section 1.337(d)-2................................................
F. Loss Duplication Regulations for Dispositions Between 3/7/02 and
9/17/08 Treasury Regulation Section 1.1502-35................................................
G. Current Unified Loss Rules for Dispositions After 9/17/08 Treasury
Regulation Section 1.1502-36................................................................................
H. Avoiding the Unified Loss Rules or Prior Loss Disallowance and
Duplication Rules...................................................................................................
II. CURRENT UNIFIED LOSS RULES FOR LOSS ON SUBSIDIARY STOCK..............
A. Background............................................................................................................
B. General Rule: Reg. 1.1502-36............................................................................
C. Basis Redetermination to Reduce Disparity..........................................................
D. Stock Basis Reduction to Prevent Non-Economic Loss........................................
E. Attribute Reduction to Prevent Duplication of Loss..............................................
F. Coordination with Loss Deferral and Other Loss Disallowance Rules.................
G. Anti-Abuse Rule - Reg. 1.1502-36(g).................................................................
III. OLD LOSS DISALLOWANCE RULES ADDRESSING CONCERNS
RELATING TO THE REPEAL OF GENERAL UTILITIES............................................
A. General Rule..........................................................................................................
B. Deconsolidations....................................................................................................
B. Allowable Loss......................................................................................................
C. Netting Rule...........................................................................................................
- ii -
Page
D. Coordination with Loss Deferral and Other Loss Disallowance Rules.................

E. Successor Rule.......................................................................................................
F. Anti-Avoidance Rules............................................................................................
G. No Tiering Up of Certain Adjustments..................................................................
H. Prior Reg. 1.1502-20(i) Transition Rules.........................................................
IV. OLD LOSS DISALLOWANCE RULES ADDRESSING CONCERNS
RELATING TO LOSS DUPLICATION............................................................................
A. Background............................................................................................................
B. Basis Redetermination Rule...................................................................................
C. Loss Suspension Rule............................................................................................
D. Worthlessness and Dispositions Not Followed by Separate Return Years
..............................................................................................................................
E. Anti-Avoidance Rules..........................................................................................
V. EXAMPLES APPLYING THE UNIFIED LOSS RULES AND LOSS
DISALLOWANCE AND DUPLICATION RULES........................................................
A. Basis Redetermination Examples.........................................................................
B. Basis Reduction Examples...................................................................................
C. Duplicated Loss Examples...................................................................................
D. Intercompany Transfers of Subsidiary Stock Examples......................................
- 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
Example 32 Deconsolidation; Economic Loss Disallowed Under Prior Rules But Not
Under Unified Loss Rules....................................................................................122
Example 33 Basis Redetermination to Eliminate an ELA.......................................................123
Example 34 Son-of-Mirrors Transaction.................................................................................125
Example 35 Wasting Asset.......................................................................................................126
Example 36 Post-Acquisition Appreciation Eliminates Stock Loss........................................126
Example 37 Distributions........................................................................................................ 127
Example 38 Loss Attributable to Post-Acquisition Loss.........................................................128
Example 39 Built-In Gain Asset Depreciates in Value............................................................129
Example 40 Built-In Gain Asset Appreciates in Value............................................................130
- iv -
Example 41 Built-In Gain in After-Acquired Asset.................................................................132

Example 42 Basis Reduction (Lower-Tier Subsidiary/No Transfer of Lower-Tier Stock).....134
Example 43 Carryover Basis in Stock.....................................................................................136
Example 44 Basis Reduction (Computing the Disconformity Amount Unrecognized
Loss Reflected in Stock Basis)............................................................................138
Example 45 Post-Acquisition Appreciation Removes Taint of Built-In Gain.........................140
Example 46 Post-Acquisition Appreciation Removes Taint of Built-In Gain Lower
Tier Subsidiary.....................................................................................................142
Example 47 Computation of Attribute Reduction Amount/Transfer of All S Shares..............144
Example 48 Transfer of Less than All S Shares.......................................................................145
Example 49 Multiple Dispositions of S Stock.........................................................................146
Example 50 Allocation of Attribute Reduction Amount Among Category D Assets..............148
Example 51 Allocation of Attribute Reduction Amount Among Category A,
Category B, and Category C................................................................................149
Example 52 Wholly Owned Lower-Tier Subsidiary................................................................151
Example 53 Intercompany Sale with Duplicated Loss............................................................154
Example 54 Intercompany Sale of Built-in Gain Stock...........................................................156
Example 55 Intercompany Sale Creates Built-in Gain Stock..................................................157
Example 56 Subsidiary with Built-in Gain and Built-in Loss Assets......................................158
I. BACKGROUND AND HISTORY OF LOSS DISALLOWANCE AND LOSS
DUPLICATION RULES
A. Investment Adjustment Rules
1. The investment adjustment rules under Reg. 1.1502-32 require that

annual positive or negative adjustments be made to the basis of the stock
of each subsidiary of a consolidated group to reflect gain or loss
recognized by the subsidiary.
a. Specifically, basis is increased by Ss taxable income and tax-

exempt income. Basis is decreased by Ss tax loss, nondeductible
expenses, and distributions with respect to Ss stock. Reg.
1.1502-32(b)(2).
b. If S has more than one class of stock outstanding, the adjustments

must be allocated between the classes. An adjustment attributable
to a distribution is allocated to the shares of Ss stock entitled to
the distribution. If the remainder of the adjustments are positive,
the adjustments are allocated first to preferred stock (and only to
the extent of dividend arrearages and distributions to which the
preferred stock becomes entitled), and second to Ss common
stock. If the remainder of the adjustments not attributable to
distributions is negative, they are allocated solely to the common
stock. Reg. 1.1502-32(c)(1).
c. The investment adjustment rules of Reg. 1.1502-32 are based on

certain assumptions regarding shareholders interests in the
subsidiary. One assumption is that each share within a class is
entitled to an equal portion of the subsidiarys items of income and
gain. Another assumption is that the subsidiarys losses are borne
by the holders of the common stock before the holders of the
preferred stock.
d. The adjustments are designed to ensure that consolidated group

members pay a single corporate tax on the groups income and use
losses only once.
-2-
2. Example 1 - Basic Investment Adjustment Rules
P S Stock X
$120
$100 basis
a. Facts: P acquires all of the stock of S for $100. P and S elect to

file a consolidated return. S earns $20 in Year 1. In Year 2, P sells
its S stock to X for $120.
b. Under the investment adjustment rules, Ps basis in its S stock is

increased by the $20 of taxable income in Year 1 to $120. Reg.
1.1502-32(b)(2)(i).
c. Then, when P sells S in Year 2, it recognizes no gain or loss.

Because of the $20 positive basis adjustment, the P group pays
only one tax on its earned income.
B. Targeted Problems
1. Problems Relating to the Repeal of General Utilities
a. Son of Mirrors Transaction
(1) The Tax Reform Act of 1986, Pub. L. No. 99-514, repealed
the General Utilities doctrine by requiring corporate-level
gain recognition on a corporations sale or distribution of
appreciated property, regardless of whether it occurs in a
liquidating or nonliquidating context.1
(2) After the repeal of the General Utilities doctrine, the

operation of the investment adjustment rules permitted
consolidated groups to sell assets without paying a
corporate-level tax. The transaction became known as the
son of mirrors transaction.
1
In General Utilities and Operating Co. v. Helvering, 296 U.S. 200 (1936), the Supreme
Court held that corporations could distribute appreciated property to their shareholders tax-free.
The Tax Reform Act of 1986 repealed the General Utilities doctrine by amending section 311(b)
of the Code. Section 311(b) imposes a corporate-level tax on the distribution of appreciated
property to shareholders, as if the corporation sold such property for its fair market value.
-3-
(3) Example 2 - Basic Son of Mirrors Transaction
(a) Facts: P purchases the stock of S from X for $200.

(1)
S Stock S Stock
X P P Z
$200 $200
$200 basis $400 basis

(2)
Land
S S Y S
$200
Land $200 Cash
$200 Value
$0 Basis
Ss only asset is land with a value of $200 and a

basis of $0. P causes S to sell the land to Y for its
fair market value of $200. P subsequently sells the
S stock to Z for its fair market value of $200.
(b) S recognizes $200 gain on the sale of the land to Y.

Under the investment adjustment rules, P increases
its basis in the S stock by $200 to $400. Reg.
1.1502-32(b)(2)(i).
(c) When P subsequently sells S, it recognizes a $200

loss, which offsets the gain recognized by S.
(4) Example 3 - Son of Mirrors Transaction - Bust Up
(1)
S Stock S Stock
X P P Y
$200 $100
(2)
$200 basis Wanted Asset $100 basis
$100 Value
$50 Basis
S S S
Unwanted Asset Unwanted Asset

$100 Value $100 Value
$50 Basis $50 Basis
-4-

S has two assets, Unwanted Asset and Wanted
Asset, each with a $100 fair market value and a $50
basis. P wants to keep Wanted Asset and dispose of
Unwanted Asset. S distributes Wanted Asset to P,
and P subsequently sells the S stock to Y for its fair
market value of $100.
(b) When S distributes Wanted Asset to P, it results in

$50 of section 311(b) gain to S, which is deferred.
See Reg. 1.1502-13(c)(2)(ii). Ps basis in its S
stock is reduced by $100 to $100 as a result of the
distribution. Reg. 1.1502-13(f)(2)(ii), 1.1502-
32(b)(2)(iv).
(c) Ps subsequent sale of S stock triggers Ss $50

deferred gain. Reg. l.1502-13(d)(1)(i), 1.1502-
13(f)(2)(iii). This gain increases Ps basis in its S
stock by $50 to $150. Reg. 1.1502-32(b)(2)(i).
Thus, P recognizes a $50 loss on the sale of its T
stock. The $50 loss offsets the $50 section 311(b)
gain.
(5) In these examples, Ss built-in gain in its asset was already

reflected in Ps initial cost basis in the S stock. Thus, the
positive investment adjustment for the gain on the sale or
distribution of Ss asset artificially increases Ps basis in its
S stock and permits P to recognize an offsetting loss, in
effect eliminating Ss gain from corporate-level tax.
(6) Arguably, the lack of a tax on the disposition of Ss asset in

these examples is appropriate. In Example 2, P invested
$200 in S and receives $200 cash when S is sold. In
Example 3, P invested $200 in S and receives a Wanted
Asset worth $100 and $100 in cash when S is sold.
(7) However, the lack of a tax is inconsistent with the purpose

of the repeal of the General Utilities doctrine: no
corporate-level tax has been paid on the built-in gain in Ss
asset, yet the asset has a stepped-up basis in the hands of
the buyer.
-5-
b. Wasting Assets Problem
(1) The Internal Revenue Service (the Service) became

concerned that the General Utilities repeal could also be
avoided where assets are not actually disposed of but
instead are used up in the process of earning income. Thus,
where assets are expected to decline in value over time, all
or a portion of the income earned from the asset is
economically a return of capital.
(2) Example 4 - Wasting Assets
S Stock S Stock
X P P Y
$200 $200
$200 basis $300 basis
S S Income S
$20/year for 5 years
Patent Patent
$0 Basis $0 Basis
$100 Cash

Ss only asset is a patent with a value of $200 and a
basis of $0. Ss asset earns $20 and declines in
value by $20 in each year over a five-year period. P
subsequently sells the S stock to Y for its fair
market value of $200.
(b) Under the investment adjustment rules, P increases

its basis in the S stock by $20 each year, or $100
over the five-year period. Reg. 1.1502-32(b)(2)
(i).
(c) When P subsequently sells S, it recognizes a $100

loss, which offsets Ss income. Note, however, that
the time value of money reduces the effect of this
offset.
-6-
2. Loss Duplication Problem
a. The Service is also concerned with the ability to duplicate losses of

consolidated group members.
b. Example 5 - Loss Duplication: Unrelated Taxpayers
S Stock
P P X
$40
$100 S Stock $100

Cash Basis
S S
$60 NOL $60 NOL
(1) Facts: P forms S with a contribution of $100. S has an

operating loss of $60, which the P group is unable to use on
its consolidated return. P subsequently sells S to X for $40.
(2) Ps basis in its S stock remains at $100, because Ss loss

has not been absorbed by the group. Reg. 1.1502-32(b)
(3)(i)(A).
(3) When P sells the S stock to X for $40, P recognizes a $60

loss. S is apportioned its $60 net operating loss carryover
when it leaves the P group. Reg. 1.1502-79(a), 1.1502-
21(b)(2).
(4) Ps loss on the sale of S is thus duplicated when S uses its

loss after leaving the P group. However, S is restricted in
its use of its apportioned losses by section 382, Reg.
1.1502-21, 1.1502-22 (SRLY rules), etc.
(5) Loss duplication can also occur if S uses the $100

contributed by P to purchase an asset and the asset declines
in value to $40.
(6) This sort of loss duplication is not unique to consolidated

returns; it also exists when separate returns are filed.
Arguably, Congress has already addressed the problem in
-7-
sections 382, 384, and 269 (not to mention the Treasurys

own response in Reg. 1.1502-15, 1.1502-21, and
1.1502-22).
c. Example 6 - Loss Duplication: Stuffing/Outside Loss Recognized

Before Inside Loss
(2)
S Preferred
Stock
P P X
$20
(1)
S Common S Preferred
$100 Cash Asset
Stock Stock
$20 Value
$50 Basis (3)
Asset
S S
Y
$20
Asset
$20 Value
$50 Basis
(1) Facts: In Year 1, P forms S with a contribution of $100 in

exchange for all of the common stock of S. In Year 2, P
contributes a built-in loss asset to S with a value of $20 and
a basis of $50 in exchange for a separate block of S
preferred stock. In Year 3, P sells the preferred stock to X
for $20. In Year 4, S sells the asset to Y for $20.
(2) P recognizes a $30 loss on the sale of the S preferred stock.

Because P continues to own all of the S common stock, S
remains a member of the P consolidated group.
(3) When S sells its asset for $20, the P group may use the $30
loss on its return. P is required to reduce its basis in the S
common stock by the amount of Ss loss absorbed by the P
group, which would result in a gain if P subsequently
disposes of the S common stock. Nonetheless, P could
delay or avoid recognition of the gain through some
planning.
(4) Loss Acceleration In the context of this fact pattern, the

Service also appears concerned with the ability of the group
to accelerate economic losses by recognizing the outside
-8-
loss before S recognizes its inside loss. See Notice 2002-

18, 2002-1 C.B. 644 (Mar. 7, 2002); Reg. 1.1502-35.
d. Example 7 - Loss Duplication: Stuffing/Inside Loss Recognized

Before Outside Loss
(3)
S Preferred
Stock
P P X
$20
(1)
S Common S Preferred
$100 Cash Asset
Stock Stock
$20 Value
$50 Basis (2)
Asset
S S
Y
$20
Asset
$20 Value
$50 Basis
(1) Facts: Same facts as in Example 6, except that S sells its

built-in loss asset to Y in Year 3, and P sells the S preferred
stock to X in Year 4.
(2) When S sells its asset for $20, it recognizes a $30 loss,
which offsets income on the P groups return. Under the
investment adjustment rules, Ps basis in each share of S
common stock is reduced by a pro rata share of the $30
loss. Reg. 1.1502-32(c)(2)(i). Ps basis in the preferred
shares is not, however, reduced. Reg. 1.1502-32(c)(3).
(3) P then recognizes a $30 loss on the sale of the S preferred

stock, which it uses to offset income on the P groups
return.
(4) Note that if P subsequently disposes of the S common

stock, it would recognize $30 additional gain. Nonetheless,
P could delay or avoid recognition of the gain through
some planning.
-9-
C. Loss Disallowance Regulations for Dispositions Between 1/31/91 and 3/7/02

History of Treasury Regulation Section 1.1502-20
1. Regulatory Authority Congress granted the Service regulatory authority

to protect the purposes behind the General Utilities repeal, including
regulations to ensure that such purposes may not be circumvented
through the use of any provision of law or regulations (including the
consolidated return regulations . . . ). Section 337(d)(1).
2. Notice 87-14
a. The Service concluded that the result in the son of mirrors

transaction undermined the repeal of the General Utilities doctrine
and issued Notice 87-14, 1987-1 C.B. 445 (Jan. 6, 1987), in
response.
b. In Notice 87-14, the Service announced that it intended to

promulgate regulations that would deny positive basis adjustments
for earnings and profits (under the former basis adjustment rules)
attributable to the sale or distribution of built-in gain property,
using a tracing method.
c. The Notice also indicated that regulations would be effective with

respect to stock in a target that was acquired after January 6, 1987,
the date of the Notice.
3. Original Set of Loss Disallowance Regulations
a. On March 9, 1990, temporary and proposed Reg. 1.1502-20T

was promulgated pursuant to Notice 87-14. Temp. Reg. 1.1502-
20T disallowed any loss recognized on the disposition of a
consolidated subsidiary by a consolidated group member.
(1) However, it contained a reattribution rule, which permitted

the selling member to elect to reattribute net operating
losses of the subsidiary to itself. See Prior Temp. Reg.
1.1502-20T(f)(1).
(2) Thus, the regulations went far beyond Notice 87-14.
(a) Although Notice 87-14 was targeted to the son of

mirrors problem, the original set of regulations
reached all of the problems perceived by the
Service: son of mirrors, wasting assets, and loss
duplication.
(b) In Notice 87-14, the Service indicated that it would

adopt a tracing rule to deny positive investment
- 10 -
adjustments attributable to the recognition of built-

in gain. Tracing would permit a seller of subsidiary
stock to establish that it has a true economic loss.
But in developing and revising the regulations, the
Service rejected tracing as too burdensome on both
taxpayers and the Service, because such a rule
would require the appraisal of each asset of an
acquired subsidiary to determine if built-in gain or
built-in loss exists.
b. Temp. Reg. 1.1502-20T applied to all consolidated subsidiary

stock that was disposed of on or after March 9, 1990, regardless of
when the stock was acquired.
(1) A transitional rule was promulgated in temporary and

proposed Reg. 1.337(d)-1T(a), which generally applied to
subsidiaries acquired after January 6, 1987 and disposed of
before March 9, 1990. Under this rule, losses on the sale of
such stock were disallowed, except to the extent that the
group established that the loss was not attributable to the
recognition of built-in gain.
(2) Therefore, despite the reassurances of Notice 87-14, the

loss disallowance rules (with one minor exception provided
in Reg. 1.337(d)-1T) did apply to subsidiaries acquired
prior to January 7, 1987.
4. Amended Set of Regulations
a. After receiving numerous comments on the loss disallowance

regulations, on November 19, 1990, Treasury and the Service
promulgated revised regulations.
b. Temp. Reg. 1.1502-20T was revoked,2 and Proposed Reg.

1.1502-20 replaced Temp. Reg. 1.1502-20T.
c. The proposed regulations generally contained the same rules as the

original -20T regulations, except that subparagraph (c) added a
limited loss allowance rule, which permitted losses to be
recognized to the extent they exceeded (i) income or gain from
extraordinary gain dispositions, (ii) the amount of positive
investment adjustments, and (iii) the amount of any duplicated
loss.
2
A group could, however, elect to apply the former Temp. Reg. 1.1502-20T in lieu of
the transitional rules of Reg. 1.337(d)-1 and -2, or with respect to pre-effective date
transactions, in order to take advantage of the reattribution rule. Reg. 1.337(d)-1(e)(3),
1.337(d)-2(g)(3), 1.1502-20(h)(4).
- 11 -
d. Prop. Reg. 1.1502-20 generally applied to subsidiary stock

disposed of after January 31, 1991.
e. The transitional rule in Temp. Reg. 1.337(d)-1T was slightly

amended and made final. Reg. 1.337(d)-1. It is generally
applicable to subsidiaries acquired after January 6, 1987 and
disposed of before November 19, 1990.3
f. Temporary and proposed Reg. 1.337(d)-2T generally carried

forward the transitional rule from November 19, 1990 to January
31, 1991.4 Temp. Reg. 1.337(d)-2T applied, however, to all
subsidiaries, regardless of when they were acquired.
5. Final Regulations
a. On September 13, 1991, Treasury and the Service issued final

regulations under Reg. 1.1502-20 and 1.337(d)-2 and slightly
modified Reg. 1.337(d)-1 (collectively, the final 1991
regulations).5
b. Although the final 1991 regulations added some important

provisions to Reg. 1.1502-20, they retained the same approach as
in the proposed regulations. The government acknowledged that
the loss disallowance rule of Reg. 1.1502-20 would disallow
economic losses. Preamble to the final 1991 regulations, 56 Fed.
Reg. 47,379, 47,380-82 (Sept. 13, 1991).
c. The final 1991 regulations did not change any of the effective
dates. Consolidated groups could avoid the loss disallowance
regulations and the window period transition rules in Temp. Reg.
1.337(d)-2T by seeking permission to deconsolidate pursuant to
Rev. Proc. 91-11, 1991-1 C.B. 470.
3
However, this rule may apply to stock disposed of after November 18, 1990. If stock of
a transitional subsidiary was deconsolidated before November 19, 1990, and the remaining
subsidiary stock held by the group was not subject to Reg. 1.337(d)-2 or 1.1502-20, then the
subsidiary continued to be treated as a transitional subsidiary. Reg. 1.337(d)-1(e)(1).
4
A selling group could, however, elect out of Reg. 1.337(d)-2 and into the general loss
disallowance regulations of Reg. 1.1502-20. Reg. 1.1502-20(h)(2).
5
See F.S.A. 199916007 (Jan. 2, 1999) (discussing the history of Reg. 1.1502-20 and
concluding that Reg. 1.1502-20 was promulgated in accordance with the Administrative
Procedure Act).
- 12 -
d. Rev. Proc. 91-11 originally set the final date for filing an
application to discontinue filing consolidated returns as June 30,
1991.
e. However, in Rev. Proc. 91-39, 1991-2 C.B. 694, the Service

modified Rev. Proc. 91-11 by providing that such applications
must be filed no later than 90 days after the date proposed Reg.
1.1502-20 was finalized (i.e., by December 12, 1991).
6. Summary The following table summarizes the applicable loss

disallowance provisions, which apply when a subsidiary is acquired and
disposed of as follows:
Subsidiary acquired before Subsidiary acquired on or

1/7/87: after 1/7/87:
Disposed of on or
after 11/19/90 but 1.337(d)-2 1.337(d)-2
before 2/1/91:
Disposed of on or
after 1/7/87 but LDRs do not apply 1.337(d)-1
before 11/19/90:
7. Removal of -20 and Related Regulations On January 23, 2007, the

Service published proposed consolidated return loss disallowance rules
that would both implement the repeal of the General Utilities doctrine and
address the duplication of losses by members of a consolidated group.
These Unified Loss Rules were finalized on September 17, 2007. The
final regulations thus remove Reg. 1.1502-20 and provide that Reg.
1.337(d)-1, 1.337(d)-2, and 1.1502-35 do not apply to transactions
subject to the Unified Loss Rules. T.D. 9424, 73 Fed. Reg. 53,933, 53,944
(Sept. 17, 2008); Reg. 1.337(d)-1(a)(1), 1.337(d)-2(a)(1), 1.1502-35(a)
(2)(iii).
D. Rite Aid Case
1. Background
The approach of Reg. 1.1502-20 had been widely criticized in that it disallows economic losses
that would otherwise be deductible in a separate return context. Indeed, taxpayers challenged the
validity of Reg. 1.1502-20. See, e.g., Rite Aid Corp. v. United States, 46 Fed. Cl. 500 (2000),
revd, 255 F.3d 1357 (Fed. Cir. 2001); Salina Partnership LP v. Commissioner, 80 T.C.M. (CCH)
686 (2000); FPL Group, Inc. v. Commissioner, T.C. Docket No. 10811-00.
The Court of Appeals for the Federal Circuit held that the governments attempt to disallow
losses capable of duplication was invalid. Rite Aid Corp. v. United States, 255 F.3d 1357 (Fed.
Cir. 2001), revg, 46 Fed. Cl. 500 (2000). The Federal Circuit concluded that disallowing a loss
that would otherwise be deductible under section 165 amounts to an imposition of tax on income
- 13 -
that would otherwise not be taxed, which the government is not authorized to do under section
1502.
2. Facts of Rite Aid
Rite Aid Corporation (Rite Aid) is the common parent of an affiliated group of corporations
that files a consolidated return. In 1984, Rite Aid acquired 80 percent of the stock of Penn
Encore, Inc. (Encore) for $3 million. A section 338 election was made with respect to the
acquisition. In 1988, Rite Aid purchased the remaining 20 percent of Encore stock for $1.5
million. From 1984 through 1994, Encore experienced net negative earnings and profits of
approximately $10.9 million and borrowed approximately $44.9 million from Rite Aid.
In January 1994, Rite Aid adopted a restructuring plan, which included the sale of Encore. Rite
Aid asked prospective bidders whether they would join in making an election under section
338(h)(10). The only bidder for Encore refused to join in a section 338(h)(10) election.
On November 23, 1994, Rite Aid sold all of the Encore stock, claiming a loss of approximately
$22.1 million. However, the loss was disallowed under Reg. 1.1502-20. Rite Aid determined
that Encores duplicated loss factor was approximately $28.5 million, its extraordinary gain
disposition factor was $9,624, and its positive investment adjustment factor was approximately
$6.2 million. Because the sum of the loss disallowance factors, or approximately $34.7 million,
exceeded Rite Aids investment loss, Rite Aids entire loss was disallowed under Reg. 1.1502-
20.
Rite Aid paid the tax and filed a claim for refund in the United States Court of Federal Claims,
claiming that Reg. 1.1502-20 was invalid.
3. Court of Federal Claims Decision
The Court of Federal Claims held that Reg. 1.1502-20 was not arbitrary, capricious, or
manifestly contrary to law, and that it served the purpose of clearly reflecting income tax liability
of both the parent and the subsidiary in a consolidated group.
The court rejected the taxpayers argument that the regulation was in derogation of section
165(a), which permits a deduction for losses sustained during the taxable year, and thus exceeded
the Treasurys authority. The court noted that the taxpayer had an opportunity, which it did not
take, to structure the sale of the subsidiary in a way that would have allowed the taxpayer to
recognize the loss (i.e., as an asset sale instead of a stock sale).
The court also rejected the taxpayers argument that the Supreme Courts decision in Illfield
Co. v. Hernandez stands for the proposition that a duplicated loss is a loss twice enjoyed by the
group not by unrelated parties. The court noted that section 1502 permits the Treasury to
implement regulations that clearly reflect income tax liability with respect to consolidated groups
and their members both during and after the period of affiliation, which is served by
prohibiting group losses that otherwise may be taken both by the group and its former member.
4. The Federal Circuit Decision

- 14 -
The Court of Appeals for the Federal Circuit reversed the Court of Federal Claims decision that
Reg. 1.1502-20 was a proper exercise of Treasurys regulatory authority. The Federal Circuit
held that duplicated loss factor of the loss disallowance rules distorts rather than reflects the tax
liability of consolidated groups and, therefore, the regulation is manifestly contrary to the
statute.
The Federal Circuit held that in the absence of a problem created from the filing of consolidated
returns, the Secretary is without authority to change the application of other tax code provisions
to a group of affiliated corporations filing a consolidated return. Because the ability of a former
consolidated subsidiary to realize a loss on its assets after the consolidated group realizes a loss
on the subsidiarys stock is not limited to the consolidated return context, the Secretary is without
authority to change the application of section 165 to the sale of the subsidiarys stock.
(1) This standard could have broad implications with respect to

other consolidated return regulations, because the
consolidated return regulations change the application of
many tax code provisions. See, e.g., Reg. 1.1502-13(f)
(2); -13(f)(6); -13(g)(3)(ii)(B)(2); -19; -32; -80.
(2) The Federal Circuit did not offer much guidance as to when
a problem is created by the filing of consolidated returns.
The Federal Circuit noted that Congress has already addressed the problem of duplicated losses
by limiting the subsidiarys potential future deduction under sections 382 and 383 not by
disallowing the parents loss on the subsidiary stock.
The Federal Circuit rejected the governments argument that if an affiliated group elects to take
advantage of the benefits of filing a consolidated return, it must take the bitter with the sweet,
noting that the bitter with the sweet does not include the invalid.
It is not clear from the courts opinion whether it invalidated all of Reg. 1.1502-20 or just the
duplicated loss provision. The court stated that the regulation was manifestly contrary to the
statute. Nonetheless, the courts analysis clearly focuses on only the duplicated loss provision,
and the Service has interpreted the opinion to invalidate only the duplicated loss provision. See
Notice 2002-11, 2002-7 I.R.B. 1 (Jan. 31, 2002).
5. Notice 2002-11
On January 31, 2002, the Service issued Notice 2002-11, announcing that it would not seek
certiorari from the Supreme Court in Rite Aid. The Notice stated that the government would not
continue to litigate the validity of the loss duplication factor in the interests of sound tax
administration.
The Notice further provided that because of the interrelationship between all of the loss
disallowance factors, Reg. 1.1502-20 would be replaced in its entirety with interim regulations
based on Reg. 1.337(d)-2.
- 15 -
Since it issued this Notice, the Service pursued General Utilities repeal concerns separately from
loss duplication concerns. However, the finalized Unified Loss Rules comprehensively address
both General Utilities repeal and loss duplication concerns. Reg. 1.1502-36, T.D. 9424 (Sept.
17, 2007), 73 Fed. Reg. 53,933 (Sept. 17, 2008).
6. Legislative Response Section 646 of the American Jobs Creation Act of

2004 (H.R. 4520) amended section 1502 to limit the decision in Rite Aid
by adding the following sentence to section 1502:
(a) IN GENERAL - In carrying out the preceding

sentence, the Secretary may prescribe rules that are
different from the provisions of chapter 1 that
would apply if such corporations filed separate
returns.
(b) RESULT NOT OVERTURNED

Notwithstanding the amendment made by
subsection (a), the Internal Revenue Code of 1986
shall be construed by treating Treasury Regulation
Sec. 1.1502-20(c)(1)(iii) (as in effect on January 1,
2001) as being inapplicable to the factual situation
in Rite Aid Corporation and Subsidiary
Corporations v. United States, 255 F.3d 1357 (Fed.
Cir. 2001).
The Conference Report (H.R. Conf. Rep. No. 108-755) explains that the reason for the provision
is the Finance Committees concern that the language of the Rite Aid opinion may lead taxpayers
to challenge other consolidated return regulations that prescribe a result that is different from the
separate return result. It also states that the provision in no way prevents or invalidates the
approaches Treasury has announced it will apply in lieu of Reg. 1.1502-20. See also H.R. Rep.
No. 108-548; S. Rep. No. 108-192.
E. Loss Disallowance Regulations for Dispositions Between 3/7/02 and 9/17/08

Treasury Regulation Section 1.337(d)-2
On March 7, 2002, Temp. Reg. 1.337(d)-2T, 1.1502-20T(i), and 1.1502-32T(b)(4)(v) were

promulgated pursuant to Notice 2002-11. See 67 Fed. Reg. 11,034 (Mar. 12, 2002). These
regulations were further amended in May 2002, May 2003, and March 2004. See 67 Fed. Reg.
37,998 (May 31, 2002); 68 Fed. Reg. 24,351 (May 7, 2003); 69 Fed. Reg. 12,799 (Mar. 18,
2004). The regulations were adopted as final regulations, without substantive change, on March
3, 2005.
The regulations address only the son of mirrors problem discussed above. At the same time the
temporary regulations were issued, the Service issued Notice 2002-18, 2002-1 C.B. 644, in
which it announced its intention to issue regulations to address loss duplication concerns.
Reg. 1.337(d)-2 is generally applicable for dispositions of stock occurring on or after March 3,
2005.
- 16 -
Reg. 1.337(d)-2 largely employs the rules that were in former Reg. 1.337(d)-2. Losses on
subsidiary stock are disallowed except to the extent that the parent establishes that the loss is not
attributable to built-in gain on the disposition of an asset. Reg. 1.337(d)-2(c)(2).
However, Reg. 1.337(d)-2 differs from former Reg. 1.337(d)-2 in that the selling group is no
longer required to dispose of its entire interest in the subsidiary. Reg. 1.337(d)-2.
For dispositions of stock occurring before March 7, 2002, or for dispositions or deconsolidation
of stock of a subsidiary after March 7, 2002 effected pursuant to a binding written contract
entered into before March 7, 2002 that was in continuous effect, Temp. Reg. 1.1502-20T(i)(2)
allows a parent to choose one of three regulatory schemes for each separate disposition of
subsidiary stock. These regulations were adopted as final regulations, without substantive
change, on March 3, 2005.
Reg. 1.1502-20 in its entirety;
Reg. 1.1502-20 without regard to the loss duplication factor; or
Reg. 1.337(d)-2.
Notice 2004-58. On August 25, 2004, the Service issued Notice 2004-58 announcing a method
that it will accept for determining the extent to which loss or basis is attributable to the
recognition of built-in gain on the disposition of an asset for purposes of applying the exception
to the loss disallowance rule in Reg. 1.337(d)-2.
This method, the basis disconformity method, disallows loss in an amount equal to the least of:
(i) the gain amount, which is the sum of all gains recognized on asset dispositions of the
subsidiary while a member of the group; (ii) the disconformity amount, which is the excess of
the shares basis over the shares proportionate interest in the subsidiarys net asset basis; and
(iii) the positive investment adjustment amount, which is the excess of the sum of all positive
investment adjustments over the sum of all negative investment adjustments (excluding
distributions) made to the share.
At the same time Notice 2004-58 was issued, Treasury and the Service issued temporary
regulations permitting taxpayers to make, amend, or revoke elections under Temp. Reg.
1.1502-20T(i). See Temp. Reg. 1.1502-20T(i)(6).
The final Unified Loss Rules modify Reg. 1.337(d)-1 and 1.337(d)-2 to state explicitly that
they do not apply to transactions subject to the Unified Loss Rules. T.D. 9424, 73 Fed. Reg. at
53,944; Reg. 1.337(d)-1(a)(1), 1.337(d)-2(a)(1).
F. Loss Duplication Regulations for Dispositions Between 3/7/02 and 9/17/08

Treasury Regulation Section 1.1502-35
1. Notice 2002-18 - On March 7, 2002, the Service issued Notice 2002-18

announcing its intention to issue regulations that will prevent a
consolidated group from obtaining more than one tax benefit from a single
- 17 -
economic loss. The Notice stated that such regulations will apply to
dispositions of stock occurring on or after March 7, 2002.
The Notice cited the following example of the type of duplicated loss to be targeted by the
forthcoming regulations: A member of the consolidated group (the transferor) contributes a
built-in loss asset to another member of the group (the transferee) in exchange for stock of the
transferee in a transaction in which the basis of such stock is determined by reference to the basis
of the transferred asset. The transferor then sells the transferee stock without causing a
deconsolidation of the transferee, thus permitting the group to benefit from the built-in loss in the
asset twice.
The Notice appears to have been triggered in part by press surrounding a similar transaction
undertaken by Bank of America. See, e.g., Sheppard, Bank of Americas Tax Plan for Bad
Loans, 2002 TNT 38-5 (Feb. 11, 2002); Mollenkamp, Rare Use of Tax Law Helps Lift Bank of
America to Hefty Profit, Wall St. J., at A2 (Jan. 24, 2002).
Thus, the Notice appears to target the stuffing-type loss duplication transactions illustrated in
Examples 6 and 7, above. The loss duplication illustrated in Example 5, above, where the
subsidiarys inside loss can be used by it after it leaves the group, was the fact scenario that led to
the invalidation of the loss duplication factor in Rite Aid. Such duplication outside the
consolidated group was not the apparent target of the Notice.
2. Proposed Treasury Regulation Section 1.1502-35
On October 23, 2002, Treasury and the Service issued proposed regulations to implement Notice
2002-18. Prop. Reg. 1.1502-35. Consistent with the Notice, the stated purpose of the proposed
regulations was to prevent a consolidated group from obtaining more than one tax benefit from a
single economic loss.
The proposed regulations contained a complicated set of rules:
(1) Basis Redetermination Rule - If a member of a

consolidated group disposes of stock of a subsidiary
member, or a share of subsidiary member stock is
deconsolidated, at a loss, then all members bases in the
subsidiary stock are aggregated and reallocated among the
common and preferred stock of the subsidiary.
(2) Loss Suspension Rule - If after applying the basis

redetermination rule, a member of a consolidated group
still recognizes a loss on the disposition of stock of a
subsidiary, then the selling members loss is suspended to
the extent of any duplicated loss.
(3) Basis Reduction Rule - If a subsidiarys stock becomes

worthless or the subsidiary disappears in a transaction in
which gain or loss is recognized, then any consolidated net
operating loss allocable to the subsidiary is treated as
- 18 -
absorbed, which results in a basis reduction under the

investment adjustment rules of Reg. 1.1502-32.
(4) The proposed regulations also contained some anti-abuse

rules.
The regulations were generally proposed to apply retroactively to transactions that occur on or
after March 7, 2002, the date of Notice 2002-18.
3. Temporary Treasury Regulation Section 1.1502-35T
Notwithstanding the criticism of the proposed regulations, see American Bar Association Section
of Taxation, Comments on Consolidated Group Basis Redetermination and Loss Suspension
(Feb. 20, 2003); New York State Bar Association Tax Section, Report on Temporary Regulation
1.337(d)-2T and Proposed Regulation 1.1502-35 (Feb. 28, 2003), on March 14, 2003,
Treasury and the Service issued temporary regulations that were substantially similar to the
proposed regulations, but reflected certain revisions based on the comments received.
Treasury and the Service made it clear in the preamble to the temporary regulations that they
were continuing to study the comments they received and specifically requested comments on
alternative regimes that they were considering.
4. Final Treasury Regulation 1.1502-35
On March 9, 2006, the temporary regulations were issued as final regulations without substantive
change. The preamble to the final regulations states that Treasury and the Service are continuing
to study the issues raised by both Reg. 1.337-2 and Reg. 1.1502-35. The preamble states that
Treasury and the Service intend to publish proposed regulations in the near term addressing
both circumvention of General Utilities repeal and loss duplication in a single integrated
regulation.
a. The final Unified Loss Rules modify Reg. 1.1502-35 to state

explicitly that it does not apply to transactions subject to the
Unified Loss Rules. T.D. 9424, 73 Fed. Reg. at 53,944; Reg.
1.1502-35(a)(2)(iii).
G. Current Unified Loss Rules for Dispositions After 9/17/08 Treasury

Regulation Section 1.1502-36
1. On September 17, 2008, Treasury and the Service issued final Unified
Loss Regulations. The final regulations adopted regulations that were
proposed in January 2007 with modest changes. The final Unified Loss
Rules address both the General Utilities repeal and loss duplication with
an integrated set of rules.
2. As a result, the regulations modify Reg. 1.337(d)-1, 1.337(d)-2, and

1.1502-35 to state explicitly that they do not apply to transactions subject
to the Unified Loss Rules. T.D. 9424, 73 Fed. Reg. at 53,944; Reg.
- 19 -
1.337(d)-1(a)(1), 1.337(d)-2(a)(1), 1.1502-35(a)(2)(iii). Additionally,

the final Unified Loss Rules modify the loss suspension rule to provide
that it applies only to losses allowed within ten years of the date that they
are recognized and that it ceases to apply ten years after the stock
disposition that gave rise to the suspended loss. 73 Fed. Reg. at 53,944.
H. Avoiding the Unified Loss Rules or Prior Loss Disallowance and Duplication
Rules
1. The regulations disallow losses on the sale of subsidiary stock, not assets.
As such, the selling group should consider structuring the transaction as an
asset sale or as a stock sale with a section 338(h)(10) election. If the
subsidiary sells its assets at a loss, the loss will be recognized.
2. If a subsidiary and buyer jointly make a section 338(h)(10) election, a

stock sale will be treated as a deemed asset sale, with the following
consequences:
a. The subsidiary is treated as selling its assets while it was a member

of the group;
b. The subsidiary is deemed to be completely liquidated under section

332, and all of the subsidiarys tax attributes move up to the parent;
c. The buyer acquires none of the tax attributes of the subsidiary and
takes a fair market value basis in the subsidiarys assets; and
d. Gain or loss on the sale of stock is ignored.
3. For example, assume that P owns all of the stock of S. Ps basis in the S
stock is $550 and its value is $500. S holds one asset, which has a basis of
$550 and a value of $500. X wants to purchase the S stock for $500. If
the S stock is sold, P would recognize a $50 loss, which would be
disallowed. Instead, P and X make an election under section 338(h)(10) to
treat the stock sale as a deemed asset sale.
a. S recognizes a $50 loss that is includable on Ps consolidated

return.
b. Ss tax attributes move up to P.
c. X takes the asset with a step-down in basis to its value of $500,

and X loses all of the tax attributes of S.
d. If a section 338(h)(10) election is not made, X acquires S with its

tax attributes, including its built-in loss assets, preserved. As a
result, even though section 382, SRLY, etc. apply, X may not be
- 20 -
willing to join in a section 338(h)(10) election or may pay less for

the S stock before X will agree to a section 338(h)(10) election.
4. As an alternative to a section 338(h)(10) election, P could merge S into a

single-member limited liability company (LLC) formed by P and sell all
of the LLC interests to X. Because the LLC is disregarded as an entity
separate from P, P would be treated as selling the assets of the LLC to X.
See Reg. 301.7701-2(a).
5. As another alternative, P could cause S to distribute its asset to P before

selling the S stock to X. Under Reg. 1.1502-13(f)(2)(iii), the principles
of section 311(b) apply to intercompany distributions. Thus, Ss $50 loss
would be deferred under Reg. 1.1502-13(c) and triggered when S leaves
the group under Reg. 1.1502-13(d). P would reduce its basis in the S
stock by the $50 loss on the distribution and by the $500 value of the
asset. Reg. 1.1502-32(b)(2)(i), (iv). Because the value of S is reduced
by the value of the property no longer owned by S, P would recognize no
gain or loss on the sale of the S stock to X. See F.S.A. 200012046 (Dec. 9,
1999); George White, Loss Disallowance Regulations Flanked?, 41 Tax
Mgmt. Memo. 248 (June 19, 2000).
II. CURRENT UNIFIED LOSS RULES FOR LOSS ON SUBSIDIARY STOCK
A. Background
1. After Rite Aid and the Services withdrawal of the loss duplication factor
of Prior Reg. 1.1502-20, Treasury and the Service have been studying
ways to deal with (i) noneconomic losses that circumvent the repeal of the
General Utilities doctrine and (ii) duplicated losses. Until Reg. 1.1502-
36, efforts to deal with the two problems have followed separate but
parallel tracks Prior Reg. 1.337(d)-2 addressed noneconomic losses and
Prior Reg. 1.1502-35 addressed duplicated losses.
2. Reg. 1.1502-36 adopts a single integrated approach to the two problems.

The regulations containing these Unified Loss Rules were proposed in
January 2007 and then finalized with a few modest changes in September
2008. Reg. 1.1502-36, T.D. 9424; Prop. Reg. 1.1502-36, 72 Fed. Reg.
2964, 2965-66 (Jan. 23, 2007). The Unified Loss Rules apply to transfers
of subsidiary stock on or after September 17, 2008. Reg. 1.1502-36(h).
3. Purposes of the Unified Loss Rules
a. The Unified Loss Rules have two principal purposes:
(1) The first is to prevent the consolidated return provisions

from reducing a groups consolidated taxable income
through the creation of a non-economic loss on S stock.
Reg. 1.1502-36(a)(2).
- 21 -
(2) The second is to prevent members (including former

members) of the group from collectively obtaining more
than one tax benefit from a single economic loss. Reg.
1.1502-36(a)(2).
b. The investment adjustment system of Reg. 1.1502-32 generally

prevents noneconomic losses. However, because that system is a
presumptive one based on certain operating assumptions, it may
result in noneconomic gain or loss where the assumptions do not
correspond to the facts. 72 Fed. Reg. at 2966.
(1) For example, the investment adjustment rules assume that

all of a subsidiarys items taken into account represent
economic gain or loss, which may not be the case where a
purchased subsidiary holds appreciated assets.
(2) Another example is that the investment adjustment rules

assume that items accrue economically to all shares equally
within a class, which may not be the case where shares
have disparate bases.
c. In addition, the investment adjustment system prevents duplicated

losses, but only if Ss inside loss in its assets is recognized before
Ps outside loss in Ss stock. If the outside loss is recognized first,
S may still benefit from the inside loss.
4. Considerations to Address General Utilities Repeal
a. The Service and Treasury rejected a tracing approach similar to

Prior Reg. 1.337(d)-2 because such an approach was determined
to be inadministrable. 72 Fed. Reg. at 2970.
(1) Tracing is further complicated by redetermination events,

or events that alter the relationship between the basis of a
share and the interest it represents. Such events include
intragroup spin-offs or section 351 exchanges. 72 Fed.
Reg. at 2970.
(2) Additional difficulties are presented when tainted

appreciation is recognized through wasting or consumption
rather than gain on the disposition of the asset. 72 Fed. Reg.
at 2970.
(3) The Service and Treasury also wanted to avoid valuation

issues. 72 Fed. Reg. at 2970.
b. The Service and Treasury also rejected a hybrid-tracing

presumptive model that would identify all assets held when a share
- 22 -
is acquired and on each redetermination date and presume all items

traced to those assets to be tainted. This approach was rejected
because it required identification of all redetermination events and
could potentially be easily manipulated. 72 Fed. Reg. at 2972.
c. The Service and Treasury rejected the basis disconformity

approach of Notice 2004-58 because it was under inclusive in that
it addresses only noneconomic stock losses to the extent of net
appreciation reflected in basis, which by its nature is reduced by
unrecognized depreciation reflected in basis. 72 Fed. Reg. at 2972.
(1) Instead of modifying the basis disconformity approach, the

Service and Treasury incorporated elements of it into its
new, unified approach discussed below. 72 Fed. Reg. at
2972-73.
5. Consideration to Address Loss Duplication Concern
a. The Service and Treasury reconsidered the appropriateness of Prior

Reg. 1.1502-35 in allowing subsidiaries to duplicate group losses
after the period of consolidation. 72 Fed. Reg. at 2975-76.
b. The Service and Treasury rejected a pure loss disallowance rule

because it would violate Rite Aid in deconsolidating transfers.
72 Fed. Reg. at 2976.
c. The Service and Treasury rejected the use of loss duplication

suspense accounts because they would present tracing issues.
72 Fed. Reg. at 2976.
6. The Unified Approach Incorporates the Following Conventions
a. Irrebuttable presumptions. 72 Fed. Reg. at 2975.
b. Loss limitation model which disallows loss duplication and also

reduces gain duplication. 72 Fed. Reg. at 2973.
c. Apply basis reduction immediately before disposition which

avoids the need for separate rules for disposition and
deconsolidation. 72 Fed. Reg. at 2973.
d. Limit basis reduction to the amount of basis disconformity.

72 Fed. Reg. at 2975-75.
e. Allow netting of all investment adjustments made to a share for all

periods. 72 Fed. Reg. at 2975.
- 23 -
f. Reduce subsidiarys attributes to extent of duplicated losses.

72 Fed. Reg. at 2977.
g. Reallocation of disparate investment adjustments of only

transferred shares, rather than full blending as required by Prior
Reg. 1.1502-35. 72 Fed. Reg. at 2978.
B. General Rule: Reg. 1.1502-36
1. Treasury regulation 1.1502-36 provides rules for adjusting members

bases in stock of a subsidiary (S) and for reducing Ss attributes when a
member (M) transfers a loss share of S stock. See Reg. 1.1502-36(a)(1).
1.1502-36 replaces Prior Reg. 1.337(d)-2 (including Notice 2004-58)
and 1.1502-35. However, the loss suspension and reimportation rules in
Prior Reg. 1.1502-35 and 1.337(d)(2) continue to apply to transactions
prior to September 17, 2008. These rules are discussed in more detail
below.
2. The Unified Loss Rules apply when a member transfers a share of

subsidiary stock and, after taking into account the effects of all applicable
rules of law, including those that would not be effective until after the
transfer, the share is a loss share. Reg. 1.1502-36(a)(1), (a)(3)(i).
3. A transfer of stock includes any event in which:
a. gain or loss would be recognized (Reg. 1.1502-36(f)(10)(i)(A));
(1) A transfer does not generally include a nonrecognition

transaction. However, a section 332 liquidation of a
subsidiary into multiple members is treated as a transfer.
Reg. 1.1502-36(f)(10)(ii).
b. the holder of a share and the subsidiary cease to be members of the

same group (Reg. 1.1502-36(f)(10)(i)(B));
c. a nonmember acquires an outstanding share from a member (Reg.

1.1502-36(f)(10)(i)(C)); or
d. the share is treated as worthless (Reg. 1.1502-36(f)(10)(i)(D)).
4. Generally, the three rules apply in the order described: (i) the basis
redetermination rule; (ii) the basis reduction rule; and (iii) the attribute
reduction rule.
5. Reg. 1.1502-36 applies and has effect immediately upon the transfer of a
loss share even if the loss is deferred, disallowed, or otherwise not taken
into account under any other applicable rules of law. Reg. 1.1502-36(a)
(4).
- 24 -
a. However, as discussed below, Reg. 1.1502-36(e)(3) defers the

application of the Unified Loss Rules until the triggering of an
intercompany loss under Reg. 1.1502-13.
6. If members transfer stock of multiple subsidiaries in one transaction, the

basis redetermination and basis reduction rules apply first with respect to
transfers of loss shares of stock of the subsidiaries at the lowest tier and
then successively to transferred shares at each next higher tier. Reg.
1.1502-36(a)(3)(ii).
a. These rules are not applied at any tier until any gain or loss
recognized (even if disallowed) on lower-tier transfers and any
items resulting from lower-tier adjustments (whether required by
the basis redetermination or basis reduction rule or otherwise) are
taken into account and reflected in stock basis. Id.
b. After the basis redetermination and reduction rules have applied

with respect to all transferred loss shares, the attribute reduction
rule applies with respect to the highest-tier transferred loss shares.
The attribute reduction rule then applies successively with respect
to transferred loss shares at each next lower tier. Id.
7. General Application of Reg. 1.1502-36:
a. The Unified Loss Rules in Reg. 1.1502-36 consist of three

principal rules that apply when a member transfers a loss share of
subsidiary stock:
(1) The first rule, Reg. 1.1502-36(b), the basis

redetermination rule, redetermines members bases in
subsidiary stock by reallocating Reg. 1.150232
adjustments (to adjust for disproportionate reflection of
gains and losses in the bases of members shares). Reg.
1.1502-36(a)(3)(ii)(A).
(2) The second rule, Reg. 1.1502-36(c), the basis reduction

rule, reduces members bases in transferred loss shares (but
not below value) by the net positive amount of all
investment adjustments applied to the bases of those shares,
but only to the extent of the shares disconformity amount
(to address non-economic stock loss). Reg. 1.1502-36(a)
(3)(ii)(A).
(3) The third rule, Reg. 1.1502-36(d), the attribute reduction

rule, reduces the subsidiarys attributes to prevent the
duplication of a loss recognized on, or preserved in the
basis of, transferred stock. Reg. 1.1502-36(a)(3)(ii)(A).
- 25 -
(4) Reg. 1.1502-36(e), (f), and (g), provide general

operating rules,6 definitions, and an anti-abuse rule,
respectively.
b. Example 8 Overview of Unified Loss Rules:
S2 Stock S Stock
B M A
Cash Cash
BIL
S2 S
Stock
Cash
1 share BIL
BIG S1
1 share
S2 BIG
(1) Facts: M owns all the outstanding shares of S stock and

one of the two outstanding shares of S2 stock, S owns all
the outstanding shares of S1 stock, and S1 owns the other
outstanding share of S2 stock. The S and S1 shares are loss
shares and the S2 shares are gain shares. As part of one
transaction, M sells all the S shares and its S2 share, and S1
sells its S2 share. The sales are to unrelated individuals,
and S and S1 do not elect to file a consolidated return after
the transaction. Each share is transferred under Reg.
1.1502-36 (the S and S2 shares because S and S2 cease to
be owned by M, and M and S1, respectively, as a result of
taxable dispositions, and the S1 shares because S and S1
cease to be members of the same group). Reg. 1.1502-36
applies to the transfer of the S and S1 (loss) shares, but not
to the transfer of the S2 (gain) shares.
(2) The gain recognized on the transferred S2 shares tiers up to

adjust members bases in all upper-tier subsidiary shares
under the principles of 1.150232. Then, if Ss
transferred S1 shares are still loss shares, 1.1502-36(b)
and (c) apply to those shares. The loss on the S1 shares is
6
Specifically, predecessor/successor rules, effects of prior 362(e)(2) transactions,
application of the Unified Loss Rules to intercompany transactions and section 332 liquidations,
and election procedures.
- 26 -
not recognized in the transfer (because there is no taxable

disposition of the shares) and so the adjustments to the
basis of the S1 shares required by 1.1502-36(b) and (c)
only tier up to adjust Ms basis in the S stock. Then, if Ms
transferred shares of S stock are still loss shares, Reg.
1.1502-36(b) and (c) apply with respect to those shares.
(3) If, after giving effect to any adjustments under Reg.

1.1502-36(b) and (c), any of the S shares are still loss
shares, Reg. 1.1502-36(d) applies with respect to the
transfer of those shares. If any transferred S1 shares are
still loss shares after the application of Reg. 1.1502-36(d)
with respect to the transfer of S shares, Reg. 1.1502-36(d)
applies with respect to the transfer of the S1 shares. Reg.
1.1502-36(a)(3)(ii)(C).
8. The regulations also address section 362(e)(2) transactions. The Service

and Treasury concluded that section 362(e)(2) should generally not apply
to intercompany transactions. Reg. 1.502-80(h).
a. The purpose of Reg. 1.502-80(h) is to allow the consolidated

return provisions to address loss duplication. 73 Fed. Reg. at
53,945.
b. The proposed regulations, which suspended the application of

section 362(e)(2) for intercompany transactions, were not adopted
because they were determined to be too complex and
administratively burdensome. 73 Fed. Reg. at 53,935.
(1) The final regulations contain an anti-abuse rule to protect

against any concern on the part of the Service and Treasury
that the inapplicability of section 362(e)(2) could be used to
reach inappropriate results. Id.
c. The Service and Treasury recognized that, because section 362(e)

(2) continues to apply prior to September 17, 2008, distortions
could result if the taxpayer does not elect to apply the rule in the
final regulations. Thus, the final regulations retain the rule in Prop.
Reg. 1.1502-36(e)(2) that provided for adjustments to offset the
effects of basis reductions under section 362(e)(2). 73 Fed. Reg. at
53,937.
(1) To adjust for distortions resulting from basis reduction

under section 362(e)(2)(A) and similar cases, the
regulations adjust the disconformity amount of the shares
received in the transaction, and the attribute reduction
amount upon the transfer of such shares, by the amount the
- 27 -
basis of such shares would have been reduced had an

election under section 362(e)(2)(C) been made. Reg.
1.1502-36(e)(2)(i), (iii).
(2) To adjust for distortions resulting from basis reduction

under section 362(e)(2)(C) and similar cases, the
regulations reduce Ss net inside attribute amount by the
amount Ss attributes would have been reduced under
section 362(e)(2)(A) had no election under section 362(e)
(2)(C) been made for purposes of computing the basis
disconformity amount or the aggregate inside loss. Reg.
1.1502-36(e)(2)(ii), (iii).
9. The final Unified Loss Rules apply to transfers of subsidiary stock on or

after September 17, 2008, unless the transfer is made pursuant to a binding
agreement that was in effect before September 17, 2008, and at all times
thereafter. Reg. 1.1502-36(h).
C. Basis Redetermination to Reduce Disparity7
1. Purpose and scope of basis redetermination rule
a. The basis redetermination rule reduces the extent to which there is

disparity in members bases in shares of S stock. The rule is
intended to prevent the operation of the investment adjustment8
system from creating non-economic or duplicated loss when
members hold S shares with disparate bases. Reg. 1.1502-36(b)
(1)(i).
b. The rule operates by reallocating previously applied investment

adjustments. The rule does not alter the aggregate amount of basis
in shares of S stock held by members or the aggregate amount of
investment adjustments applied to shares of S stock. Id.
c. Exceptions to Basis Redetermination Rule
7
See Section V.A., below, for examples illustrating the basis redetermination rule.
8
The term investment adjustment means the adjustment for items described in
1.1502-32(b)(2), excluding Reg. 1.1502-32(b)(2)(iv) (distributions). The term includes all
such adjustments reflected in the basis of the share, whether originally applied directly by Reg.
1.1502-32 or otherwise. The term therefore includes investment adjustments reallocated to the
share, and it does not include investment adjustments reallocated from the share, whether
pursuant to this section or any other provision of law. It also includes the proportionate amount
of investment adjustments reflected in the basis of a share after the basis is apportioned among
shares, for example in a transaction qualifying under section 355. Reg. 1.1502-36(b)(1)(iii).
- 28 -
(1) No Potential for Redetermination Basis redetermination

will not be required if redetermination would not result in a
change to any members basis in any share of S stock.
Thus, the basis redetermination rule does not apply if the
members basis in the shares of S common stock are equal
and the members basis in the shares of S preferred stock
reflect no gain or loss. Reg. 1.1502-36(b)(1)(ii)(A).
(a) For example, if S has only one class of stock

outstanding and there is no disparity in members
bases in S shares, no members basis would be
changed by the application of the rule. Thus, no
redetermination would be required.
(b) Similarly, if S has preferred and common stock

outstanding, there is no gain or loss on any
members preferred shares, and there is no disparity
in members bases in the common stock, no
members basis would be changed by the
application of the rule. Thus, no redetermination
would be required.
(c) The effect of the reallocation of investment

adjustments in such cases is only an increase, not a
decrease, in basis disparity. 73 Fed. Reg. at 53,938.
(2) Disposition of Entire Interest Basis redetermination will

not be required if, within the groups taxable year in which
the transfer occurs, every share of S stock held by a
member is transferred to a nonmember in one or more fully
taxable transactions, becomes worthless, or a combination
thereof. Reg. 1.1502-36(b)(1)(ii)(B).
(a) A taxpayer that qualifies for this exception may

nonetheless elect to have the basis redetermination
rule apply. Reg. 1.1502-36(b)(ii)(B). Taxpayers
may choose to do this, for example, if it would
result in a reduced gain or avoid the application of
the Unified Loss Rules with respect to upper-tier
shares. 73 Fed. Reg. at 53,939.
(b) Because of this exception, the basis redetermination

rule should not be widely applicable, as
consolidated groups most often will dispose of their
entire interest in the loss subsidiary.
2. Operation of Basis Redetermination Rule

- 29 -
When a member transfers a share of subsidiary (S) stock and, after the
application of all other provisions of the Code and regulations, the share is
a loss share, the basis redetermination rule subjects all members shares of
S stock to redetermination. Reg. 1.1502-36(b)(2).
a. Under the basis redetermination rule, investment adjustments

(exclusive of distributions) that were previously applied to
members bases in S stock are generally reallocated in a manner
that, to the greatest extent possible, first eliminates loss on
preferred shares and then eliminates basis disparity on all shares.
Reg. 1.1502-36(b)(2)(iii). The rule removes both positive and
negative adjustments, and so addresses both non-economic and
duplicated losses. 72 Fed. Reg. at 2978.
b. The basis redetermination rule operates by first removing positive

investment adjustments (but not in excess of the shares loss) from
the bases of transferred loss shares of common stock. Reg.
1.1502-36(b)(2)(i)(A).
(1) This represents a change from the proposed regulations,

which also removed positive investment adjustments from
preferred stock. The rule was changed, because the
positive investment adjustments allocated to preferred stock
account solely for the right to receive distributions and do
not reflect unrecognized loss. 73 Fed. Reg. at 53,938.
(2) Nonetheless, representatives from the Service have

informally indicated that they are considering going back to
the rule in the proposed regulations, because there can be
recognized built-in gain attributable to the preferred shares
if there is no value in the rest of the company.
c. Then, to the extent of any remaining loss on the transferred shares,

negative investment adjustments are removed from shares of
common stock that are not transferred loss shares and applied to
reduce the loss on transferred loss shares. Reg. 1.1502-36(b)(2)
(i)(B). The negative adjustments are reallocated to reduce
preferred stock first and then to common stock. Reg. 1.1502-
36(b)(2)(i)(B).
d. Finally, the positive adjustments removed from the transferred

common loss shares are allocated and applied to increase basis in
the other S shares, without regard to whether such shares are
transferred. The positive investment adjustments are applied first
to the preferred stock (up to the value) and then to the common
stock. Reg. 1.1502-36(b)(2)(ii).
- 30 -
e. Thus, the basis redetermination rule effectively removes basis from

transferred loss shares and uses it to reduce disparity in members
bases in S shares.
3. Limits to Basis Redetermination
a. First, because the premise of the basis redetermination rule is that

the original allocation of an item did not represent the most
economically appropriate allocation of the item, redeterminations
under the rule are limited to allocations of investment adjustments
that could have been made at the time an item was taken into
account. Accordingly, no adjustments can be reallocated to shares
that were not held by members in the year taken into account, as
members shares would not have been able to receive those
adjustments in the original allocation. Reg. 1.1502-36(b)(2)(iii)
(B)(2)(i).
b. The primary purpose of the rule is to reduce loss on transferred

shares. However, because its secondary purpose is to decrease
disconformity to the greatest extent possible, in certain fact
patterns, the application of the rule will actually increase loss on
some shares. See Example 28, below. The application of the rule
will not, however, create gain on shares. Overall, the rule has no
effect on the aggregate amount of gain or loss on members bases
in subsidiary stock. 72 Fed. Reg. at 2979.
c. In the basis reallocation rule, and in several other provisions of the

regulations, there is a direction to allocate items in a manner that
reduces disparity to the greatest extent possible. The regulations
do not, however, prescribe the manner in which such
determinations are to be made. According to the Unified Loss
Rules, taxpayers are allowed flexibility in choosing the methods
and formulas to be employed in making these determinations and
the Service will respect any reasonable method or formula so
employed. Reg. 1.1502-36(b)(2)(iii)(A).
d. Another limitation on reallocation is that an investment adjustment

cannot be reallocated except to the extent that the full effect of the
reallocation can be accomplished. Thus, an investment adjustment
cannot be reallocated to the extent the resulting basis has
previously been taken into account (including at a higher-tier).
This rule guards against double benefits from an adjustment (for
example, by not allowing positive adjustments to be moved from,
or negative adjustments be moved to, shares after the item would
have affected basis that was taken into account in recognizing gain
or loss). It also guards against the loss of a benefit (for example,
by not allocating positive adjustments to previously transferred
- 31 -
shares that can no longer benefit from the basis). Reg. 1.1502-
36(b)(2)(iii)(B)(2).
D. Stock Basis Reduction to Prevent Non-Economic Loss9
1. Background: The basis reduction rule reduces Ms basis in a transferred

share of S stock in order to prevent non-economic stock loss and thereby
promote the clear reflection of the groups income. The effect of the basis
reduction rule is to limit the reduction of Ms basis in the S share to the
amount of net unrealized appreciation reflected in the shares basis
immediately before the transfer. The rule also limits the reduction of Ms
basis in the S share to the portion of the shares basis that is attributable to
investment adjustments made pursuant to the consolidated return
regulations. Reg. 1.1502-36(c)(1). The rule is intended to eliminate
stock loss that is presumed non-economic.
2. Basis Reduction Rule:
If, after basis redetermination, any members transferred share is a loss

share (even if the share only became a loss share as a result of the
application of the basis redetermination rule), the basis of that share is
subject to reduction under the basis reduction rule. Reg. 1.1502-36(c)
(2).
a. The rule operates by reducing the basis of each transferred loss

share (but not below value) by the lesser of the shares net positive
adjustment and its disconformity amount. Reg. 1.1502-36(c)(2)
(i)-(ii).
(1) A shares net positive adjustment is computed as the greater

of zero and the sum of all investment adjustments
(excluding distributions) applied to the basis of the
transferred loss share, including by reason of prior basis
reallocations (hereinafter referred to as the PIA amount).
Reg. 1.1502-36(c)(3).
(a) This rule identifies the extent to which basis has

been increased by the investment adjustment
provisions for items of income, gain, deduction, and
loss (whether taxable or not) that have been taken
into account by the group. 72 Fed. Reg. at 2979.
(2) A shares disconformity amount is the excess of its basis

over its allocable portion of Ss net inside attributes,
determined at the time of the transfer. Reg. 1.1502-36(c)
9
See Section V.B., below, for examples illustrating the basis reduction rule.
- 32 -
(4). This amount identifies the net amount of unrealized

appreciation reflected in the basis of the share.
(a) The term net inside attributes is defined as the

sum of Ss loss carryovers, deferred deductions,
cash, and asset basis, reduced by Ss liabilities.
Reg. 1.1502-36(c)(5).
(i) The term loss carryovers is defined as

losses that are attributable to S, including
any losses that would be apportioned to S
under the principles of 1.1502-21(b)(2) if
S had a separate return year.
(ii) Note that this differs from the definition of

loss carryovers for purposes of the
attribution reduction rule, which do not
include any amount of losses waived under
1.1502-32(b)(4). Reg. 1.1502-36(f)(6).
Waived losses are included in the
disconformity computation, because
excluding them would have the effect of
increasing disconformity under
circumstances unrelated to the existence of
built-in gain (which is what the
disconformity amount is trying to measure).
In contrast, waived losses are excluded from
the computation of net inside attributes to
prevent attributes that cannot be duplicated
from being taken into account in reducing
attributes. See 73 Fed. Reg. at 53,940.
(b) Because the disconformity amount is computed at

the time of the transfer, the disconformity amount
reflects the effects of all prior redetermination
events. Reg. 1.1502-36(c)(5).
b. Lower-Tier Subsidiaries For purposes of computing the

disconformity amount, if S holds stock of a lower-tier subsidiary
(S1) that was not transferred in the transaction, Ss net inside
attribute amount is computed by treating Ss basis in S1 stock as
tentatively reduced by the lesser of the S1 shares PIA amount
and its disconformity amount. Reg. 1.1502-36(c)(6)(i)-(ii).
(1) This reduction is made only for purposes of determining

basis reduction to the S share, and has no other effect. 72
Fed. Reg. at 2979.
- 33 -
(2) The purpose of this adjustment is to prevent S1s

recognized items from giving rise to non-economic loss in
S stock, for example, when S1 recognizes gain that is
already reflected (indirectly) in Ps basis in S shares. Reg.
1.1502-36(c)(6)(i).
(3) If there are multiple tiers of subsidiaries, then the tentative

reduction occurs at the lowest tier first and then to each
successively higher tier. Reg. 1.1502-36(c)(6)(iii).
(4) When determining the disconformity amount of a share of

subsidiary stock, no tentative reduction is made to the basis
of lower-tier shares that were transferred in the transaction
(without regard to whether S retained the shares after the
transaction, such as when S1 is transferred because S and
S1 cease to be members of the same group but S continues
to hold S1 stock). Reg. 1.1502-36(c)(6)(iv).
(a) The basis reduction rule applies directly to each

transfer, starting with the lowest-tier transfer, so any
non-economic loss in S stock that was attributable
to S1s items will have been eliminated by the time
that the basis reduction rule applies to the S stock.
(b) In addition, the tentative basis reduction rule does

not apply to shares that are lower-tier to any shares
that were transferred in the transaction. Reg.
1.1502-36(c)(6)(iv). The application of the rule to
those shares is unnecessary because, when the basis
reduction rule applied to S1, it eliminated any
inappropriate effects from items that tiered up from
subsidiaries that were lower tier to S1. Id.; see also
72 Fed. Reg. at 2979-80.
3. Netting of Gains and Losses
a. For purposes of computing the basis reduction required under Reg.

1.1502-36(c), the basis of each transferred loss share of S stock is
treated as reduced proportionately (as to loss) by the amount of
gain taken into account by members with respect to all transferred
gain shares of S stock, provided that:
(1) The gain and loss shares are transferred in the same
transaction; and
(2) The gain is taken into account in the year of the transaction.
Reg. 1.1502-36(c)(7)(i).
- 34 -
b. Example 9 Netting Rule Application (Allocation of Gain Amount

to Determine Net Loss)
$60/share X
P
Sh. A Sh. B Sh. C

$60 Value $60 Value $60 Value
$54 Basis $100 Basis $80 Basis
(1) Facts: P owns three outstanding shares of S common stock.

Share A has a basis of $54, Share B has a basis of $100, and
Share C has a basis if $80. P sells all three shares of S
stock to X for $60 each. Ps sales of Share B and Share C
are transfers of loss shares subject to Reg. 1.1502-36(c).
(2) For this purpose, P can net its $6 gain on Share A against its
bases in Share B and Share C. The gain is allocated to
Share B and Share C proportionately based on the amount
of loss in each share. Thus, $4 of gain ($40/$60 $6) is
treated as allocated to Share B and $2 of gain ($20/$60
$6) is treated as allocated to Share C. Accordingly, P
computes the basis reduction required under Reg. 1.1502-
36(c) by treating its basis in Share B as $96 ($100 less $4)
and its basis in Share C as $78 ($80 less $2). If, after the
application of Reg. 1.1502-36(c), the sales of Share B and
Share C are still transfers of loss shares, then the transfers
are subject to Reg. 1.1502-36(d). Although the bases of
Share B and Share C are not reduced by gain for purposes
of Reg. 1.1502-36(d), Reg. 1.1502-36(d)(3)(i)(A)
applies netting principles to limit adjustments under Reg.
1.1502-36(d). See example at Reg. 1.1502-36(c)(7)(ii).
(3) If P sold the gain share to another member of the

consolidated group, the gain would be deferred under Reg.
1.1502-13. Because it is not taken into account in the
year of the transfer, it cannot be used to reduce Ps loss on
Share B. Id.
- 35 -
E. Attribute Reduction to Prevent Duplication of Loss10
1. Background: Reg. 1.1502-36(d) reduces Ss attributes to the extent they

duplicate a net loss on shares of S stock transferred by members in a single
transaction. Reg. 1.1502-36(d).
a. The rule is intended to insure that the group does not recognize
more than one loss with respect to a single economic loss
regardless of whether the group chooses to dispose of the
subsidiary stock before or after the subsidiary recognizes the loss
with respect to its assets or operations. 73 Fed. Reg. at 53,940.
b. The rule furthers single entity principles by preventing S from

using deductions and losses to the extent that the group or its
members (including former members) have either used, or
preserved for later use, a corresponding loss in S shares. Reg.
1.1502-36(d)(1).
c. The rule applies without regard to whether S ceases to be a

member after the transfer of its shares. Reg. 1.1502-36(d)(1).
(1) This represents a change from the prior loss disallowance

rules, which contained different rules depending upon
whether S was or was not deconsolidated as a result of the
transfer. See Prior Reg. 1.1502-35(b)(1) & (b)(2).
2. Attribute Reduction Rule: If any transferred share remains a loss share

after application of Reg. 1.1502-36(c), the subsidiarys attributes
(including the consolidated attributes attributable to the subsidiary) are
reduced by the attribute reduction amount immediately before the transfer.
Reg. 1.1502-36(d)(2)(i).
a. This rule differs from the prior loss duplication rules under Reg.
1.1502-35, which suspended outside losses in favor of inside
losses. Specifically, Reg. 1.1502-35 suspended the outside loss if
the subsidiary remained consolidated, reduced the suspended loss
for any inside losses used by the subsidiary, and only allowed any
remaining outside loss when the subsidiary left the group.
b. The Unified Loss Rules, in contrast, generally allow the outside

loss but immediately eliminate the duplicate inside loss.
3. Attribute Reduction Amount: Under Reg. 1.1502-36(d), the attribute

reduction amount is computed as the lesser of the net stock loss and the
aggregate inside loss. Reg. 1.1502-36(d)(3)(i).
10
See Section V.C., below, for examples illustrating the attribute reduction rule.
- 36 -
a. Net stock loss is the excess of the sum of the bases (after
application of the basis reduction rule) of all S shares transferred
by members in the same transaction over the value of such shares.
Reg. 1.1502-36(d)(3)(ii).
b. Ss aggregate inside loss is the excess of Ss net inside attributes

over the value of all of the S shares. Reg. 1.1502-36(d)(3)(iii)
(A).
(1) Ss net inside attribute amount is the sum of Ss net

operating and capital loss carryovers, deferred deductions,
money, and basis in assets other than money reduced by the
amount of Ss liabilities. Reg. 1.1502-36(d)(3)(iii)(B).
(2) Unlike comparable rules in the old regulations, the attribute

reduction amount is not limited to the shares proportionate
interest in the subsidiarys inside loss.
d. Exception: If the aggregate attribution reduction amount is less

than five percent of the aggregate value of the shares transferred by
members in the transaction, the attribution reduction rule does not
apply to the transfer. Reg. 1.1502-36(d)(2)(ii).
(3) If the exception applies, the taxpayer may nonetheless elect

to apply the attribute reduction rule. Reg. 1.1502-36(d)
(2)(ii). A taxpayer may want to do so, for example, to take
advantage of the election to reattribute subsidiary losses, as
discussed more fully below. See 73 Fed. Reg. at 53,941.
4. Application of Attribute Reduction
a. Attributes Available for Reduction:
(1) Category A Capital loss carryovers
(2) Category B Net operating loss carryovers
(3) Category C Deferred deductions
(4) Category D Basis of assets, other than Class I assets in

Reg. 1.338-6(b)(1) (i.e., cash and general deposit
accounts). Reg. 1.1502-36(d)(4)(i).
b. Category A, B, and C Attributes
(1) After Ss attribute reduction amount is determined, it is first

applied to reduce or eliminate items that represent actual
realized losses, such as capital loss carryovers, net
- 37 -
operating loss carryovers, and deferred deductions. Reg.

1.1502-36(d)(4)(ii)(A).
(2) The taxpayer may specify the allocation of Ss attribute

reduction amount among the attributes in Category A,
Category B and Category C. If no specification is made,
the attributes will first be used to reduce Category A capital
loss carryovers (oldest to newest), then Category B NOL
carryovers (oldest to newest), and then Category C deferred
deductions (proportionately).
(a) The final regulations reversed the order of Category

A and B attributes, because capital loss carryovers
have a shorter expiration period and are thus more
likely than net operating losses to expire unused
and, therefore, less likely to duplicate loss. 73 Fed.
Reg. at 53,941.
(b) Attributes in Category A, Category B, and Category

C must be reduced in full before any reduction is
made to Category D (asset basis). Reg. 1.1502-
36(d)(4)(ii)(A)(1).
c. Category D Attributes
(1) If Ss attribute reduction amount exceeds the Category A,

B, and C items, the excess is then applied to reduce or
eliminate Category D attributes (i.e., asset basis, including
the stock of lower tier subsidiaries). Reg. 1.1502-36(d)
(4)(ii)(B)(1).
(2) Ss attribution reduction amount is allocated to the non-

stock Category D assets in reverse section 1060 order.
Thus, it is first applied proportionately to reduce Ss bases
in Class VII assets, as defined by Reg. 1.338-6(b)(2)(vii),
then in the same manner successively to Class VI, Class V,
Class IV, Class III, and Class II assets, as defined by Reg.
1.338-6(b)(2). Reg. 1.1502-36(d)(4)(ii)(B)(2).
(3) Lower-Tier Subsidiaries If S holds stock of another

subsidiary (S1), the basis of such stock is treated as a
Category D attribute. The reduction amount must be
allocated proportionately (by basis) between the stock of
each of Ss lower-tier subsidiaries (treating all shares of
each subsidiary as a single share) and the non-stock
Category D assets. Reg. 1.1502-36(d)(4)(ii)(B)(1), (d)(5)
(i)(A), (d)(5)(ii).
- 38 -
(a) For this purpose, Ss basis in the deemed single

share of S1 stock is its deemed basis, which is the
greater of the sum of Ss basis in each share of S1s
stock and the portion of S1s net inside attribute
amount allocable to Ss shares of the S1 stock. Reg.
1.1502-36(d)(5)(i)(B), (d)(5)(ii).
(i) The deemed basis is reduced by (i) the value

of Ss transferred shares of S1 stock, and
(ii) the nontransferred shares allocable
portion of the excess of S1s non-loss assets
over S1s liabilities. Reg. 1.1502-36(d)(5)
(ii).
(ii) For example, P owns all the stock of S with

a basis of $150, S owns all the stock of S1
with a basis of $100, and S1 owns an asset
with a basis of $150. Ss deemed basis in S1
stock is $150, the greater of $100 (Ss actual
basis in S1 stock) and $150 (the S1 shares
allocable portion of S1s net inside attribute
amount), which is the maximum amount of
inside loss that S can recognize. 72 Fed.
Reg. at 2980.
(b) If S1 has lower-tier subsidiaries, Ss deemed basis is

determined first with respect to the stock of the
lowest tier subsidiary and then for each next highest
tier. Reg. 1.1502-36(d)(5)(i)(C).
(c) The attribute reduction amount allocated to Ss

block of S1 stock is then apportioned and applied to
reduce the bases of Ss individual shares of S1 stock
in a manner that, to the greatest extent possible,
reduces loss in preferred stock and disparity in both
common and preferred stock. Reg. 1.1502-36(d)
(5)(iii)(B).
(i) However, no allocated amount is

apportioned to any transferred S1 share if
gain or loss is recognized on the transfer of
that share. Reg. 1.1502-36(d)(5)(iii)(A).
Recognition of gain or loss establishes that
the basis of that share no longer reflects
unrecognized loss.
- 39 -
(ii) In addition, no allocated amount that is

apportioned to any transferred S1 share is to
be applied to reduce the basis of the share
below its value. Reg. 1.1502-36(d)(5)(iii)
(C). This prevents attribute reduction from
creating gain on such shares.
(d) Any portion of Ss attribute reduction amount that is

allocated to S1 stock, tiers down and becomes an
attribute reduction amount of S1. The attribute
reduction rules then apply to reduce S1s attributes
in the same manner that they apply Ss attribute
reduction amount to reduce Ss attributes. Reg.
1.1502-36(d)(5)(v)(A).
(e) Because the attribute reduction amount represents

the maximum potential amount of duplication in the
lower-tier subsidiary, the Unified Loss Rules
include two modifications to prevent the reduction
of attributes beyond the amount necessary to
eliminate duplicated loss.
(i) Conforming Limit Rule: This rule prevents

the tier down of attribute reduction from
reducing S1s net inside attributes below the
sum of the value of the S1 shares transferred
by members and the aggregate bases that
members have in nontransferred S1 stock
(after any reduction to those shares by the
direct application of Ss attribute reduction
amount). Reg. 1.1502-36(d)(5)(v)(B).
(ii) Basis Restoration Rule: This rule reverses

stock basis reductions made by the attribute
reduction rule, but only to the extent
necessary to conform net inside attributes
and outside stock basis at each tier. Basis
restoration adjustments are made at each
tier, but they do not give rise to any upper-
tier adjustments. Reg. 1.1502-36(d)(5)
(vi).
(f) Commentators complained about the complexity of

the tier-down rule and suggested adopting a look-
through approach, which would apply the rules
solely on the basis of the lower tier subsidiarys net
inside attributes. Treasury and the Service rejected
- 40 -
this approach. Although they recognized that it

would simplify the rules, they were concerned that
it would produce inappropriate results by either
disallowing economic loss where lower tier
subsidiary stock reflected unrecognized
appreciation or permitting son-of-mirrors
transactions at lower tiers.
d. If the attribute reduction amount exceeds attributes available for

reduction, then, if the subsidiary has a liability that has not been
taken into account, the excess attribute reduction amount is
suspended and applied to prevent the deduction or capitalization of
payments later made by S or another person with respect to the
liability. Reg. 1.1502-36(d)(4)(ii)(C)(1).
e. If the attribute reduction amount exceeds the amount of Ss

liabilities, that excess attribute reduction amount has no further
effect. Reg. 1.1502-36(d)(4)(ii)(C)(2).
5. Elections to Reduce the Potential for Loss Duplication: The common

parent of a group can elect to reduce stock basis, reattribute Category A,
B, or C attributes, or do some combination of basis reduction and attribute
reattribution in order to prevent the reduction of attributes otherwise
required under the proposed rules. Reg. 1.1502-36(d)(6)(i).
a. The total amount that can be the subject of the election is limited to
the amount that Ss attributes would otherwise be subject to
reduction. Reg. 1.1502-36(d)(6)(i).
b. Taxpayers may make a protective election to reattribute attributes

and/or to reduce stock basis to avoid attribute reduction. 73 Fed.
Reg. at 53,942.
c. Special Rules for Elections to Reattribute Attributes:
(1) The election to reattribute attributes can only be made if S

ceases to be a member of the P group as a result of the
transfer. This is because the election is not intended to be
merely a mechanism for changing location of items within
a group. Reg. 1.1502-36(d)(6)(iv)(A).
(2) Similar to the rule regarding attribute reduction in Reg.

1.1502-36(d)(4)(ii)(A)(1), P may specify the amount of
attributes in Category A, B, and C to reallocate. In the
absence of any specification, they will be reattributed in
order. Reg. 1.1502-36(d)(6)(iv)(A).
- 41 -
(3) When the election to reattribute attributes is made, P is

treated as succeeding to the attributes as though it had
acquired them in a section 381(a) transaction, and it is
treated as a noncapital, nondeductible expense under Reg.
1.1502-32(b)(2)(iii). Reg. 1.1502-36(d)(6)(iv)(A).
(4) Limitation on Reattribution from Lower-Tier Subsidiaries:

P may only reattribute attributes of lower-tier subsidiaries
that would otherwise be reduced as a result of tier-down
attribute reduction to the extent that the reattribution does
not create an excess loss account in the stock of any lower-
tier subsidiary. This prevents circular computations of the
attribute reduction amount. Reg. 1.1502-36(d)(6)(iv)(C).
(5) To the extent loss duplication has not been eliminated by

the election, the attribute reduction rules apply in their
general manner. 72 Fed. Reg. at 2981.
d. Special Rules for Election to Reduce Stock Basis:
(1) The election is made with respect to all transferred S shares

in proportion to the amount of loss in each share. Reg.
1.1502-36(d)(6)(v)(A).
(2) If there is still a stock loss after taking into account

elections under Reg. 1.1502-36(d)(6), and such loss
would be permanently disallowed (e.g., under section
311(a)), P will be deemed to have made the stock basis
reduction election with respect to such loss. Reg. 1.1502-
36(d)(6)(v)(C). This is intended to protect against
inadvertent attribute reduction. 73 Fed. Reg. at 53,942.
6. Attribute Reduction in the Case of Worthlessness and Dissolution: All of

Ss attributes are eliminated if:
- 42 -
a. A members S stock becomes worthless within the meaning of

Reg. 1.1502-80(c),11 the member recognizes a net deduction or
loss, and S remains a member of the group; or
b. A member recognizes a deduction or loss on the S stock in a

transaction in which S ceases to exist and does not become a
nonmember within the meaning of Reg. 1.1502-19(c)(2).
c. Example 10 Worthlessness Where S Continues as a Member
$0 Value
$75 Basis
S Assets
Creditors
CNOL = $100
(1) Facts: P owns the sole share of S stock. The share is

worthless under section 165. S has disposed of all its assets
in payment of claims to creditors. P claims a worthless
securities deduction with respect to the share. The
worthlessness is a transfer of a loss share. After the
application of the basis redetermination rule and the basis
reduction rule, Ps basis in the share is $75. The portion of
the consolidated net operating loss attributable to S is $100.
(2) Under the attribute reduction rule, Ss attribute reduction

amount is $75, the lesser of Ps $75 net stock loss and Ss
$100 aggregate inside loss ($100 net inside attribution
11
Reg. 1.1502-80(c) provides that stock of a member is not treated as worthless under
section 165 before the stock is treated as disposed of under Reg. 1.1502-19(c)(1)(iii).
Taxpayers raised concerns that Reg. 1.1502-80(c) could prevent a group from claiming a
worthless stock deduction if the subsidiary stock is worthless but the subsidiary ceases to be a
member of the group before it has disposed of substantially all of its assets as required by Reg.
1.1502-19(c)(1)(iii). The Service and Treasury amended Reg. 1.1502-80(c) to clarify that the
deferral of an otherwise allowable loss under section 165 terminates immediately prior to the
time that the subsidiary ceases to be a member of the group. Reg. 1.1502-80(c). The preamble
to the temporary regulations noted that Reg. 1.1502-80(c) is intended to defer, not disallow,
worthless stock deductions with respect to subsidiary stock. 69 Fed. Reg. 12,799, 12,800 (Mar.
18, 2004).
- 43 -
amount over $0 value of the S share). Ss attributes are

reduced by $75, from $100 to $25. Because S remains a
member of the group, the remaining $25 of the
consolidated net operating loss is eliminated because the S
shares is worthless and P recognizes a deduction with
respect to the share. P recognizes a $75 worthless stock
deduction. S has $0 net inside attributes. The consolidated
net operating loss is reduced by $100. See Reg. 1.1502-
36(d)(7)(iii).
F. Coordination with Loss Deferral and Other Loss Disallowance Rules
1. Reg. 1.1502-36 applies and has effect immediately upon the transfer of a
loss share even if the loss is deferred, disallowed, or otherwise not taken
into account under any other applicable rules of law.
a. For example, if M sells loss shares of S stock to another member of

the same controlled group but not consolidated group, every
members bases in shares of S stock and all of Ss attributes may
be adjusted under this section even though Ms loss is deferred
under Reg. 1.267(f)-1. Reg. 1.1502-36(a)(4).
2. However, Reg. 1.1502-36(e)(3) defers the application of the Unified

Loss Rules until the triggering of an intercompany loss under Reg.
1.1502-13.12
a. In determining the application of the Unified Loss Rules to an

intercompany loss, all transferor-members are treated as divisions
of a single corporation. Reg. 1.1502-36(e)(3)(i).
(1) Reg. 1.1502-36(e)(3) appears to incorporate the single

entity approach that applies for purposes of Reg. 1.1502-
13, which provides that the transferor and transferee
members are treated as engaging in their actual transaction,
rather than treating the transaction as not occurring. Reg.
1.1502-13(c)(3). Thus, changes with respect to the
subsidiary shares resulting from the intercompany
transaction should not be taken into account, but changes
after the intercompany transfer but before the loss is
triggered should be taken into account, in determining
whether and how the Unified Loss Rules apply to the
intercompany item.
(2) For example, in an intercompany sale, the buying member

would be treated as receiving the sold property but would
succeed to the selling members basis in the property. Id.
12
See Section V.D., below, for examples of intercompany transfers of subsidiary stock.
- 44 -
b. The regulations further provide that appropriate adjustments will

be made to the intercompany item(s), any members basis in a
share of a subsidiary, to the subsidiarys attributes, or any
combination thereof, to further the purposes of Reg. 1.1502-36
and 1.1502-13. Id.
c. If the transfer occurred before September 17, 2008, and the

transferor-members intercompany item is taken into account after
September 17, 2008, the parent may elect to apply the current
Unified Loss Rules to the transfer. Reg. 1.1502-36(e)(3)(ii).
G. Anti-Abuse Rule - Reg. 1.1502-36(g)
1. If a taxpayer acts with a view to avoid the purposes of Reg. 1.1502-36,

or to apply the rules of Reg. 1.1502-36 to avoid the purposes of any
other rule of law, appropriate adjustments will be made to carry out the
purposes of Reg. 1.1502-36 or such other rule of law. Reg. 1.1502-
36(g).
2. Transactions Triggering Anti-Abuse Rule
a. Loss Trafficking S acquires and liquidates a corporation with an

NOL to utilize its NOL to minimize the basis disconformity (and
therefore the basis reduction). Reg. 1.1502-36(g), Ex. 1.
b. Preventing Attribute Reduction
(1) S contributes an asset with a high basis to a partnership in

order to avoid reducing its basis under Reg. 1.1502-36(d).
Reg. 1.1502-36(g), Ex. 2.
(2) S loans cash to another member to create an intercompany

receivable that would be reduced under the attribute
reduction rule (thereby minimizing reduction to Ss other
attributes). Reg. 1.1502-36(g), Ex. 3.
(3) P contributes stock with a low basis to a partnership and

sells stock with a high basis at a loss to reduce net stock
loss under Reg. 1.1502-36(d). Reg. 1.1502-36(g), Ex.
4.
b. Gain Stuffing P contributes a gain asset to S to avoid recognition

of net loss (and therefore application of Reg. 1.1502-36) upon
the sale of the stock. Reg. 1.1502-36(g), Ex. 5.
- 45 -
III. OLD LOSS DISALLOWANCE RULES ADDRESSING CONCERNS RELATING

TO THE REPEAL OF GENERAL UTILITIES
A. General Rule
1. The old regulations governing the disallowance of losses on the

disposition of stock of a member of a consolidated group were issued as
temporary regulations on March 7, 2002 and were adopted, without
substantive change, as final regulations on March 3, 2005. See Prior Reg.
1.337(d)-2.
2. In general, the old regulations provided that no deduction was allowed for
any loss recognized by a member of a consolidated group with respect to
the disposition of stock of a subsidiary. Prior Reg. 1.337(d)-2(a)(1).
This was the same as the general rule of the pre-2002 loss disallowance
regulations. See Prior Reg. 1.1502-20(a)(1).
3. Disposition was defined in the same manner as the pre-2002 regulations

as any event in which gain or loss is recognized, in whole or in part. Prior
Reg. 1.337(d)-2(a)(2)(ii); cf. Prior Reg. 1.1502-20(a)(2). A worthless
stock deduction under section 165(g)(3) thus constituted a disposition
that triggered the general loss disallowance rule. See Prior Reg. 1.1502-
20(a)(1).
B. Deconsolidations
1. Under the old regulations, if a members basis in its subsidiary stock

exceeded the stocks fair market value immediately before the stock was
deconsolidated, the members basis in the subsidiary stock was reduced to
the stocks fair market value. Prior Reg. 1.337(d)-2(b).
2. Deconsolidation was defined as any event that causes a share of stock

of a subsidiary that remains outstanding to be no longer owned by a
member of any consolidated group of which the subsidiary is also a
member. Prior Reg. 1.337(d)-2(b)(2).
3. If both a disposition and a deconsolidation occurred with respect to a share

in the same transaction, then the general disallowance rule of Prior Reg.
1.337(d)-2(a)(1) applied first, and the deconsolidation rule of Prior Reg.
1.337(d)-2(b)(1) applied next to the extent necessary to effectuate the
purposes of the regulation. Prior Reg. 1.337(d)-2(b)(1).
4. The pre-2002 regulations provided an identical rule for the reduction of

basis upon deconsolidation. Prior Reg. 1.1502-20(b)(1). However, the
pre-2002 regulations contained an additional requirement if a share of
stock retained by a group were deconsolidated and then disposed of within
two years after the date of deconsolidation, which is not contained in Prior
Reg. 1.337(d)-2.
- 46 -
a. In such cases, the group was required to file a statement with its
return for the year of the disposition setting forth the amount of
any prior basis reduction, the basis of the subsidiarys stock
immediately before the disposition, the amount realized on the
disposition, and the amount of loss recognized on the disposition.
Prior Reg. 1.1502-20(b)(5).
b. Failure to file the statement resulted in the disallowance of a

deduction for the loss.
c. The preamble to the final 1991 regulations clarified that the

statement must be filed regardless of whether there was a reduction
in the basis of stock under the deconsolidation rule. 56 Fed. Reg.
at 47,384.
5. The current Unified Loss Rules in Reg. 1.1502-36 apply to transferred

loss shares, which are defined to include deconsolidations. Reg. 1.1502-
36(f)(10)(i)(B). They do not contain a separate deconsolidation rule.
6. Example 11 Definition of Deconsolidation
P P
$200 basis
$100 basis
(3) S1 Stock
S S Z
$100
(1) $100 basis $200 basis
T Stock
X S1 S1
$100 $200 basis

(2)
T T Asset Y
$100
Asset
$100 Value
$0 Basis
a. Facts: P owns all of the stock of S, and S owns all of the stock of
S1. P has a basis of $100 in the S stock, and S has a basis of $100
in the S1 stock. In Year 1, S1 purchases all of the stock of T from
- 47 -
X for $100. T has an asset with a value of $100 and a basis of $0.
In Year 2, T sells the asset to Y for $100. In Year 3, S sells all of its
S1 stock to Z, an unrelated investor, for $100.
b. T recognizes a gain of $100 on the sale of its built-in gain asset to

Y in Year 2. As a result, S1s basis in the T stock, Ss basis in the
S1 stock, and Ps basis in the S stock are increased from $100 to
$200. Reg. 1.1502-32(b)(2)(i). Thus, when S sells its S1 stock
to Z in Year 3, it recognizes a $100 loss.
c. Under the general loss disallowance rule of the old regulations, Ss

$100 loss on the sale of S1 stock is disallowed. Prior Reg.
1.337(d)-2(a)(1); see also Prior Reg. 1.1502-20(a)(1).
d. If S1 and T are not members of a consolidated group immediately

after the sale of the stock of S1, then the T stock will be considered
deconsolidated. S1 must, therefore, reduce its basis of the T stock
to its $100 value immediately before the sale. If, however, S1 and
T become members of the Z consolidated group immediately after
the sale of S1, then the T stock will not be considered
deconsolidated and no reduction is required. Prior Reg.
1.337(d)-2(b)(1)-(2); see also Prior Reg. 1.1502-20(b)(6), Ex.
3. Z may expect post-acquisition appreciation to be sheltered by
the loss with respect to the T stock. Alternatively, Z may be
willing to stuff and wait two years and avoid the application of
the anti-stuffing rule of the old regulations.
(1) In anticipation of a possible sale, consolidated groups may

want to preserve a lower tier subsidiary stocks built-in loss
by arranging for a member holding company to own the
stock.
(2) However, if a holding company is formed in a section 351

transaction, and the holding companys stock is sold shortly
thereafter, the step-transaction doctrine may be applied to
disqualify the stock contribution as tax free under section
351. See, e.g., Intermountain Lumber Co. v.
Commissioner, 65 T.C. 1025 (1976); Rev. Rul. 70-140,
1970-1 C.B. 73.
(3) Additionally, the contribution of a lower tier subsidiarys

built-in loss stock to a holding company with a view to
selling the holding company stock and avoiding the loss
disallowance rule may trigger the anti-stuffing rule when
the holding companys stock is sold.
- 48 -
7. Example 12 Using the Deconsolidation Rule to Avoid Gain Recognition
(2)
$400
P X
S stock
$21
(1) $400 (3)
21% of T1 basis $79% of
T1
$21
S S

$100 Value
$200 Basis
T1 T2 T1 T2
a. Facts: P owns all of the stock of S, which has two assets the
stock of subsidiaries T1 and T2. The T1 stock has a value of $100
and a basis of $200, and the T2 stock has a value of $300 and a
basis of $100. X is willing to acquire S for $400, but does not
want the T2 stock.
b. If X purchases S and sells T2 immediately, the X group would

recognize a $200 gain. If X instead immediately causes S to
distribute T1 to X, S would recognize a deferred intercompany loss
equal to $100. Reg. 1.1502-13(f)(2)(iii). Xs basis in its S stock
would ultimately be reduced by $200 (i.e., $100 value of T1 upon
distribution, plus $100 loss when absorbed). Thus, a sale by X of
S would result in $100 of gain.
c. Alternatively, S sells 21% of the T1 stock to X, producing a $21

loss which is disallowed under the loss disallowance rules of Prior
Reg. 1.337(d)-2. Because the sale results in a deconsolidation of
Tl from S, Ss basis in its remaining 79% of Tls stock is reduced
to the stocks fair market value $79. Prior Reg. 1.337(d)-2(b);
see also Prior Reg. 1.1502-20(b).
(1) X then purchases S for $400. X causes S to distribute its

remaining 79% of Tls stock and the $21 of cash to X. As a
result of the distribution, Xs basis in S is reduced only by
$100, the adjusted basis of the Tl stock and the cash. See
Reg. 1.1502-13(f)(2).
- 49 -
(2) Xs basis in the S stock is now $300. X sells S for $300

(the value of T2) and recognizes no gain or loss.
(3) The $21 disallowed loss on Ss sale of 21% of the Tl stock

and the $79 basis reduction to the remaining 79% of the T1
stock resulting from the deconsolidation are treated as
noncapital, nondeductible expenses for purposes of
computing investment adjustments. Reg. 1.1502-32(b)(3)
(iii). The deemed $100 loss produces a $100 reduction in
Ps basis in S. Therefore, Ps gain on the sale of S is
increased by $100 (the amount of gain eliminated by X).
B. Allowable Loss
1. General Rules - Under Prior Reg. 1.337(d)-2(c), a loss would not be

disallowed under the loss disallowance rule of Prior Reg. 1.337(d)-2(a),
and basis would not be reduced under the deconsolidation rule of Prior
Reg. 1.337(d)-2(b), to the extent the taxpayer establishes that the loss
or basis is not attributable to the recognition of built-in gain, net of directly
related expenses, on the disposition of an asset (emphasis added).
a. The regulations provided that gain recognized on the disposition of

an asset was built-in gain to the extent attributable, directly or
indirectly, in whole or in part, to any excess of value over basis
that is reflected, before the disposition of the asset, in the basis of
the share. Prior Reg. 1.337(d)-2(c)(2).
(1) Practitioners, and it appears the Service, had assumed that

Prior Reg. 1.337(d)-2 required a pure tracing approach in
determining whether gain is built-in.
(2) However, at an American Bar Association Tax Section

meeting in May 2004, the Service announced a paradigm
shift in its interpretation of Prior Reg. 1.337(d)-2 based
on its interpretation of the time for testing whether gain is
built-in.
(a) Notice 87-14 defined built-in gain as the excess of

value over basis at the time the subsidiary stock was
acquired, regardless of whether the acquisition of
stock resulted in the subsidiarys becoming a
member of the group.
(b) The transitional rule of Prior Reg. 1.337(d)-1

defined built-in gain as the excess of value over
basis determined immediately before the
transitional subsidiary became a member of the
group.
- 50 -
(c) Prior Reg. 1.337(d)-2 referred to the excess of

value over basis before the disposition of the asset.
Practitioners assumed that this rule simply
incorporated the tracing approach of Notice 87-14
and Prior Reg. 1.337(d)-1. But the Service
believed that the language difference relating to the
timing of the built-in gain determination required a
different approach.
(d) The Service developed two approaches for tracking

built-in gainthe modified tracing approach and
the basis disconformity approach, which were later
enumerated in Notice 2004-58 issued on August 25,
2004.
b. Loss or basis could be attributable to the recognition of built-in

gain on the disposition of an asset by a prior group. Id.
c. The taxpayer had to file a statement with its return in order to

claim an allowed loss. Prior Reg. 1.337(d)-2(c)(1). The
statement had to set forth the name and EIN of the subsidiary and
the amount of the loss allowed or the amount of basis not reduced.
d. The language net of directly related expenses was added as a

clarification on March 18, 2004. See T.D. 9118, 69 Fed. Reg.
12,799 (Mar. 18, 2004). Taxpayers had questioned whether built-
in gain recognized on the disposition of an asset could be reduced
by expenses attributable to the recognition of that gain. The
preamble to the amended regulations stated that [t]he IRS and
Treasury Department believe that, because expenses attributable to
the recognition of built-in gain reduce the basis of the subsidiarys
stock, the computation of the amount of stock loss that is
attributable to the recognition of built-in gain should take such
expenses into account. Id.
2. Determination of Built-In Gain
a. In order to be considered built-in gain, the gain must be

attributable to an excess of value over basis that was reflected in
the basis of the share before the disposition of the asset.
b. Pure Tracing Approach - Under a pure tracing approach, gain was

considered built-in to the extent of the appreciation in an asset
owned by the subsidiary at the time the basis of the subsidiary
stock was determined.
- 51 -
c. Modified Tracing Approach
(1) Under the modified tracing approach, as announced by the

Service at the May 2004 ABA meeting, gain was
considered built-in (i) if the asset (or a predecessor asset
with the same basis characteristics) was owned by the
subsidiary when the basis of the share on which loss was
being recognized (or basis was being reduced) was
determined or redetermined, (ii) to the extent of the shares
proportionate interest in appreciation in the asset at that
time.
(a) Redetermination was required any time the

subsidiary engaged in a transaction that could alter
the shares interest in unrealized appreciation, such
as acquisitions of assets with built-in gain, mergers,
or intragroup spin-offs.
(2) In Notice 2004-58, the Service was much less specific

about the modified tracing approach, simply stating that
[u]nder a tracing approach, events subsequent to the
acquisition of a share of subsidiary stock that create or alter
the disconformity between the basis of the share and the
shares interest in the aggregate basis of assets the
disposition of which would adjust the basis of the share (for
example, the acquisition by a subsidiary of stock of another
corporation that joins the consolidated group, an intra-
group spin-off under section 355, or a contribution of
property to a subsidiary under section 351) may need to be
taken into account to determine the extent to which stock
loss or basis is attributable to the recognition of built-in
gain on the disposition of an asset. (Hereinafter such
subsequent events are referred to as alteration events.)
(3) The Unified Loss Rules reject a tracing approach, even the
modified one, as inadministrable. The Service and
Treasury believed that the potentially large number of
alteration events would greatly increase complexity. 72
Fed. Reg. at 2972.
d. Basis Disconformity Approach
(1) The basis disconformity approach permitted by Notice

2004-58 looked at outside basis at the time the subsidiarys
- 52 -
asset was disposed of13 to determine whether the inside gain

was already accounted for, or sheltered, by outside basis.
(2) The focus of this approach was on items that increase stock
basis without increasing the value of the subsidiary.
(3) Specifically, gain was treated as built-in under the basis

disconformity approach to the extent of the least of:
(a) Gain Amount - The sum of all gains (net of directly

related expenses) recognized on asset dispositions
while the subsidiary was a member of the group;
(b) Basis Disconformity Amount - The excess of the

shares basis over the shares proportionate interest
in the subsidiarys net asset basis;14 or
(c) Positive Investment Amount (PIA Amount) - The

excess of the sum of all positive investment
adjustments made to the share under Reg. 1.1502-
32 over negative adjustments (excluding
distributions). Thus, a netting concept was
incorporated.
(4) The concept of basis disconformity was incorporated into

the final Unified Loss Rules. The final regulations delete
the gain amount from the formula, thus expanding the rule
beyond disconformity attributable to asset dispositions to
reach all events triggering PIAs (e.g., wasting assets).
3. Disposition of an Asset
a. Although the burden of proof was on the taxpayer, the regulations

allowed losses that were not attributable to the recognition of built-
in gain on the disposition of an asset.
13
The Service took the position that because recognition of gain moves asset and stock
basis in tandem, the time for testing basis disconformity may be before either the disposition of
the asset or the disposition of the subsidiarys stock. As discussed below, certain transactions
that alter the inside and outside basis conformity required special treatment.
14
Net asset basis was defined similar to the way it was defined for purposes of
determining duplicated loss under prior Reg. 1.1502-20(c)the sum of the subsidiarys money,
asset basis other than stock of lower tier subsidiaries, net operating loss carryforwards and
deductions but that have been recognized but deferred, over the subsidiarys liabilities.
- 53 -
(1) The loss disallowance rule of Prior Reg. 1.337(d)-2 was

thus aimed at the classic son-of-mirrors transaction
illustrated by Examples 2 and 3, above.
(2) It did not reach the generation of income from wasting

assets illustrated by Example 4, above. Assume, for
example, that P acquires S with a $100 built-in gain asset
that generates $10 income each year and declines in value
$10 each year. P increases its basis in S $10 each year. In
Year 5, P sells the S stock for $100, recognizing a $50 loss.
The loss was not disallowed under Prior Reg. 1.337(d)-2,
because it was not attributable to the disposition of a built-
in gain asset.
(3) The basis disconformity approach announced by the

Service in Notice 2004-58 likewise required the disposition
of an asset by inclusion of the gain amount in its formula.
(4) Nonetheless, the government remained concerned about the

avoidance of the General Utilities repeal through the use of
wasting assets. As a result, the Unified Loss Rules delete
the gain amount from the basis reduction formula, thus
permitting them to reach wasting assets.
b. The old regulations did not define the phrase disposition of an

asset.
(1) It was clear that such phrase included the actual sale or
exchange of an asset that is treated as such for tax purposes.
(2) However, the tax law treats a number of transactions that

are not sales or exchanges as a sale or exchange.
Conversely, it treats many actual sales or exchanges as
something else.
(a) For example, a distribution on stock that exceeds

earnings and profits and the basis of the stock is
treated as gain from the sale or exchange of
property under section 301(c)(3)(A).
(b) Similarly, section 631(a) permits taxpayers to elect

to treat the cutting of timber as a sale or exchange
of such timber.
(c) On the other hand, gain from the sale or exchange

of stock of a controlled foreign corporation is
treated as a dividend under section 1248(a).
- 54 -
(3) Perhaps the definition of extraordinary gain dispositions

contained in Prior Reg. 1.1502-20(c)(2)(i) could provide
some guidance. Extraordinary gain dispositions included
actual or deemed dispositions of capital assets, property
used in a trade or business, and certain bulk asset
dispositions.
For purposes of the old regulations, disposition of an asset included the disposition of stock or
securities. Prior Reg. 1.337(d)-2(c)(2).
4. Recognition of Built-In Gain
a. Reg. 1.337(d)-2(b) provided that a loss would not be disallowed

under the loss disallowance rule to the extent the taxpayer
established that it was not attributable to the recognition of built-in
gain. Thus, built-in gain must actually be recognized by the
subsidiary before it would trigger the loss disallowance rules.
b. The basis disconformity approach likewise required the

recognition of built-in gain by inclusion of the gain and PIA
amounts in its formula.
c. Gain could be built-in gain if it was attributable directly or

indirectly to an excess of value over basis. Prior Reg. 1.337(d)-
2(c)(2). Thus, for example, if S had a built-in gain in Asset A and
exchanged it in a tax-free section 1031 exchange for Asset B, the
sale of Asset B for a gain constituted a built-in gain.
5. Offsetting Gains and Losses
The old regulations permitted the recognition of built-in gains to be offset by the recognition of
built-in losses or by the absorption of net operating loss carryovers. See Prior Reg. 1.337(d)-
2(c)(4), Example.
This was considerably more favorable than the result under pre-2002 Reg. 1.1502-20(c)(1)(i),
which disallowed a loss to the extent of any recognized extraordinary gain, without any offset for
built-in losses.
- 55 -
a. Example 13 - Built-In Loss Offsets Built-In Gain
(1)
S Stock S Stock
X P P W
$40
$50
$50 basis
$50 basis
S S S
(2)
Sell Gain
Gain Asset Asset for $50 $40
$50 Value
Y Cash/New
$0 Basis Asset
(3)
Loss Asset Sell Loss
$0 Value Asset for $0 Z
$50 Basis
(1) Facts: In Year 1, P acquires the stock of S for $50. S has

two assets: Gain Asset with a value of $50 and a basis of
$0 and Loss Asset with a value of $0 and a basis of $50. In
Year 2, S sells Gain Asset to Y for $50, and reinvests the
proceeds in New Asset. In Year 3, S sells Loss Asset to Z
for $0. The value of New Asset declines to $40. P then
sells all of the S stock to W for $40.
(2) Under the investment adjustment rules, Ps basis in the S

stock is increased by Ss $50 gain in Year 2 and is
decreased by Ss $50 loss in Year 3. Reg. 1.1502-32(b)
(2)(i). Thus, when P sells its S stock in Year 3, it
recognizes a $10 loss.
(3) Amount of Loss Disallowed
(a) Under a pure tracing approach, for purposes of

determining whether Ps $10 loss is attributable to a
built-in gain, Ss recognized built-in gain is offset
by Ss recognized built-in loss. Thus, none of Ps
$10 loss is attributable to built-in gain and is
therefore allowed. Prior Reg. 1.337(d)-2(c)(4),
- 56 -
Example; see also Prior Reg. 1.337(d)-1(a)(5), Ex.

4.15
(b) The result should be the same under the modified

tracing approach. There has been no alteration
event. Ss reinvestment in New Asset and its
subsequent decline in value did not create any
inside/outside basis disparity because the value of S
declined by the same amount.
(c) Similarly, under the basis disconformity approach,

Ps loss should be allowed. The PIA amount is $0
because the $50 built-in loss offsets the $50 built-in
gain. Accordingly, none of Ps loss is disallowed.
(4) The result would be the same if, instead of having a built-in
loss in Loss Asset, S had a net operating loss carryover
when P purchases the S stock, and the net operating loss is
used to offset the built-in gain. Id.
(5) What if the P group were unable to use the loss that S
recognized on the sale of Loss Asset? In that case, Ps loss
on the sale of the S stock would be $60 instead of $10. Is
the $50 loss attributable to Ss built-in gain disallowed?
Because Ps basis in S reflected both Ss unrealized built-in
gain and unrealized built-in loss, arguably the result should
not be different.
(6) What if Ss loss was not built-in but arose after the
acquisition as a result of the depreciation in value of Loss
Asset?
(a) Under a pure tracing approach, because the loss

arose only after Ss acquisition, it was not reflected
in Ps basis in S and thus should not be available to
offset Ss built-in gain. Only built-in losses may be
netted against built-in gains under a pure tracing
approach.
(b) The result should be the same under the modified

tracing approach, because there has been no
alteration event.
(c) Under the basis disconformity approach, however,

Ps loss should be allowed. The basis disconformity
15
The examples in Reg. 1.337(d)-1(a)(5) and Prior Reg. 1.1502-20(a)(5) (other than
examples 3, 4, and 5) are incorporated by reference in Reg. 1.337(d)-2(c)(4).
- 57 -
approach looks at net investment adjustments rather

than built-in losses. Thus, recognized losses may
offset built-in gains, even if attributable to post-
acquisition depreciation in value.
(7) The new Unified Loss Rules should reach the same result
as the basis disconformity approach, because positive and
negative investment adjustments are netted in determining
the PIA factor.
6. Safe Harbors Circumstances Under Which Gain Should Not Be

Considered Built-In
a. Pure Tracing Approach In some circumstances, it should be

relatively straightforward to show that a gain was not built-in.
For example, there could be no potential for the recognition of
built-in gain in the following circumstances:
(1) If a subsidiary was purchased in a transaction in which the

parties made a section 338(h)(10) election to treat the stock
purchase as a deemed asset purchase, so that the basis of
the assets reflect their fair market value at the time of the
acquisition.
(2) If a subsidiary was a member of the group since its

inception.
(3) If a subsidiary continued to hold all of the assets it held on

the date of its acquisition.
b. When the Service first announced the modified tracing and basis
disconformity approaches, it stated that it would recognize the
following safe harbors. However, Notice 2004-58 was silent on
this issue.
(1) If a subsidiary was purchased in a transaction in which the

parties made a section 338(h)(10) election, then there
would be no built-in gain, as long as there had not been any
redetermination transactions.
(2) If P acquired all of the S stock in a single section 351

transaction where P was the only transferor, then there
would be no built-in gain, as long as there had not been any
redetermination transactions.
c. The new Unified Loss Rules did not adopt any of these safe
harbors, because the Service and Treasury viewed them as
unnecessary. Because basis disconformity is measured
- 58 -
immediately before the transfer of loss shares, the rule

automatically excludes situations where there is basis conformity.
See 72 Fed. Reg. at 2982.
7. Allowable Loss Under Pre-2002 Treasury Regulation Section 1.1502-20

Rules
a. Similar to Prior Reg. 1.337(d)-2, Prior Reg. 1.1502-20(a)

contained a blanket loss disallowance rule and then carved out
situations where the loss would be allowed. Under Prior Reg.
1.1502-20(c), loss was permitted to the extent it exceeded a
shares allocable part of the sum of the following factors:
(1) Extraordinary gain dispositions Income or gain, net of

directly related expenses, allocated to the share from
extraordinary gain dispositions;
(2) Positive investment adjustments (PIAs) The amount of

the positive adjustment with respect to the share under Reg.
1.1502-32 for each consolidated return year, but only to
the extent the amount exceeded the extraordinary gain
amount; and
(3) Loss duplication The amount of any duplicated loss.
As was the case with Prior Reg. 1.337(d)-2(c), the limited loss allowance rule in Prior Reg.
1.1502-20(c) also applied to the deconsolidation rule. Thus, the amount of the basis reduction
was limited to the sum of the extraordinary gain dispositions, PIAs, and duplicated loss factors
allocable to Ps remaining S stock. Prior Reg. 1.1502-20(c)(1).
b. Extraordinary Gain Disposition Factor
(1) Extraordinary gain dispositions were defined as

dispositions after November 18, 1990 resulting in gain
from the disposition of capital assets, property used in a
trade or business, and certain bulk asset dispositions. Prior
Reg. 1.1502-20(c)(2)(i).
(2) Income from discharge of indebtedness and a change in

method of accounting resulting in positive section 481
adjustments were also treated as extraordinary gain
dispositions.
(3) Note that Prior Reg. 1.337(d)-2, with its focus on built-in
gain items, essentially retained the extraordinary gain
disposition factor. However, the new Unified Loss Rules
eliminate it.
- 59 -
(4) The amount of extraordinary gain could be reduced by

directly related expenses from the disposition. Prior Reg.
1.1502-20(c)(1)(i).
(5) Unlike Prior Reg. 1.337(d)-2, loss from extraordinary

dispositions could not be used to offset gain from
extraordinary gain dispositions under Prior Reg. 1.1502-
20. See Prior Reg. 1.337(d)-2(c)(4), Example.
(6) To illustrate the extraordinary gain disposition factor,

assume that P acquires all of the stock of S for $100. S has
assets it uses in its trade or business with a value of $100
and a basis of $0. S sells the assets, resulting in a $100
gain, which increases Ps basis in its S stock to $200. S
uses the cash to buy a capital asset for $100. P sells its S
stock for $100, resulting in a $100 loss ($200 basis less
$100 value). The amount of extraordinary gain is $100.
Because the $100 loss does not exceed the $100
extraordinary gain, all of the $100 loss would be disallowed
under the prior rules. Note that the result was the same
under Prior Reg. 1.337(d)-2 and is the same under the
new Unified Loss Rules.
c. PIA Factor
(1) A positive investment adjustment was defined as the sum

of the amounts under Reg. 1.1502-32(b)(2)(i) through
(iii) for the consolidated return year. Thus, the basis
adjustments attributable to taxable income, tax loss, tax-
exempt income, and noncapital, nondeductible expenses
were netted for the taxable year to determine the amount (if
any) of the PIA.
(a) This amount was not reduced by negative

adjustments attributable to distributions.
(b) In addition, losses were taken into account as they

arose, not when they were absorbed. Prior Reg.
1.1502-20(c)(2)(ii).
(c) Netting of profits and losses arising in the same

year was permitted, but netting positive and
negative investment adjustments from different
years was not permitted. See Prior Reg. 1.1502-
20(c)(4), Ex. 3.
(2) Thus, all net PIAs were presumed to be attributable to

built-in gain. The reason for the PIA factor was the
- 60 -
Services concern over wasting assets. Prior Reg.

1.337(d)-2 did not reach wasting assets.16 The new
Unified Loss Rules return to the historic presumption.
(3) To illustrate the PIA factor, assume that P acquires all of the
stock of S for $100. S has an asset with a $100 value and a
$0 basis. In Year 1, S earns $100 of operating income, and
Ps basis in S is increased by $100 to $200. In Year 2, Ss
asset declines in value to $0. S invests the $100 from
operating income in another asset, which loses $25 during
the year. The loss is absorbed by the P group, thus reducing
Ps basis in S to $175. In Year 3, P sells S for $75, realizing
a $100 loss. Under the limited loss allowance rule of Prior
Reg. 1.1502-20, the loss disallowed was equal to the
amount of the PIAs $100 from Year 1. This amount was
not reduced by the $25 loss from Year 2. Thus, all of Ps
$100 loss was disallowed.
d. Loss Duplication Factor
(1) Duplicated loss was defined as the excess of (A) the sum of
the aggregate asset basis, loss carryovers, and deferred
deductions (such as suspended losses under the passive
activity loss rules) of the subsidiary, over (B) the value of
the subsidiarys stock and any liabilities of the subsidiary.
Prior Reg. 1.1502-20(c)(2)(vi).
(a) The amounts computed in the loss duplication

formula included the subsidiarys share of
corresponding amounts with respect to lower tier
subsidiaries. Id.
(b) Aggregate asset basis did not include any stock or

securities in another subsidiary. Id. Note that the
Unified Loss Rules do include the basis of lower-
tier subsidiaries in computing both basis reduction
and attribute reduction. See Reg. 1.1502-36(c)(6),
(d)(5).
(2) The loss duplication factor was intended to ensure that a

stock loss allowed under the regulations was not duplicated
at a later time. Prior Reg. 1.337(d)-2 does not contain a
16
After the Federal Circuit invalidated the loss duplication factor in Rite Aid, the Service
conceded the loss disallowance issue in the context of a PIA factor in Square D Co. v.
Commissioner, 118 T.C. 299 (2002). See Michael L. Schler, Consolidated Return Loss
Disallowance: Conceptual Issues, 2002 Tax Notes Today 88-30 n.10 (May 3, 2002).
- 61 -
loss duplication factor, but the Service issued Prior Reg.

1.1502-35 to address its duplicated loss concern.
(3) To illustrate the duplicated loss factor, assume that P forms

S with a contribution of $100. S buys a manufacturing
plant for $100. S has an operating loss of $60, which the P
group is unable to use on its consolidated return and which
cannot be carried back. Ss basis in its assets is reduced to
$40. Ps basis in its S stock remains at $100. Reg.
1.1502-32(b)(2) and (3). P sells S to X for $40,
recognizing a $60 loss. S is apportioned its $60 net
operating loss carryover when it leaves the P group. Reg.
1.1502-79(a), 1.1502-21(b)(2).
Under Prior Reg. 1.1502-20, Ss duplicated loss was $60,

determined as follows:
Sum of Ss asset bases ($40)

and loss carryovers ($60): $100
Less value of Ss stock: $ 40
Duplicated Loss: $ 60
Because Ps $60 loss on the sale of S does not exceed the

$60 duplicated loss, all of Ps loss would have been
disallowed. Importantly, P would be permitted to
reattribute to itself Ss $60 loss carryover. However, if the
duplicated loss were attributable to a built-in loss asset, no
such relief was available to P.
C. Netting Rule
1. There was a narrow exception to the loss disallowance rule of Prior Reg.
1.337(d)-2: Loss could be recognized to the extent that gain was taken
into account by group members on the sale of the subsidiary stock having
the same material terms as a consequence of the same plan or
arrangement. Prior Reg. 1.337(d)-2(a)(4).
a. A similar netting rule applied to the deconsolidation rule. Thus,

basis was not required to be reduced upon deconsolidation to the
extent that gain was taken into account by group members with
respect to subsidiary stock having the same material terms as a
consequence of the same plan or arrangement. Prior Reg.
1.337(d)-2(b)(4).
b. The subsidiary stock must have the same material terms for the
netting rule to apply.
- 62 -
(1) If, for example, the subsidiary stock sold at a loss was
common stock and the subsidiary stock sold at a gain was
preferred stock, netting would not be available, because the
preferred stock does not have the same material terms as
the common stock.
(2) However, if both blocks of subsidiary stock sold were

preferred stock, netting would be permitted if the loss on
the sale of preferred stock were offset by the gain on the
sale of preferred stock having the same material terms.
c. This netting rule was the same as the netting rule contained in pre-
2002 Reg. 1.1502-20(a)(4), (b)(4).17
d. The Unified Loss Rules also contain a netting rule. However, the
rule is not limited to stock having the same material terms, and the
stock must be transferred in the same transaction rather than the
same plan or arrangement. Reg. 1.1502-36(c)(7). See Section
II,D,3, above.
17
The temporary regulations, as originally promulgated, did not contain a netting rule, but
they were amended on May 31, 2002 to provide such a rule. See Preamble to Prior Temp. Reg.
1.337(d)-2T, 67 Fed. Reg. at 37,998 (indicating that Temp. Reg. 1.337(d)-2T was amended to
provide a netting rule similar to that of Prior Reg. 1.1502-20(a)(4)). The final regulations
contained the same netting rule found in the temporary regulations.
- 63 -
2. Example 14 - Netting Gains and Losses
P
Sell T Stock
X
50 Shares
$100 Value
Sell T Stock $150 Basis
S
50 Shares
$100 Value T
$50 Basis
a. Facts: P owns all of the stock of S and 50 shares of T common

stock. S owns the remaining 50 shares of T common stock. P has
a $150 basis in its T stock, which is worth $100. S has a $50 basis
in its T stock, which is also worth $100. P and S sell all of their T
stock outside the group to X, an unrelated buyer.
b. Ss $50 gain is permitted to offset Ps $50 loss under the netting

rule.
(1) If P and S sell their T stock to the public, the public would
likely be treated as one purchaser for purposes of applying
the netting rule. Cf. Prior Reg. 1.1502-20(a)(5), Ex. 5.
(2) In addition, netting is permitted if stock is sold to more than

one purchaser, provided it is pursuant to the same plan or
arrangement.
c. Assume that S distributes its T stock to P, resulting in $50 of

section 311(b) gain that is deferred. Reg. 1.1502-13(c); -13(f)
(2)(iii). If P sells all of the T stock outside the group, the deferred
gain is taken into account. Reg. 1.1502-13(d)(2)(i). Loss will be
permitted to be recognized under Prior Reg. 1.337(d)-2(a)(4)
but only to the extent of the $50 deferred gain.
d. The netting rule may also have the effect of sheltering son-of-
mirror type losses. Assume in Example 14 that S purchases 50
percent of the T stock for $50 and P thereafter purchases the
remaining 50 percent for $100. T sells a built-in gain asset and
recognizes $50 gain, which results in a basis increase of $25 to
each of Ps and Ss 50-percent interest. Reg. 1.1502-32(b)(2)(i).
- 64 -
Thus, Ps basis in its T shares is increased to $125 and Ss basis is

increased to $75. When P and S sell their stock to X, P recognizes
a loss of $25 and S recognizes gain of $25. Nonetheless, under the
netting rule, Ss gain may offset Ps loss.
3. Example 15 - Netting Under the Deconsolidation Rule
X
50 Shares
$100 Value
Sell T Stock $150 Basis
S
50 Shares
$100 Value T
$50 Basis
a. Facts: Same as Example 14, except that P does not sell its T stock.
b. Ss sale of T stock to X for $100 results in a $50 gain. Under the

deconsolidation rule, P must reduce the basis of its T stock by $50
from $150 to $100, the value of the T stock immediately before
deconsolidation. However, under the netting rule, because Ss $50
gain is recognized as a consequence of the same plan or
arrangement as that giving rise to the deconsolidation, Ps $50
basis reduction in its T stock is eliminated. Ps basis in its T stock
thus remains at $150. Prior Reg. 1.337(d)-2(b)(4); see also Prior
Reg. 1.1502-20(b)(4), (b)(6), Ex. 6.
c. Of course, the P group could have avoided a gain if P had sold its T
stock instead of S.
d. The netting rules also provide for an anti-duplication rule in the

event the loss disallowance rule and deconsolidation rule apply to
the same transaction. If gain from the sale of subsidiary stock
could be used to allow the use of a loss that would otherwise be
disallowed and also to prevent a reduction in basis that would be
required under the deconsolidation rule, the gain may be taken into
account only once. Prior Reg. 1.337(d)-2(a)(4); see also Prior
Reg. 1.1502-20(a)(4), 1.1502-20(b)(6), Ex. 7. In this
- 65 -
circumstance, the group has the option to use the netting rule under
either the loss disallowance rule or the deconsolidation rule.
(1) Assume in the above example that P owns 100 shares of T

stock with a $200 value and a $300 basis. At the same time
S sells its T stock for a $50 gain, P sells 50 shares of T
stock for a $50 loss ($100 value less $150 basis). The $50
loss would be disallowed under Prior Reg. 1.337(d)-2(a)
(1).
(2) The $50 gain on Ss sale of the T stock can be used under
the netting rule in the loss disallowance rule or the
deconsolidation rule, but may be taken into account only
once. If the P group chooses to use the $50 gain to offset
the $50 loss, P must reduce the basis of its remaining T
stock by $50 to its $100 value.
D. Coordination with Loss Deferral and Other Loss Disallowance Rules
1. The old regulations expressly incorporated the rule of Prior Reg. 1.1502-
20(a)(3) (with appropriate adjustments to reflect differences between the
approach of this section and that of 1.1502-20), which applied special
rules in the case where a loss on the sale of subsidiary stock would be
deferred or disallowed under a Code provision or regulation other than
Prior Reg. 1.1502-20. Prior Reg. 1.337(d)-2(a)(3).
2. Prior Reg. 1.1502-20(a)(3)(i) provided that any other provision of the

Code or regulations that disallowed or deferred a loss on the disposition of
subsidiary stock applied before the general loss disallowance rule. If the
loss was deferred under another provision, then the loss was subject to the
loss disallowance rule when the loss was ultimately taken into account.
3. However, if a so-called overriding event occurred prior to the time that a

deferred loss was taken into account, the loss was subject to the loss
disallowance rule at that time. Prior Reg. 1.1502-20(a)(3)(i), (ii). The
overriding events included the following:
a. The subsidiary stock ceased to be owned by a member of the

consolidated group;
b. The subsidiary stock was canceled or redeemed (regardless of

whether it is retired or held as treasury stock); and
c. The subsidiary stock was treated as disposed of under Reg.

1.1502-19(c)(1)(ii)(B) or (c)(1)(iii). Under Reg. 1.1502-19(c)
(1)(ii)(B) and (c)(1)(iii), a disposition is deemed to occur as
follows:
- 66 -
(1) At the time S becomes a nonmember, or Ps basis in the

stock is reflected, directly or indirectly, in whole or in part,
in the basis of any asset other than member stock;
(2) At the time substantially all of Ss assets are treated as

disposed of, abandoned, or destroyed for federal income tax
purposes;
(3) At the time an indebtedness of S is discharged, if any part

of the amount discharged is not included in gross income
and is not treated as tax-exempt income under Reg.
1.1502-32(b)(3)(ii)(C); or
(4) At the time a member takes into account a deduction or loss

for the uncollectible indebtedness of S, and the deduction
or loss is not matched in the same tax year by Ss taking
into account a corresponding amount of income.
4. Compare the Unified Loss Rules, which apply immediately upon the
transfer of a loss share even if the loss is deferred, disallowed, or
otherwise not taken into account under any other applicable rules of law.
The only exception is with respect to intercompany losses under Reg.
1.1502-13, in which case the Unified Loss Rules apply upon the
triggering of the loss. Reg. 1.1502-36(e)(3).
5. Example 16 - Coordination With Loss Deferral Rules
(3) T Stock
P Y
$100
(2) Sell T
Stock
S
$100 Value
$100 Basis
(1) Asset
T X
$100
Asset:
$100 Value
$40 Basis
- 67 -
a. Facts: P owns all of the stock of S, and S owns all of the stock of
recently purchased T. S has a $100 basis in its T stock, which is
worth $100. T owns one asset with a value of $100 and a basis of
$40. T sells the asset to X for $100. S then sells its T stock to P
for $100. P later sells all of the T stock for $100 to Y, a member of
the same controlled group (as defined in section 267(f)) as P but
not a member of the P consolidated group.
b. T recognizes a $60 gain on the sale of its asset, which increases Ss

basis in the T stock from $100 to $160. When S sells the T stock
to P, it recognizes a $60 loss that is deferred under section 267(f)
and Reg. 1.1502-13(c). (This sale is not subject to section 304(a)
(1). See Rev. Rul. 74-605, 1974-2 C.B. 97; Reg. 1.1502-80(b)).
c. Pursuant to Prior Reg. 1.1502-20(a)(3), the loss disallowance

rule would not ordinarily apply to Ss $60 loss, because the loss is
deferred under section 267(f) and Reg. 1.1502-13(c). Although
Ps sale of the T stock to Y would cause Ss deferred loss to be
taken into account under Reg. 1.1502-13(d), Reg. 1.267(f)-1(b)
(1) and -1(c)(1)(i) provide that the loss is not taken into account,
because Y is a member of the same controlled group as P and S.
Nevertheless, the sale of the T stock to Y is an overriding event,
since T ceases to be a member of the P consolidated group.
Therefore, Ss $60 loss is disallowed under Prior Reg. 1.337(d)-
2(a)(1) and is never taken into account under section 267(f). See
Prior Reg. 1.1502-20(a)(5), Ex. 6(ii).
E. Successor Rule
1. Prior Reg. 1.337(d)-2(d) incorporated the successor rules (and examples)

of Prior Reg. 1.1502-20(d). Thus, Prior Reg. 1.337(d)-2 applied, to the
extent necessary to effectuate the purposes of the regulation, to any
property the basis of which is determined, directly or indirectly, in whole
or in part, by reference to the basis of a subsidiarys stock. See Prior Reg.
1.1502-20(d)(1).
2. Example 17 Successor Rule
P X
LP interest
$100 Value
S stock
$100 Value GP Interest
$200 Basis
S LP
- 68 -
a. Facts: P owns all of the stock of S, which has a value of $100 and
a basis of $200. P contributes its S stock to LP partnership in
exchange for a limited partnership interest worth $100.
b. Pursuant to the deconsolidation rule, P is required to reduce the

basis of its S stock to its $100 fair market value immediately
before the transfer of the S stock to LP. As a result, P takes a $100
basis in its partnership interest under section 722, and the
partnership takes a $100 basis in the S stock under section 723.
c. Ps partnership interest is a successor interest to the S stock. If P

sells the partnership interest at a loss within two years, Ps loss will
be disallowed. Prior Reg. 1.1502-20(d)(2), Ex. 2.
3. The Unified Loss Rules apply generally to predecessor or successor

persons, groups, and assets to the extent necessary to effectuate the
purposes of the regulations. Reg. 1.1502-36(e)(1).
F. Anti-Avoidance Rules
1. Prior Rules Apply Prior Reg. 1.337(d)-2(e) incorporated the anti-

avoidance rules (and examples) of pre-2002 Reg. 1.1502-20(e).
2. General Anti-Avoidance Rule
a. Prior Reg. 1.1502-20(e)(1) contained a catch-all anti-

avoidance rule: The rules of section 1.1502-20 must be applied
in a manner that is consistent with and reasonably carries out their
purposes. If a taxpayer acts with a view to avoid the effect of the
rules of this section, adjustments will be made as necessary to
carry out their purposes. See also Reg. 1.1502-36(g).
b. Example 18 Shifting of Value
(3)
S Common
S Stock P Z
X P
$100
$100
$100 basis S Preferred
(1)
$100 Land stock
(2) Asset
S S S Y
$100
Asset
$100 Value
$0 Basis
- 69 -
(1) Facts: In Year 1, P buys all of the stock of S for $100, and
S becomes a member of the P group. S holds an asset with
a value of $100 and a basis of $0. In Year 2, with the
proscribed view, P transfers land with a value of $100 to S
in exchange for preferred stock with a $200 redemption
price. S sells the built-in gain asset to Y for $100. In Year
3, P sells the S common stock to Z for $100.
(2) The $100 redemption premium increases the value of the

preferred stock to $200 and decreases the value of the
common stock to $0. When S sells the built-in gain asset
for $100, Ps basis in the common and preferred S stock is
increased to $300. As a result of the cumulative
redetermination rule of Reg. 1.1502-32(c)(4), Ps basis in
the S preferred stock increases from $100 to $200 and Ps
basis in the common stock remains $100. Thus, P
recognizes a $100 loss when it sells the S common stock.
(3) Under section 305, the redemption premium on the

preferred stock is treated as a section 301 distribution. As a
result, Ps bases in the preferred and common stock are
unaffected.
(4) Ps loss on the sale of the S common stock is disallowed

under Prior Reg. 1.1502-20(e)(1) and 1.337(d)-2(e). See
Prior Reg. 1.1502-20(e)(3), Ex. 1. The disallowance
prevents the preferred stock from shifting value and stock
basis adjustments from the common stock to avoid
disallowance of the loss.
3. Anti-Stuffing Rule
a. The anti-stuffing rule was triggered when (i) any asset was
transferred to a subsidiary, (ii) the stock of the subsidiary was
disposed of within two years of the transfer, and (iii) the transfer
was with a view to avoiding, directly or indirectly, the loss
disallowance rule, deconsolidation rule, or gain recognition on the
transferred asset. Prior Reg. 1.1502-20(e)(2)(i).
b. If the anti-stuffing rule was triggered, the basis of the subsidiary

stock that was disposed of was reduced immediately prior to the
disposition so as to cause gain recognition in the amount equal to
the avoided loss disallowance, basis reduction, or gain recognition.
Prior Reg. 1.1502-20(e)(2)(ii).
- 70 -
c. The anti-stuffing rule also applied to a transfer of a consolidated

subsidiarys stock to another consolidated subsidiary. Prior Reg.
1.1502-20(e)(3), Ex. 4.
d. Example 19 Basic Stuffing Case
(4)
(1) $200
S Stock P Z
X P
S Stock
$100 (3)
Asset 2: $200 basis
$100 basis $100 Value
(2) $0 Basis
Asset 1 S
S S Y
$100 Cash
Asset 1 $100 cash
$100 Value
$0 Basis
(1) Facts: In Year 1, P acquires S for $100 and S becomes a

member of the P group. S has an asset with a $100 value
and $0 basis, which it sells outside the group to Y. In Year
5, P transfers to S in a section 351 transaction an asset with
a $100 value and a $0 basis with a view to avoiding the loss
disallowance rule. In Year 6, P sells its S stock to Z for
$200.
(2) Under the investment adjustment rules, Ps basis in the S

stock is increased by Ss $100 gain to $200. Reg. 1.1502-
32(b)(2)(i). When P sells its S stock in Year 6, it recognizes
no gain or loss.
(3) Under the anti-stuffing rule, P must reduce its basis in S to

$100 immediately before the sale of the S stock, resulting
in a $100 gain to P. This gain is equal to the $100 gain P
avoided by making the asset transfer. Prior Reg. 1.1502-
20(e)(3), Ex. 2.
(4) If P would have waited for more than two years after the
asset transfer to sell S, provided the sale was not pursuant
to a prearranged plan, the anti-stuffing rule would not have
applied.
- 71 -
(5) If the S stock were deconsolidated in Year 6 rather than

sold, P would still be required to reduce the basis in its S
stock by $100 immediately before the deconsolidation.
Prior Reg. 1.1502-20(e)(3), Ex. 2(iii).
(6) If the P stock were acquired by another group in Year 6, the

$100 basis reduction would still be required, even though
the asset transfer took place outside the acquiring group.
According to the regulations, the anti-stuffing rule
requires only that the transferor have the view at the time
of the transfer. Prior Reg. 1.1502-20(e)(3), Ex. 2(iv).
e. The Unified Loss Rules include anti-stuffing in the general anti-

abuse rule but it is not subject to the 2-year limitation. Reg.
1.1502-36(g).
G. No Tiering Up of Certain Adjustments
1. Prior Reg. 1.337(d)-2(f) incorporates the rules (and examples) of pre-

2002 Reg. 1.1502-20(f), which limited the tiering up of certain
investment adjustments.
2. A loss that was recognized but disallowed was treated as a noncapital,

nondeductible expense, and under Reg. 1.1502-32(b)(3)(iii), caused a
negative investment adjustment.18 Under Reg. 1.1502-33, a subsidiarys
earnings and profits are similarly reduced (for earnings and profits
purposes) by the amount of the subsidiarys disallowed loss. Under Reg.
1.1502-33(b), the reduction in earnings and profits is reflected in the
earnings and profits of the parent of such a subsidiary.
3. In the case of a deconsolidation of a subsidiary, the basis of the stock of

the subsidiary would be reduced to reflect its fair market value. Prior Reg.
1.337(d)-2 (b)(1). Under Reg. 1.1502-32(b)(3)(iii), the reduction of
the basis of the subsidiarys stock will be treated as a noncapital,
nondeductible expense and will cause a negative investment adjustment.
In that case, the earnings and profits of the parent will be reduced by a
similar amount immediately prior to the deconsolidation.
4. Prior Reg. 1.1502-20(f)(1) provided that if the basis of a subsidiarys

stock was reduced upon the deconsolidation of such subsidiarys stock,
then no corresponding adjustment was made under the investment
18
Note that if a members basis in the subsidiary stock was reduced under Reg. 1.1502-
32 by reason of a disallowed loss, and such disallowed loss is reduced by reason of an election
under Prior Reg. 1.1502-20(i), but would have expired or been absorbed in a closed year, then
the members basis in the subsidiary stock could be increased for purposes of determining the
groups or members federal income tax liability for open years. Prior Reg. 1.1502-20(i)(3)(v)
(B).
- 72 -
adjustment system to the basis of the stock of the subsidiarys parent, if

there is a deconsolidation or disposition of the parents stock in the same
transaction.
5. The Unified Loss Rules in Reg. 1.1502-36 apply to transferred loss

shares, which are defined to include deconsolidations. Reg. 1.1502-
36(f)(10)(i)(B). They do not contain a separate deconsolidation rule.
6. Example 20 Deconsolidation of Parent in Same Transaction as

Subsidiary
P
$100 Basis
S (3) S-1 Stock
A
$100 Basis
S-1
$100 Basis
(1) T Stock $100
X S-2
$100
(2) Sell Asset

T Y
$100
Asset
$100 Value
$0 Basis
a. Facts: P owns all of the stock of S, S owns all the stock of S-1, and
S-1 owns all the stock of S-2. Ps basis in the S stock is $100, Ss
basis in the S-1 stock is $100, and S-1s basis in the S-2 stock is
$100. In Year 1, S-2 buys the stock of T for $100. T holds an asset
with a value of $100 and a basis of $0. In Year 2, T sells the asset
to Y for $100. In Year 6, S sells the S-1 stock to Individual A for
$100. The new S-1 group does not file a consolidated return.
b. Under the investment adjustment system, in Year 2, when T

recognizes $100 gain, the basis of each subsidiarys stock increases
from $100 to $200. Thus, when S sells the stock of S-1, it
- 73 -
c. The $100 loss resulting from the sale of the S-1 stock is
disallowed. Prior Reg. 1.337(d)-2(a)(1). Under Reg. 1.1502-
32(b)(3)(iii), Ss disallowed loss is treated as a noncapital,
nondeductible expense that reduces Ps basis in the S stock. Under
Reg. 1.1502-33, Ss earnings and profits are reduced, and this
reduction is also reflected in Ps earnings and profits.
d. Under Prior Reg. 1.337(d)-2(b)(1), the basis of the stock of T and

S-2 must be reduced immediately before the sale from $200 to
$100, because their stock is deconsolidated as a result of Ss sale of
the S-1 stock. However, under Prior Reg. 1.1502-20(f)(1) and
Prior Reg. 1.337(d)-2(f), the basis reduction to neither the T
stock nor the S-2 stock tiers up, because the S-2 stock is
deconsolidated and the S-1 stock is disposed of in the same
transaction.
e. Similar treatment applies for purposes of the tiering up of earnings

and profits under Reg. 1.1502-33.
H. Prior Reg. 1.1502-20(i) Transition Rules
1. General Rule For dispositions of stock occurring before March 7, 2002,

or for dispositions or deconsolidation of stock of a subsidiary after March
7, 2002 effected pursuant to a binding written contract entered into before
March 7, 2002 that was in continuous effect, Prior Reg. 1.1502-20(i)(2)
allowed a parent to choose one of three regulatory schemes for each
separate disposition of subsidiary stock:
a. Prior Reg. 1.1502-20 in its entirety;
b. Prior Reg. 1.1502-20 without regard to the loss duplication factor

(-20 Lite); or
c. Prior Reg. 1.337(d)-2.
2. Election The parents election under Prior Reg. 1.1502-20(i)(2) must

have been filed with a timely filed (including extensions)19 original return
for the taxable year that included any date on or before March 7, 2002.
Prior Reg. 1.1502-20(i)(3)(v)(4).
a. If the date of the disposition or deconsolidation of the stock was

after March 7, 2002 pursuant to a binding contract, the election
could either be filed (i) with or as part of a timely filed original
return for the tax year that includes the disposition or
deconsolidation date, or (ii) with or as part of an amended return
19
Note that the election provisions were amended by the Service on May 31, 2002 to
clarify that a timely filed return included extensions. See 67 Fed. Reg. at 37,998.
- 74 -
filed before the date that the original return for the tax year that
includes March 7, 2002 is due. Id.20
b. If no election was filed, Prior Reg. 1.1502-20 applied in its

entirety, including the loss duplication factor invalidated by Rite
Aid. See Prior Reg. 1.1502-20(i)(2). Thus, a parent need not file
an election under Prior Reg. 1.1502-20(i)(2) if it was going to
apply 1.1502-20 in its entirety.
c. In conjunction with the issuance of Notice 2004-58, the Service

issued temporary regulations to permit taxpayers to make, amend,
or revoke elections under Prior Reg. 1.1502-20(i). See Prior
Reg. 1.1502-20(i)(6); Temporary Regulations on Extension of
Time to Elect Method for Determining Allowable Loss, 69 Fed.
Reg. 52,419 (August 26, 2004).
(1) A taxpayer that was permitted to make an election under

1.1502-20(i), but did not previously make such an
election, could make an election to apply either -20 Lite or
Prior Reg. 1.337(d)-2. The regulations also permitted a
taxpayer that previously made an election to apply -20 Lite
to revoke the election and apply Prior Reg. 1.1502-20 in
its entirety, or to amend the election in order to apply Prior
Reg. 1.337(d)-2. In addition, the regulations permitted a
taxpayer that previously made an election to apply Prior
Reg. 1.337(d)-2 to revoke the election and apply Prior
Reg. 1.1502-20 in its entirety or to amend the election in
order to apply -20 Lite.
(2) To revoke or amend an election, the taxpayer had to include

a statement with or as part of any timely filed (including
any extensions) original return for a taxable year that
included any date on or before August 26, 2004, or with or
as part of an amended return filed before the date the
original return for the taxable year that included August 26,
2004 is due (including any extensions).
3. Cascading Losses
a. Allowance of Loss in Open Years If an election to apply -20 Lite

or Prior Reg. 1.337(d)-2 increased the loss allowed on the
disposition of subsidiary stock, but the year of the disposition is
closed, and the absorption of such extra loss would have affected
the tax treatment of another item that has an effect in an open year,
20
The May 31, 2002 amendments to the temporary regulations also clarified that
elections could be made on an original return filed for the tax year 2001, even though it does not
include March 7, 2002. See 67 Fed. Reg. at 37,998.
- 75 -
then the taxpayer could adjust the other item. Prior Reg. 1.1502-
20(i)(3)(v)(A).21
b. Corresponding Basis Adjustment If a members basis in stock of

a subsidiary was reduced pursuant to Reg. 1.1502-32 because a
loss with respect to such stock was disallowed under Prior Reg.
1.1502-20, then to the extent such disallowed loss is allowed as a
result of an election to apply -20 Lite or Prior Reg. 1.337(d)-2
but would have been absorbed or expired in a closed year, the
members basis in the subsidiary stock may be increased for
purposes of determining the groups or the shareholder-members
federal income tax liability for an open year. Prior Reg. 1.1502-
20(i)(3)(v)(B).22
c. For example, assume that P owns all of the stock of S and they file
a consolidated return. Ps S stock becomes worthless in 1995, but
Ps $20 loss is disallowed under Prior Reg. 1.1502-20. Ps
worthless stock loss would not be disallowed under Prior Reg.
1.337(d)-2. The 1995, 1996, and 1997 tax years are closed.
Assume that the P group has the following consolidated net income
for 1995-1998:
1995 1996 1997 1998

Consolidated income $25 ($20) $10 $6
Net income after 172 $ 5 $ 0 $10 $6
Ps allowed loss would have reduced the P groups consolidated

income in 1995 to $5, and the $20 operating loss in 1996 could
have been carried back to offset the $5 in 1995 and carried forward
to offset the $10 in 1997 and $5 of the $6 in 1998. Although the
1995-1997 tax years are closed, the P group may utilize the loss
carryforward that would have otherwise been available to it in
1998 to reduce its net income after 172 to $1. In addition, if Ps
basis in S is relevant to a determination of federal income tax
liability of P or the P group, then its basis may be increased by the
$20 loss now allowed.
4. Reattribution Rule
a. Prior Reg. 1.337(d)-2 did not provide for the reattribution of

losses.
21
Note that this provision was added by the amendments to the temporary regulations
issued on May 31, 2002. See 67 Fed. Reg. at 37,999.
22
This provision was also added by the amendments to the temporary regulations issued
on May 31, 2002. See 67 Fed. Reg. at 37,999.
- 76 -
b. Pre-2002 Treasury Regulation Section 1.1502-20
(1) Under Prior Reg. 1.1502-20(g)(1), upon the disposition of

subsidiary stock, a parent could elect to reattribute to itself
the subsidiarys net operating and net capital losses
(including SRLY losses) to the extent of the disallowed
loss.
(2) The parent could elect to retain any or all such losses, and
could specify the particular year and the character of the
loss that is subject to reattribution.
(3) The parent could also reattribute to itself losses of a lower

tier subsidiary.
(4) There were a number of limitations on a parents ability to

reattribute losses to itself:
(a) Losses of a subsidiary could not be reattributed to

the extent that the subsidiary (and all higher tier
subsidiaries) was insolvent. Prior Reg. 1.1502-
20(g)(2).
(b) A SRLY loss reattributed to a parent retained its

SRLY taint in the parents hands.
(c) Reattributed losses could not be carried back to a

parents taxable year.
(d) The reattribution election was not available if the

anti-stuffing rule applied or for stock whose basis
was reduced because of the deconsolidation rule.
(e) In the event of bankruptcy, a judge could enjoin a

parent from making the reattribution election on the
ground that the loss is an asset of the bankrupt
subsidiarys estate. See In re Prudential Lines Inc.,
928 F.2d 565 (2d Cir. 1991), affg, 107 Bankr. 832
(S.D.N.Y. 1989) (enjoining parent from claiming
worthless stock deduction which would have
effectively eliminated subsidiarys loss carryover
under section 382).
(f) If a parent reattributed to itself the losses of a

subsidiary, usually the subsidiary would have less
value and the parent would receive less
consideration for the subsidiary stock. If the
subsidiary had minority shareholders, they could
- 77 -
complain that the parent as majority shareholder

breached its fiduciary duty to them. See e.g.,
Meyerson v. El Paso Natural Gas Co., 246 A.2d 789
(Del. Ch. 1967) (business judgment rule protects
parents use of subsidiarys losses).
(5) Example 21 Reattribution Rule
$60
P X
S stock
$100 Basis
$40 loss
carryover
(a) Facts: P owns the stock of S, which has a basis of

$100. S has an unused net operating loss of $40. P
sells S for $60, producing a $40 loss, which is
disallowed under the loss disallowance rule. P
elects to reattribute to itself Ss $40 loss carryover.
(b) The reattribution is treated as a reduction of Ss loss

carryover, which creates a negative investment
adjustment under Reg. 1.1502-32(b)(3)(iii). Thus,
Ps basis in Ss stock is reduced by $40, and P has
no gain or loss on the sale of Ss stock.
(c) Although Ps sale of the S stock may result in an

ownership change under section 382, the
reattributed losses are not subject to the section 382
limitation on the use of losses. Prior Reg. 1.1502-
20(g)(1).
c. Prior Treasury Regulation Section 1.337(d)-2
(1) Prior Reg. 1.337(d)-2, effective for dispositions or

deconsolidations on or after March 3, 2005, did not contain
a reattribution rule. Nor did Prior Temp. Reg. 1.337(d)-
2T (which is not substantively different from the final
regulations), which was effective for dispositions or
deconsolidations on or after March 7, 2002, contain a
reattribution rule.
- 78 -
(2) However, for dispositions and deconsolidations before

March 7, 2002, Prior Reg. 1.1502-20(i) permitted
taxpayers to elect to apply (i) Prior Reg. 1.1502-20 in its
entirety, (ii) -20 Lite, or (iii) Prior Reg. 1.337(d)-2.
(3) The prior regulations contained a special rule where an

election to reattribute losses under Reg. 1.1502-20(g) was
in place and the amount of such losses were reduced by
reason of an election under Prior Reg. 1.1502-20(i).
(a) If the parent elected to apply -20 Lite pursuant to

Prior Reg. 1.1502-20(i)(2)(i), the amount of
reattributed loss had to be reduced to the extent that
it exceeded the greater of (i) the amount of loss
disallowed under -20 Lite; and (ii) the amount of
reattributed losses that the consolidated group
absorbed in the closed years. Prior Reg. 1.1502-
20(i)(3)(i). However, in order to reattribute losses
under Prior Reg. 1.1502-20(g), the parent must
have made a valid election under Prior Reg.
1.1502-20(g). The transition rules did not extend
the time for filing this election. Further, if the
parent already made an election under Prior Reg.
1.1502-20(g), it may not revoke the election.
Prior Reg. 1.1502-20(i)(3)(i).
(b) A parent could not reattribute any losses if it elected

to apply Prior Reg. 1.337(d)-2. Prior Reg.
1.1502-20(i)(3)(ii). However, if the parent had
already elected under Prior Reg. 1.1502-20(g)
with respect to the disposition of subsidiary stock,
the parent could reattribute losses equal to the
greater of zero or the amount of reattributed losses
that the consolidated group absorbed in the closed
years. Prior Reg. 1.1502-20(i)(3)(ii).
(c) If any losses were reattributed under Prior Reg.

1.1502-20(g), such reattribution was binding on
the subsidiary and any group of which the
subsidiary was or became a member. Prior Reg.
1.1502-20(i)(3)(vii).
(i) Indeed, even if the subsidiary subsequently

ceased to be a member of the group, the
subsidiary could not take advantage of the
reattributed losses.
- 79 -
(ii) On the other hand, if the election to apply

-20 Lite or Prior Reg. 1.337(d)-2 resulted
in the reduction in the losses reattributed to
the parent pursuant to a Prior Reg. 1.1502-
20(g) election, the subsidiary, or any group
of which the subsidiary is a member, could
use such losses. Prior Reg. 1.1502-20(i)
(3)(vii).
(iii) As such, the parent had to notify the

subsidiary prior to the date that the
consolidated group filed its income tax
return for the year that includes March 7,
2002. Prior Reg. 1.1502-20(i)(3)(D)(iv).
If the acquiror of the subsidiary stock was a
member of a consolidated group at the time
of the disposition, the parent also had to
notify the parent of the acquirors group. Id.
(iv) The temporary regulations also added Prior

Temp. Reg. 1.1502-32T(b)(4)(v) to
provide for the waiver of loss carryovers
that revert to a subsidiary as a result of an
election under Prior Temp. Reg. 1.1502-
20T(i) (Reg. 1.1502-32(b)(4)(v) and Prior
Reg. 1.1502-20(i) have since been made
final). Absent such rules, the expiration of
loss carryovers would result in a negative
basis adjustment to the buyer under Reg.
1.1502-32(b).
a) Under the temporary regulations, if

reattributed losses reverted to the
subsidiary and such loss carryovers
expired or would have been used in a
closed year, the buyer would be
deemed to have waived the loss
carryovers. Prior Temp. Reg.
1.1502-32T(b)(4)(v)(A).
b) The temporary regulations were later

amended to make the deemed waiver
rule optional in order to provide
relief where the deemed waiver rule
operated to deny the use of excess
losses. Id.; 68 Fed. Reg. 24,351.
- 80 -
c) If reattributed losses reverted to the

subsidiary in open years, the buyer
could make an election to waive
those loss carryovers. Reg.
1.1502-32(b)(4)(v)(B).
(d) Thus, in Example 21 above, if P elected to apply

-20 Lite, its $40 loss would not be disallowed, and S
would reacquire its net operating losses to the extent
not used by the P group in the interim. X may elect
to waive such carryovers if the year is open, or to
deem such a waiver if the year is closed.
(e) Prior Reg. 1.1502-20 provided special rules for

apportioning a section 382 limitation when the
reattributed losses were subject to such limitation.
(i) Reduction of section 382 limitation by

parent A parent could reduce the amount
of section 382 limitation apportioned to
itself, if, as a result of the application of the
reattribution rules of Prior Reg. 1.1502-
20(i)(3)(i) or (ii), and Prior Reg. 1.1502-
20(i)(3)(vii), pre-change attributes subject to
a 382 limitation were treated as the
subsidiarys losses and the parent previously
elected to apportion all or part of such
limitation to itself under Reg. 1.1502-
96(d). This applies to separate, subgroup,
and consolidated section 382 limitations.
See Prior Reg. 1.1502-20(i)(3)(iii)(A)-(C).
(ii) Subsidiary no longer member of group or

subgroup If the subsidiary was no longer a
member of the loss group or subgroup to
which the pre-change attributes relate, the
parent could increase the total amount of the
section 382 limitation apportioned to such
subsidiary (or loss subgroup that includes
the subsidiary) under Reg. 1.1502-95(c).
Prior Reg. 1.1502-20(i)(3)(iii)(B)-(C).
a) Subgroup section 382 limitation

The amount by which the parent
could increase the subgroup 382
limitation apportioned to the
subsidiary was limited to the amount
- 81 -
by which the section 382 limitation

apportioned to the parent is reduced
under Prior Reg. 1.1502-20(i)(3)
(iii)(B).
b) Consolidated section 382 limitation

The amount by which the parent
could increase the consolidated 382
limitation (or subgroup section 382
limitation where the common parent
was a member of the loss subgroup)
apportioned to the subsidiary was
limited to the product of the element
(described in Reg. 1.1502-95(c))
and the percentage of the total
consolidated (or loss subgroup) pre-
change attributes in the year that the
subsidiary left the group that were
treated as the subsidiarys losses.
Prior Reg. 1.1502-20(i)(3)(iii)(C).23
(iii) Ps reduction under Prior Reg. 1.1502-20

(i)(3)(iii)(A) or (B) of its section 382
limitation was effective as of the date on
which the previous apportionment was
effective. Prior Reg. 1.1502-20(i)(3)(iii)
(D)(ii). Increases in a subgroup or
consolidated section 382 limitation
apportioned to a departing subsidiary (or
loss subgroup that includes such subsidiary)
under Prior Reg. 1.1502-20(i)(3)(iii)(B) or
(C) were effective for all years ending after
the date that the subsidiary ceases to be a
member of the group or loss subgroup.
(iv) Prior Reg. 1.1502-20 prescribed several

limitations on the adjustments to the section
382 limitation:
a) In adjusting the consolidated or

subgroups section 382 limitation,
23
Specifically, the formula in Prior Reg. 1.1502-20(i)(3)(III)(C) was as follows: the element x
(prechange attributes subject to the 382 limitation treated as losses of the subsidiary or loss
subgroup due to Prior Reg. 1.1502-20(i)(3)(i) or (ii) and 1.1502-20(i)(3)(vii)) (total pre-
change attributes subject to the limitation determined as of the close of the taxable year in which
the subsidiary ceases to be a member of the group (or loss subgroup)).
- 82 -
the parent could not include section

382 limitations that had been
previously apportioned to another
subsidiary or loss subgroup prior to
the date of the Prior Reg. 1.1502-
20(i)(2) election. Prior Reg.
1.1502-20(i)(3)(iii)(D)(i).
b) Any adjustment had to be consistent

with the principles of 1.1502-
95(c). Prior Reg. 1.1502-20(i)(3)
(iii)(D)(ii). For example, if
apportionment of a separate section
382 limitation to a parent was
reduced under the 382 limitation
rules, the amount of such limitation
available to the subsidiary was
increased.
c) A parent could only make

adjustments under Prior Reg.
1.1502-20(i)(3)(iii)(A), (B), and
(C). Prior Reg. 1.1502-20(i)(3)(iii)
(D)(iv). These adjustments had to be
made as part of the election to apply
-20 Lite or to apply Prior Reg.
1.337(d)-2.
5. Waiver of Loss Carryovers
a. Waiver Election In General
(1) Reg. 1.1502-32(b)(4) provided that, if a subsidiary had a

loss carryover from a separate return limitation year when
it became a member of a consolidated group, the group
could make an election to treat all or any portion of the loss
carryover as expiring immediately before the subsidiary
became a member of the consolidated group.
(2) This election permitted an acquiring group to avoid the loss

of stock basis that otherwise would result if the subsidiarys
loss carryovers were to expire before the group could
absorb them. See Reg. 1.1502-32(b)(2)(iii).
(3) The election may be made by identifying either the amount

of each loss carryover deemed to expire or the amount of
each loss carryover deemed not to expire.
- 83 -
(4) Any loss waived under Reg. 1.1502-32(b)(4) could be

excluded from the selling groups computation of
duplicated losses. Thus, the waiver could have the effect
under the prior loss disallowance regulations of increasing
the amount of stock loss allowed on the disposition of
subsidiary stock.
(5) Under the Unified Loss Rules, losses waived under Reg.
1.1502-32(b)(4) are excluded from the computation of net
inside attributes for purposes of measuring the attribute
reduction amount. This prevents attributes that cannot be
duplicated from being taken into account in reducing
attributes. However, for purposes of computing the basis
disconformity amount, such waived losses are counted.
This is because excluding them would have the effect of
increasing disconformity under circumstances unrelated to
the existence of built-in gain (which is what the
disconformity amount is trying to measure). See 73 Fed.
Reg. at 53,940.
b. Effect of Election Under Prior Reg. 1.1502-20(i)
(1) Acquiring and selling groups could have negotiated to have

the acquiring group waive loss carryovers in an effort to
increase the amount of loss allowed to the selling group.
Thus, Treasury and the Service believed that in cases where
a selling group elected to apply -20 Lite or Prior Reg.
1.337(d)-2, it was appropriate to permit an acquiring
group to amend prior waivers of loss carryovers. On May
7, 2003, Treasury and the Service amended the temporary
regulations to provide for the amendment of prior waivers.
See 68 Fed. Reg. at 24,352. This amendment was also
reflected in the final regulations.
(2) Amendment of Prior Waivers
(a) If a selling group elected to apply -20T Lite or Prior

Reg. 1.337(d)-2, which had the effect of
increasing the loss allowed on the disposition of the
subsidiary stock, then the acquiring group could
reduce the amount of any loss carryover deemed to
expire (or increase the amount of any loss carryover
deemed not to expire) as a result of Reg. 1.1502-
32(b)(4). Reg. 1.1502-32(b)(4)(vii)(A).
(b) The aggregate amount of loss carryovers that could

be treated as not expiring as a result of such an
- 84 -
amendment was limited to the amount of the

duplicated loss with respect to the subsidiarys
stock. This limitation was intended to ensure that
the loss carryovers subject to the amendment did, in
fact, increase the amount of the allowed loss. 68
Fed. Reg. at 24,352.
(c) In addition, to enable the acquiring groups use of

loss carryovers that were not deemed to expire as a
result of an amendment made under this provision,
the regulations permitted a selling group to
reapportion separate, subgroup, and consolidated
section 382 limitations.
(d) If a loss previously deemed to expire was deemed

not to expire as a result of an election under this
provision, but the year to which such loss would
have been carried was closed, then to the extent that
the absorption of such loss would have affected the
tax treatment of another item that has an effect in an
open year, then the amendment of the waiver under
Reg. 1.1502-32(b)(4) will affect the treatment of
such other item. Prior Reg. 1.1502-20(i)(3)(v)
(D).
(3) Avoiding Inadvertent Waivers If the acquiring group

made its original waiver election by identifying those losses
that were deemed not to expire, it could have inadvertently
waived those losses that were reattributed to the selling
group but reverted to the subsidiary as a result of an
election to apply -20 Lite or Prior Reg. 1.337(d)-2. In
such cases, the regulations permitted the acquiring group to
amend its waiver election to provide that the additional
losses were deemed not to expire. Reg. 1.1502-32(b)(4)
(vii)(B).
6. Determining Whether and Which Election to Make A parents choice of

regulatory framework for the disposition of subsidiary stock could
significantly affect the consequences of the disposition. For example,
Prior Reg. 1.1502-20 adopted certain presumptions that could be easier
to prove than the tracing approach under Prior Reg. 1.337(d)-2. On the
other hand, Prior Reg. 1.337(d)-2 did not provide for loss reattribution,
whereas Prior Reg. 1.1502-20 did.
a. Circumstances where taxpayer may want to apply Prior Reg.

1.1502-20 in its entirety:
- 85 -
(1) The seller reattributed net operating losses, and a capital

loss would not reduce the sellers taxes.
(2) The seller reattributed net operating losses and had PIAs
that it could not prove were not attributable to built-in gain.
(3) The seller benefited from netting positive and negative

adjustments during the year and could not prove that they
are not attributable to built-in gain.24
(4) The sellers loss was not attributable to duplicated loss, and
the seller would prefer reattributing losses over Prior Reg.
1.337(d)-2.
(5) The failure to file a timely election under Prior Reg.

1.1502-20(i) (Prior Reg. 1.1502-20 in its entirety is the
default rule).
b. Circumstances where taxpayer may want to elect to apply -20 Lite:
(1) The sellers loss was attributable to duplicated loss, and a

capital loss would reduce the sellers taxes.
(2) The sellers loss was attributable to duplicated loss and it

reattributed net operating losses. Even though the seller
could use the capital loss, it is paid by the buyer to make
the election.
(3) The sellers loss was attributable to duplicated loss, but the
seller benefited from netting positive and negative
investment adjustments within a year.25
(4) The seller was eligible to claim some of its loss, and it
reattributed some net operating losses. However, it was
uncertain whether it had duplicated losses.
c. Circumstances where taxpayer may want to elect to apply Prior

Reg. 1.337(d)-2:
(1) The seller had PIAs or extraordinary gain, which it could

prove were not attributable to built-in gain, and the seller
did not reattribute net operating losses but could use a
capital loss.
24
If the taxpayer fell in this category, it could be possible to achieve the same result under
the basis disconformity approach, since the PIA amount permitted netting of positive and
negative adjustments.
25
See supra note 18.
- 86 -
(2) The seller had PIAs or extraordinary gain, which it could

prove were not attributable to built-in gain, and although
the seller reattributed net operating losses, the buyer would
pay the seller to make the election.
(3) The seller had no loss disallowance factors, but failed to

file the statement of allowed loss required by Prior Reg.
1.1502-20(c)(3) and could not or did not want to seek
9100 relief.
IV. OLD LOSS DISALLOWANCE RULES ADDRESSING CONCERNS RELATING

TO LOSS DUPLICATION
A. Background
1. On March 7, 2002, at the same time it issued Prior Temp. Reg. 1.337(d)-
2T, the Service issued Notice 2002-18 announcing its intention to issue
regulations addressing loss duplication concerns. See Examples 6 & 7,
above for an illustration of the loss duplication concerns.
2. On October 23, 2002, Treasury and the Service issued proposed

regulations to implement Notice 2002-18. Prior Prop. Reg. 1.1502-35.
On March 14, 2003, Treasury and the Service issued the proposed
regulations in temporary form without significant modification. The
regulations generally applied retroactively to transactions that occurred on
or after March 7, 2002, the date of Notice 2002-18 (but only if such
transactions occurred during a taxable year the original return for which
was due after March 14, 2003, see Code 1503(a); Prior Temp. Reg.
1.1502-35T(i)). These regulations were made final without significant
modification on March 9, 2006.
3. Treasury and the Service made it clear in the preamble to the temporary
regulations that they were continuing to study the comments they received
and specifically requested comments on alternative regimes that they were
considering. Treasury and the Service also stated in the preamble to the
final regulations on March 9, 2006 that they intend to publish proposed
regulations in the near term addressing both circumvention of General
Utilities repeal and loss duplication in a single integrated regulation.
a. Unified Loss Rules As described above, Treasury and the Service

issued an integrated regulation addressing both the circumvention
of the General Utilities repeal and loss duplication. Reg. 1.1502-
36.
b. Treasury and the Service believed that a subsidiarys use of a group

loss in a separate return year after the group has recognized the
benefit of the loss distorts the subsidiarys separate year income.
However, to preserve the result in Rite Aid, stock loss may not be
- 87 -
disallowed in deconsolidating transfers. Thus, the Unified Loss

Rules permit the stock loss but reduce the subsidiarys attributes to
the extent of any duplicated loss. 72 Fed. Reg. at 2975.
4. Consistent with Notice 2002-18, Treasury and the Service identified the
purpose of the temporary regulations as being the prevention of a
consolidated group from obtaining more than one tax benefit from a single
economic loss in a manner that does not permanently disallow the
economic loss once. Prior Reg. 1.1502-35T(a), (c)(8). However, the
regulations are not limited to stuffing transactions illustrated by Examples
6 and 7, above.
5. Treasury and the Service believed that the basis redetermination and loss
suspension rules in the regulations, which are discussed in detail below,
would not apply frequently. These rules only applied when a member sold
less than all of the stock of a subsidiary member to a nonmember.
a. The governments belief was based on the assumption that when a

group seeks to raise capital, the parent or the subsidiary will
typically issue stock directly, or the parent will sell all of the stock
of the subsidiary member. 67 Fed. Reg. 65,060, 65,064 (Oct. 23,
2002).
b. If a loss were not subject to the loss duplication rules of Prior Reg.
1.1502-35, the Service and Treasury would apparently rely on
Reg. 1.1502-32(e) and Charles Ilfeld Co. v. Hernandez, 292 U.S.
62 (1934), to disallow a duplicative loss. See I.L.M. 200423027
(May 17, 2004).
B. Basis Redetermination Rule
1. Effect of Investment Adjustment Rules
a. The investment adjustment rules of Reg. 1.1502-32 are based on

certain assumptions regarding shareholders interests in the
subsidiary. One assumption is that each share within a class is
entitled to an equal portion of the subsidiarys items of income and
gain. Another assumption is that the subsidiarys losses are borne
by the holders of the common stock before the holders of the
preferred stock.
b. The preamble to the proposed loss duplication regulations stated

that these assumptions result in an allocation of basis adjustments
without regard to differences in members bases in their shares of
stock of the subsidiary and without regard to whether a basis
adjustment reflects a built-in item with respect to contributed
property. Treasury and the Service thus felt that a basis
redetermination rule was necessary to revise certain basis
- 88 -
adjustments in an effort to mitigate the effect of the assumptions.

67 Fed. Reg. at 65,062.
c. The basis redetermination rule under Prior Reg. 1.1502-35

applied differently depending on whether the subsidiary remained
a member of the consolidated group.
2. Basis Redetermination Where Subsidiary Remained Member of the Group
a. If a member transferred a share of stock of a subsidiary member

that had a basis in excess of its value (i.e., a loss share), and
immediately after the transfer, the subsidiary remained a member
of the group, then the basis of each share of the subsidiary stock
held by each member of the group was redetermined immediately
before such transfer as follows (Prior Reg. 1.1502-35(b)(1)):26
(1) First, the basis of all of the members of the group in the
subsidiary members stock were aggregated.
(2) Second, the aggregated basis was first allocated to the

subsidiary members preferred stock held by members of
the group, in proportion to, but not in excess of, the value
of those shares on the date of the transfer.
(3) Third, any remaining basis was allocated among all of the
common shares of subsidiary member stock held by
members of the group in proportion to the value of such
shares on the date of the transfer.
b. The effect of the basis redetermination rule was to eliminate gain

or loss on preferred shares and equalize gain or loss on each
common share. Note that even though these regulations were
promulgated in response to the governments concern about
duplicating economic losses, the basis redetermination rule was not
limited to situations where duplicated losses exist.
c. It is not clear how the basis redetermination rules applied in the

situation where there was an aggregate excess loss account
(ELA) in the subsidiary stock. There appear to be two ways to
interpret the basis redetermination rule. See Example 31, below.
26
The final regulations, which adopted the temporary regulations without significant
modification, included a somewhat simpler approach than the proposed regulations and triggered
the basis redetermination rule upon the transfer of loss stock. Under the proposed regulations,
the basis redetermination rule was triggered upon the disposition or deconsolidation of any
share of loss stock. See Prop. Reg. 1.1502-35(b)(1), (d)(1) & (d)(2). The reference to
deconsolidation of a share could be easily confused with deconsolidation of a subsidiary.
- 89 -
(1) First, since an ELA is treated as negative basis for all

federal income tax purposes, Reg. 1.1502-19(a)(2)(ii), the
preferred stock could take a proportionate share of the
ELA. Arguably, because the aggregate ELA will always be
less than the fair market value of the preferred stock, the
entire ELA would be allocated to the preferred stock, and
the common stock would take a zero basis. The entire ELA
would then be triggered upon the sale of the preferred
stock.
(2) Second, one could argue that the basis redetermination rule
was intended only to reallocate positive basis. Under this
interpretation, only the aggregate positive basis would be
reallocated. This would have the effect of reducing the
basis of the preferred stock to its fair market value and
reducing the ELA in the common stock.
(3) Triggering gain on the sale of the preferred stock seems

like the wrong answer. Thus, the second approach seems to
be the preferable one. Nonetheless, the literal language of
the regulations seems to favor the first interpretation.
d. Exceptions The basis redetermination rule of Prior Reg.

1.1502-35(b)(1) did not apply to a transfer of subsidiary member
stock if (Prior Reg. 1.1502-35(b)(3)(i)):
(1) During the taxable year of such transfer, in one or more

fully taxable transactions, the members of the group
disposed of all of the shares of the subsidiary member stock
to a nonmember;
(2) During the taxable year of such transfer, members of the

group were allowed a worthless stock deduction under
section 165(g) with respect to all of the shares of the
subsidiary member stock (other than the shares that would
otherwise trigger the application of Prior Reg. 1.1502-
35(b)(1)); or
(3) Such transfer was to a member of the group, and section

332, 351, or 361 applies to such transfer.
3. Basis Redetermination Where Subsidiary Was Deconsolidated
a. Where a subsidiary was deconsolidated as a result of the transfer of

subsidiary shares, the basis redetermination was more limited.
b. If, immediately before a deconsolidation of a subsidiary member,

any share of stock of a subsidiary member owned by a member had
- 90 -
a basis in excess of its value (i.e., a loss share), then the basis of
each share of the subsidiary stock held by each member of the
group was redetermined to the extent of the reallocable basis
amount immediately before the deconsolidation. Prior Reg.
1.1502-35(b)(2).
c. The reallocable basis amount was equal to the lesser of:
(1) The aggregate of the loss in the subsidiarys loss shares

held by members immediately before the deconsolidation;
and
(2) The total of the subsidiarys items of deduction and loss,

and the subsidiarys allocable share of items of deduction
and loss of lower tier subsidiary members, that were taken
into account in computing basis adjustments under Reg.
1.1502-32 allocable to non-loss shares held by members
immediately before the deconsolidation.
(3) The regulations thus presumed that items allocated to non-

loss shares resulted in a duplicated loss and therefore
tainted only those shares.
d. The basis of the subsidiarys shares held by members of the group

were adjusted immediately before the deconsolidation as follows:
(1) First, the basis of every loss share held by members of the
group was reduced, but not below its fair market value, by
the reallocable basis amount in a manner that caused the
ratio of the basis to the value of each such share to be the
same.
(2) Second, the basis of any preferred shares of the subsidiary

held by members of the group was increased, but not above
its fair market value, by the reallocable basis amount in a
manner that caused the ratio of the basis to the value of
each such share to be the same.
(3) Third, any remaining reallocable basis amount increased

the basis of all common shares of the subsidiary held by
members of the group in a manner that caused the ratio of
the basis to the value of each such share to be the same.
(4) Note that the problem identified above regarding

reallocation of basis when there is an aggregate ELA did
not appear to be present in the context of a deconsolidated
subsidiary. Because the basis of a loss share could not be
- 91 -
reduced below its fair market value, it would seem to

preclude allocation of a proportionate amount of an ELA.
e. Exceptions Under Prior Reg. 1.1502-35(b)(3)(ii), the basis

redetermination rule of Prior Reg. 1.1502-35(b)(2) did not apply
to a deconsolidation of a subsidiary member if:
(1) During the taxable year of such deconsolidation, in one or

more fully taxable transactions, the members of the group
disposed of all of the shares of the subsidiary member stock
to a nonmember;
(2) Such deconsolidation resulted from a fully taxable

disposition of some of the shares of the subsidiary member
to a nonmember, and during the taxable year of such
deconsolidation, members of the group were allowed a
worthless stock deduction under section 165(g) with
respect to all of the shares of the subsidiary member stock
that they own immediately after the deconsolidation; or
(3) The deconsolidation of the subsidiary member resulted

from the deconsolidation of a higher tier member and,
immediately after the deconsolidation of the subsidiary
member, none of the stock of the subsidiary member was
owned by a group member.
4. Lower Tier Subsidiaries If, immediately after the transfer or

deconsolidation of a subsidiary member, a lower tier subsidiary member,
some of the stock of which was owned by the subsidiary member, was a
member of the group, then for purposes of applying the basis
redetermination rules, the subsidiary member was treated as having
transferred its stock of the lower tier member. Prior Reg. 1.1502-35(b)
(4).
5. Basis Adjustments for Higher Tier Stock The basis adjustments made as
a result of the basis redetermination rule resulted in basis adjustments to
higher tier member stock. The adjustment was made from the lowest tier
to the highest. Prior Reg. 1.1502-35(b)(5).
6. Ordering Rules The investment adjustment rules of Reg. 1.1502-32

applied first; then the basis redetermination rules of Prior Reg. 1.1502-
35(b) applied (from lowest tier to highest tier, if applicable); then the loss
disallowance rules of Prior Reg. 1.337(d)-2 applied. Prior Reg.
1.1502-35(b)(6).
7. As discussed in section II above, the final Unified Loss Rules adopt a

much more limited basis redetermination rule. Reg. 1.1502-36(b).
Unlike the basis redetermination rule of Prior Reg. 1.1502-35, which
- 92 -
fully blended basis, the final basis redetermination rule in Reg. 1.1502-
36(b) only reallocates investment adjustments previously made to stock
basis. In addition, it only reduces the basis of loss shares that were
transferred, thus allowing the other shares to benefit fully from future
appreciation. 72 Fed. Reg. at 2978-79.
C. Loss Suspension Rule
1. General Rule If, after application of the basis redetermination rule, a

member of a consolidated group recognized a loss on the disposition of a
share of a subsidiary member, then such loss was suspended to the extent
of the duplicated loss with respect to such share of stock. Prior Reg.
1.1502-35(c)(1). The loss suspension rule applied only if, immediately
after the disposition of such share, the subsidiary remained a member of
the consolidated group. Id.
2. Duplicated Loss Duplicated loss was determined immediately after a

disposition and equaled the excess, if any, of (Prior Reg. 1.1502-35(d)(4)
(i)):
a. The sum of:
(1) The aggregate adjusted basis of the subsidiary members

assets, other than stock that a subsidiary member owned in
another subsidiary member, and
(2) Any losses attributable to the subsidiary member and

carried to the subsidiary members first taxable year
following the disposition, and
(3) Any deductions of the subsidiary member that had been

recognized but were deferred under a provision of the
Code; over
b. The sum of:
(1) The value of the subsidiary members stock, and
(2) Any liabilities of the subsidiary member that had been

taken into account for tax purposes.
c. The amounts computed in the loss duplication formula included

the subsidiary members share of corresponding amounts with
respect to lower-tier subsidiaries. Prior Reg. 1.1502-35(d)(4)(ii)
(A).
d. The duplicated loss formula was substantially identical to the one

contained in Prior Reg. 1.1502-20(c)(2)(vi), except that securities
- 93 -
of other members of the group were not excluded from the

computation of the subsidiarys aggregate asset basis.
e. Similarly, the Unified Loss Rules do not exclude securities of other

members of the group form the computation of net inside asset
basis.
3. Lower Tier Subsidiaries A special rule applied if a loss was recognized

on the disposition of a share of stock of a subsidiary member, but the loss
suspension rule otherwise would not apply because the subsidiary member
left the group. In that case, if the departing subsidiary member owned
stock of a lower-tier subsidiary member that remained a member of the
group after the disposition, then the loss was suspended to the extent the
duplicated loss of the departing member was attributable to the remaining
member. Prior Reg. 1.1502-35(c)(2).
4. Treatment of Suspended Loss A suspended loss was treated as a

noncapital, nondeductible expense of the member that disposed of
subsidiary member stock incurred during the taxable year that included the
date of the disposition of stock for purposes of Reg. 1.1502-32. As a
result, the basis of a higher tier members stock was reduced by the
suspended loss in the year it was suspended. Prior Reg. 1.1502-35(c)(3).
5. Reduction of Suspended Loss
a. The amount of suspended loss was reduced as the subsidiary

member subsequently recognized the duplicate deduction and loss
items. Specifically, the suspended loss was reduced, but not below
zero, by the subsidiary members items of deduction and loss, and
the subsidiary members allocable share of items of deduction and
loss of lower tier members, that were taken into account in
determining consolidated taxable income and were allocable to the
period beginning on the date of the disposition that gave rise to the
suspended loss and ending on the day the subsidiary ceases to be a
member of the consolidated group. Prior Reg. 1.1502-35(c)(4)
(i).
(1) The prior regulations presumed that all deductions and

losses were attributable to the duplicated loss that gave rise
to the suspended loss. However, the presumption was
rebuttable. If the taxpayer could establish that the item of
deduction or loss was not part of the duplicated loss, then
the taxpayer would not have to reduce its suspended loss.
Id.
(2) A suspended loss was also reduced by items of deduction

and loss of any successor to the subsidiary member. See
- 94 -
Prior Reg. 1.1502-35(c)(4). For this purpose, a successor

was defined as a transferee of assets in a transaction (i) to
which section 381(a) applied, (ii) in which substantially all
of the assets of the transferor were transferred to members
in a complete liquidation, (iii) in which the successors
basis in assets was determined (directly or indirectly, in
whole or in part) by reference to the transferors basis in
such assets, or (iv) which was an intercompany transaction,
but only with respect to assets that were being accounted
for by the transferor in a prior intercompany transaction.
Prior Reg. 1.1502-35(d)(5).
The prior temporary regulations also added a limitation on the reduction of a suspended loss that
was not contained in the proposed regulations. This limitation was included in the prior final
regulations as well.
(3) The amount of the reduction could not exceed the excess of
the amount of the subsidiary members items of deduction
and loss over the amount of such items that were taken into
account in determining the basis adjustments made to the
subsidiary members stock under Reg. 1.1502-32. Id.
(4) The reason for this limitation was to prevent the

disallowance of a tax loss for an economic loss. 68 Fed.
Reg. at 12,288. To address this concern, a general
statement was also added to clarify that the loss suspension
rule is not to be applied in a manner that permanently
disallows an otherwise allowable deduction for an
economic loss and permitting a proper adjustment in such
cases. Prior Reg. 1.1502-35(c)(8).
6. Allowance of Loss
a. To the extent not reduced, a suspended loss was allowed as a

deduction to the group when the subsidiary member (or any
successor) left the group or a worthless stock loss under section
165(g) was taken with respect to all of the subsidiary member
stock owned by members. Prior Reg. 1.1502-35(c)(5)(i)(A).
b. The Unified Loss Rules amended Prior Reg. 1.1502-35(c)(5) to

provide that, in any event, a suspended loss would be allowed after
10 years. Prior Reg. 1.1502-35(c)(5)(i)(B).
c. However, no adjustments could be made to the basis of the

subsidiary members stock under Reg. 1.1502-32 for a suspended
loss that was taken into account. Prior Reg. 1.1502-35(c)(5)(ii).
- 95 -
Such basis adjustments would already have been made at the time
the loss was suspended. See Prior Reg. 1.1502-35(c)(3).
d. The suspended loss was allowed only if the taxpayer filed a

statement of allowed loss with its tax return. Prior Reg. 1.1502-
35(c)(5)(iii).
7. Special Rule for Successor Assets If a member acquires an asset and the
basis of such asset was determined, directly or indirectly, in whole or in
part, by reference to the basis of stock of a subsidiary member, and at the
time of the acquisition there was duplicated loss in the stock of the
subsidiary member, then any loss recognized on the disposition of such
asset was suspended. Prior Reg. 1.1502-35(c)(6)(i), (ii). This rule did
not apply if the subsidiary member was not a member of the group
immediately after the disposition of the asset. Prior Reg. 1.1502-35(c)
(6)(iii).
8. Coordination With Other Deferral or Disallowance Rules
The loss suspension rules did not apply to a loss that was disallowed under any other provision
of the Code or regulations. Prior Reg. 1.1502-35(c)(7)(i).
If a loss was deferred under another provision, the loss suspension rules applied when the loss
would otherwise be taken into account under such other provision. However, if an overriding
event occurred before the deferred loss is taken into account, then the loss suspension rules
applied immediately before the event occurred. Id. An overriding event occurred if the stock
ceased to be owned by a member of the consolidated group, was canceled or redeemed, or was
treated as disposed of under Reg. 1.1502-19(c)(1)(ii)(B) (subsidiary became a nonmember) or
(c)(1)(iii) (worthlessness). Prior Reg. 1.1502-35(c)(6)(ii).
9. Ordering Rules The loss suspension rules applied only after the
investment adjustment rules of Reg. 1.1502-32, the basis
redetermination rules of Prior Reg. 1.1502-35(b), and the loss
disallowance rules of Prior Reg. 1.337(d)-2 applied. Prior Reg.
1.1502-35(c)(9).
D. Worthlessness and Dispositions Not Followed by Separate Return Years
1. General Rule Under Prior Reg. 1.1502-35(f), if stock of a subsidiary

member was treated as worthless under section 165 (taking into account
Reg. 1.1502-80(c)), or if a member of a group disposed of subsidiary
member stock and, on the following day, the subsidiary was not a member
of the group and did not have a separate return year (e.g., dissolution of an
insolvent subsidiary to which section 332 does not apply), then:
a. All losses treated as attributable to the subsidiary under Reg.

1.1502-21(b)(2)(iv) were taken into account in computing the
taxable income of the group, the subsidiary, and any carryback
- 96 -
group of which the subsidiary was previously a member for the

taxable year that includes the determination of worthlessness or the
disposition and any prior taxable year.
b. Any remaining losses not utilized were treated as expired, but not
absorbed by the group as of the beginning of the groups taxable
year that includes the determination of worthlessness or the
disposition. Thus, the losses deemed expired did not reduce basis
under Reg. 1.1502-32(b)(3)(iii), so a worthless stock deduction
was available with respect to the remaining basis.
c. Taxpayers expressed a concern that Prior Temp. Reg. 1.1502-

35T(f) could eliminate a subsidiarys losses even if the subsidiary
has a separate return year following the year the group claims the
worthless stock deduction. The Service and Treasury amended
Prior Temp. Reg. 1.1502-35T(f) to provide that the subsidiarys
losses were treated as expired only if a member claims a worthless
stock deduction and the subsidiary was a member of a group that
includes the member claiming the worthless stock deduction. Prior
Temp. Reg. 1.1502-35T(f)(1). This amendment was included in
the prior final regulations.
d. Example 22 Worthless Stock Deduction
P P
S shares
(1) $50
Bank S Bank S
(2) $100 Assets
$70 Value
$70 Basis
(1) Facts: In Year 1, P forms S by transferring $50 in exchange

for all of the S stock. S borrows $100 from Bank. S loses
$80, which is not utilized by the group. In Year 2, S
dissolves and transfers its assets (with a $70 value and
basis) to Bank.
- 97 -
(2) S has $30 of cancellation of indebtedness income and

reduces its $80 NOL by $30. As a result, there is no net
adjustment to Ps basis in its S stock.
(3) Because S has dissolved, P may claim a worthless stock

deduction with respect to the S stock. Ss remaining NOL
disappears under Prior Reg. 1.1502-35(f).
(4) What if S remains in existence and simply ceases doing

business?
(a) P would be precluded from claiming a worthless

stock deduction because S has not yet disposed of
substantially all of its assets. See Reg. 1.1502-
80(c).
(b) Reg. 1.1502-80(c) was promulgated in part to

prevent the duplicated loss rule of Prior Reg.
1.1502-20(c)(2)(vi) from eliminating the benefit
of the worthless stock deduction. Given the
elimination of the Prior Reg. 1.1502-20(c) loss
duplication rule, taxpayers have questioned whether
Reg. 1.1502-80(c) remains necessary. In the
preamble to amendments to Reg. 1.1502-80(c),
the Service and Treasury indicated that they are
evaluating this issue. 69 Fed. Reg. at 12,800.
2. Proposed Regulations This rule differed from the proposed regulations,

which required the reduction of the basis of the subsidiary stock by the
amount of any loss carryforwards attributable to the subsidiary under Reg.
1.1502-21.
a. The reason for the rule was to prevent taxpayers from taking the
position that a group is entitled to a subsidiary members loss
carryforwards even after the group has enjoyed full basis recovery
through a worthless stock or other deduction.
b. Commentators contended that the basis reduction rule could deny a

group a single tax loss for its economic loss. The revision made in
the temporary regulations (and retained in the final regulations)
was intended to address this. See 68 Fed. Reg. at 12,288.
3. Special Transition Election in Prior Temporary Regulations
a. Because of the change in the rule, the temporary regulations

provided a special transition rule. If stock of a subsidiary member
was treated as worthless between March 7, 2002 and March 14,
2003, or if a member of the group disposed of a subsidiary member
- 98 -
during this period and, on the following day, the subsidiary was not
a member of the group and did not have a separate return year,
then the common parent may make an irrevocable election to
reattribute to itself all or any portion of the losses treated as
attributable to the subsidiary member under Reg. 1.1502-21(b)(2)
(iv). Prior Temp. Reg. 1.1502-35T(f)(2).
b. The reattributed losses were treated as absorbed by the group

immediately before the allowance of any loss or inclusion of any
income or gain with respect to the determination of worthlessness
or the disposition. Prior Temp. Reg. 1.1502-35T(f)(2).
4. The Unified Loss Rules treat worthlessness under Reg. 1.1502-80(c) as a

transfer of a loss share. Accordingly, the general rules of the Unified Loss
Rules apply.
a. The basis redetermination rule does not apply if all of the

subsidiarys shares held by members become worthless under Reg.
1.1502-80(c) in one taxable transaction. Reg. 1.1502-36(b)(1)
(ii)(B).
b. The basis reduction rule applies normally; there are no special

rules regarding worthless stock deductions. See Reg. 1.1502-
36(c).
c. The attribute reduction rule contains a special worthless stock rule.

If any attributes remain after application of the attribute reduction
rule, they are eliminated if:
(1) A member transfers a share of subsidiary stock solely by

reason of its worthlessness and the provisions of Reg.
1.1502-80(c) are satisfied; the member recognizes a net
deduction or loss; and the subsidiary continues to be a
member of the group; or
(2) The member recognizes a net deduction or loss in a

transaction in which the subsidiary ceases to be a member
and does not become a nonmember (i.e., does not have a
separate return year).
E. Anti-Avoidance Rules
1. Transfer of Share Without Loss in Avoidance If a non-loss share of

subsidiary member stock was transferred with a view to avoiding the
application of the basis redetermination rules prior to the transfer of loss
stock, or a deconsolidation, of such subsidiary, then the basis
redetermination rule applied immediately prior to the transfer of the non-
loss stock. Prior Reg. 1.1502-35(g)(1).
- 99 -
2. Transfer of Loss Property in Avoidance
a. If a member of a consolidated group contributed a built-in loss

asset to a partnership in a section 721 transaction or to a
nonmember in a section 351 transaction, and such partnership or
corporation contributed such asset to a subsidiary member in a
section 351 transaction, and such contributions were undertaken
with a view to avoiding the basis redetermination or loss
suspension rule, then adjustments had to be made to carry out the
purposes of the regulations. Prior Reg. 1.1502-35(g)(2).
b. Example 23 Transfer of Property to Avoid Basis Redetermination

Rule
(6)
PS Interest
P P P P Y
(3) $40
100 (2) (4) $80 PS Interest
$100
20
shares shares
PS Interest Asset A
$20 Value
S stock $50 Basis
S S S
P S P P
S S
(5) $20 S
Asset A
(4) Asset A X
(1) Facts: In Year 1, P forms S by transferring $100 in

exchange for 100 shares of S stock, which is all of the
outstanding stock of S. In Year 2, P contributes the 20
shares of S common stock to a partnership, PS, in exchange
for a 20-percent partnership interest. S remains a member
of the P group. In Year 3, P transfers Asset A, with a value
of $20 and a basis of $50, to PS in exchange for an
additional partnership interest. Also in Year 3, PS
contributes Asset A to S, and P contributes an additional
$80 to S. In Year 4, S sells Asset A to X for $20,
recognizing a loss of $30, and P sells its interest in PS to Y
for $40, recognizing a loss of $30.
(2) If Ps contributions of S stock and Asset A to PS were

undertaken with a view to avoiding the basis
redetermination rule or the loss suspension rule, then
adjustments must be made such that the group does not
- 100 -
obtain more than one tax benefit from the $30 loss inherent
in Asset A. Prior Reg. 1.1502-35(g)(5), Ex. 1.
3. Anti-Loss Reimportation
a. If the consolidated group was allowed a loss from the sale of

subsidiary stock, and the subsidiary was deconsolidated, the
subsidiarys duplicate inside loss may not be reimported within 10
years of the deconsolidation. Prior Reg. 1.1502-35(g)(3)(i).
b. Loss reimportation could occur in a number of ways:
(1) The subsidiary member (or any successor) re-joined the

consolidated group while it still owned the loss asset or any
asset whose basis reflects the basis of the loss asset. Prior
Reg. 1.1502-35(g)(3)(i)(B)(1), (2).
(2) A member of the consolidated group acquired the loss

asset, or any asset whose basis reflected the basis of the
loss asset, from the subsidiary member (or any successor)
in a section 381 or 351 transaction. Prior Reg. 1.1502-
35(g)(3)(i)(B)(3).

consolidated group while it had a liability that it had on the
date of the disposition and such liability would give rise to
a deduction. Prior Reg. 1.1502-35(g)(3)(i)(B)(4).
(4) A member of the consolidated group assumed a liability

that was a liability of the subsidiary member (or any
successor) on the date of the disposition in a section 381 or
351 transaction. Prior Reg. 1.1502-35(g)(3)(i)(B)(5).

consolidated group while it had losses or deferred
deductions that (i) it had on the date of the disposition,
(ii) were attributable to an asset owned on the date of the
disposition or an asset whose basis is reflected in the basis
of such asset, or (iii) were attributable to a liability (within
the meaning of section 358(h)(3)) that it had on the date of
the disposition. Prior Reg. 1.1502-35(g)(3)(i)(B)(6)-(9).
(a) For this purpose, any losses and deductions or

assets of the subsidiary were presumed to have
existed on the date of the disposition. However,
such presumption was rebuttable. Prior Reg.
1.1502-35(g)(3)(ii)(B), (C).
- 101 -
(6) A member of the consolidated group succeeded to any

losses or deferred deductions described in (5). Prior Reg.
1.1502-35(g)(3)(i)(B)(10)
(7) Any losses or deferred deductions described in (5) were

carried back to a pre-disposition taxable year of the
subsidiary. Prior Reg. 1.1502-35(g)(3)(i)(B)(11).
c. If a loss was reimported, then the group is denied the use of:
(1) Any loss recognized that was attributable to a built-in loss

asset, or any asset whose basis reflected the basis of the
loss asset, that was owned by the subsidiary (or any
successor) on the date of the disposition to the extent of the
lesser of (i) the loss inherent in such asset on the date of the
disposition, or (ii) the loss inherent in such asset on the date
of the reimportation. Prior Reg. 1.1502-35(g)(3)(iii)(A),
(B).
(2) Any loss or deduction described in paragraphs (3) through

(7), above. Prior Reg. 1.1502-35(g)(3)(iii)(C), (D).
However a loss or deduction described in paragraph (6),
above, could be carried forward to a post-disposition
taxable year of the subsidiary. Prior Reg. 1.1502-35(g)(3)
(iii)(D).
d. A loss or deduction that was disallowed under the anti-loss

reimportation rule was treated as a noncapital, nondeductible
expense incurred during the taxable year that such loss would
otherwise be absorbed for purposes of Reg. 1.1502-32(b)(3)(iii)
and, thus, resulted in a downward basis adjustment. Prior Reg.
1.1502-35(g)(3)(iv).
e. The effective date of the anti-loss reimportation rule was different

from the effective date of the prior regulation as a whole. The anti-
loss reimportation rule applied to losses reimported as a result of
an event that occurred on or after October 18, 2002.
- 102 -
f. Example 24 Loss Reimportation
(2) (5)
S Stock M/S Stock
P X X P X
$240 $300
(1) Asset A
S Stock $100 Value (3) (5)
$120 Basis (4) Asset A Asset D
Asset B Merge S M/S Z
S M Y
$50 Value
$70 Basis $100 $20
Asset C $10 NOL
$90 Value Asset C
$100 Basis $80 Value
$100 Basis
Asset D
$60 Value
$70 Basis
(1) Facts: In Year 1, P forms S by transferring Asset A, with a

value of $100 and a basis of $120, Asset B, with a value of
$50 and a basis of $70, and Asset C, with a value of $90
and a basis of $100, in exchange for 100 shares of S1
common stock. In Year 2, P sells the stock of S to X for
$240, recognizing a $50 loss. In Year 3, S sells Asset A to
Y, recognizing a $20 loss. Also in Year 3, S merges into M
in a section 368(a)(1)(A) reorganization.
In Year 8, P purchases all of the stock of M for $300. At

that time, M has a $10 NOL. In addition, M owns Asset D,
which was acquired in exchange for Asset B in a section
1031 exchange. Asset C has a value of $80 and a basis of
$100, and Asset D has a value of $60 and a basis of $70. In
Year 9, P has operating income of $50, and M recognizes
$20 loss on the sale of Asset C. In Year 10, P has operating
income of $50, and M recognizes a $50 loss on the sale of
Asset D.
(2) Ps $50 loss was attributable to a duplicated loss and, thus,

may not be reimported for 10 years. M is a successor to S,
and its $10 NOL is presumed to be attributable to assets
owned by S on the date of Ps disposition of S. Provided
that P cannot rebut the presumption, the P group will not be
able to use Ms $10 NOL. Such loss will, however, result
- 103 -
in a reduction in Ps basis in its M stock during the taxable

year that it would otherwise be absorbed (i.e., year 9). Reg.
1.1502-32(b)(3)(iii)(D).
(3) In addition, the P group will be denied $10 of the loss

recognized on the sale of Asset C (i.e., the lesser of the $10
built-in loss on the date of Ps disposition of S and the $20
built-in loss on the date of the reimportation). The P group
will also be denied $10 of the loss recognized on the sale of
Asset D (i.e., the lesser of the $20 built-in loss in Asset B,
the predecessor to Asset D, on the date of Ps disposition of
S and the $10 built-in loss on the date of the reimportation).
Each disallowed loss will result in a reduction in Ps basis
in its M stock during the taxable year that includes the date
of the disposition of the asset with respect to which the loss
was recognized. Prior Reg. 1.1502-35(g)(5), Ex. 2.
4. Revised Anti-Loss Reimportation Rule
a. On April 10, 2007, the Service and Treasury released temporary

regulations that revised the anti-loss reimportation rule that applied
following a disposition of a stock of a subsidiary at a loss for
corporations filing consolidated returns. 72 Fed. Reg. 17804 (Apr.
10, 2007).
b. The temporary regulations revised Prior Reg. 1.1502-35(g)(3) to

clarify that losses reflected in the basis of subsidiary stock at the
time of deconsolidation could not be recognized and reimported
into the group, regardless of whether the stock losses were
recognized when the subsidiary is a member of the group. 72 Fed.
Reg. 17804, 17805 (Apr. 10, 2007). Specifically, under Prior
Temp. Reg. 1.1502-35T(g)(3), immediately before the time that a
reimported item (or any portion of a reimported item) would be
properly taken into account, such item (or such portion of the item)
was reduced to zero and no deduction or loss was allowed, directly
or indirectly, with respect to that item. See Prior Temp. Reg.
1.1502-35T(g)(3)(ii).
c. The anti-loss reimportation rule was also revised to replace the list
of events that caused the application of the rule with a list of
criteria that identify reimportation transactions that would be
treated as subject to the rule. 72 Fed. Reg. 17804 (Apr. 10, 2007).
Specifically, Prior Temp Reg. 1.1502-35T(g)(3) applied when:
(1) a member of a group (the selling group) recognized and

was allowed a loss with respect to a share of stock of S, a
subsidiary or former subsidiary of the selling group;
- 104 -
(2) the stock loss was duplicated (in whole or in part) in Ss

attributes (duplicating items) at the earlier of the time that
the loss was recognized or that S ceased to be a member;
(3) within ten years of the date that S ceased to be a member,

there was a reimportation event (defined for this purpose as
any event after which a duplicating item is a reimported
item). A reimported item was any duplicating item that was
reflected in the attributes of any member of the selling
group, including S, or, if not reflected in the attributes,
would be properly taken into account by any member of the
selling group.
(4) The temporary regulations that revised the anti-loss

reimportation rule applied to reimportation events that
occurred on or after April 10, 2007 if they occurred with
respect to stock of a subsidiary sold on or after March 7,
2002, or with respect to stock of a subsidiary or former
subsidiary sold on or after April 10, 2007. See Prior Temp.
Reg. 1.1502-35T(g)(3)(i).
5. Avoidance of Gain Recognition
a. If a transaction was structured with a view to, and had the effect of,
deferring or avoiding the recognition of gain on a disposition of
stock by invoking the basis redetermination rule, and the stock loss
that gave rise to the application of the basis redetermination rule
was not significant, then the basis redetermination and loss
suspension rules applied. Prior Reg. 1.1502-35(g)(4). No
definition was provided for the phrase not significant.
b. This anti-abuse rule was added in the prior temporary regulations

in response to comments that the basis redetermination rule could
be used to shift the location of gain and loss within the
consolidated group in a manner unintended by the proposed
regulations. See 68 Fed. Reg. at 12,289. The prior final
regulations maintained the same anti-abuse rule.
c. Example 25 Transfers to Avoid Gain Recognition

(2)
S2 Stock
P X
$500
$500 Value
$400 Basis
S1 (1) S2
S3 Preferred
50% Common
$200 Value
50% Common $100 Basis
$150 Basis Preferred
S3 S3 Common $9 Value
$10 Basis
- 105 -
(1) Facts: P owns all of the stock of S1 and S2. The S2 stock
has a value of $500 and a basis of $400. S1 owns 50
percent of the S3 common stock, with a basis of $150. S2
owns the remaining S3 common stock, with a value of
$200 and a basis of $100 and one share of S3 preferred
stock, with a value of $9 and a basis of $10. P, intending to
sell the S2 stock without recognizing a substantial portion
of the built-in gain, causes a recapitalization of S3 in which
S2s common stock in S3 is exchanged for new S3
preferred stock. P then sells the S2 stock.
(2) Because S2 owns stock of S3, which remains a member of

the P group, S2 is deemed to have transferred the S3 stock,
including the one share of built-in loss stock. As a result,
the basis redetermination rule applies, and the aggregate
basis of S3 stock is allocated first to the S3 preferred shares
held by S2 up to their value of $209 and then to the S3
common share held by S1. Thus, S2s basis in the S3
preferred stock is increased from $110 to $209. This tiers
up and increases Ps basis in the S2 stock from $400 to
$499. Accordingly, P will recognize gain of only $1 on the
sale of S2.
(3) However, because the recapitalization of S3 was structured

with a view to, and has the effect of, avoiding the
recognition of gain by invoking the basis redetermination
rule, Prior Temp. Reg. 1.1502-35T(g)(4) applies to turn
off the basis redetermination rule. Thus, P recognizes $100
gain on the disposition of S2 stock. Prior Reg. 1.1502-
35(g)(5), Ex. 3.
(1) What if the stock loss giving rise to the application of the
basis redetermination rule were not merely $1? How much
loss is necessary before it becomes significant?
6. Other Anti-Abuse Rules The rules of Prior Reg. 1.1502-35 did not
preclude the application of anti-abuse rules under other provisions of the
Code and Regulations thereunder. Prior Reg. 1.1502-35(h).
- 106 -
7. General Anti-Avoidance Rule
a. The prior temporary regulations that revised the anti-loss

reimportation rule also added a general anti-avoidance rule under
Prior Temp. Reg. 1.1502-35T(g)(6), which provided that
appropriate adjustments would be made if a taxpayer acted with a
view to avoid the purposes of Prior Reg. 1.1502-35. 72 Fed.
Reg. 17804, 17805 (Apr. 10, 2007).
b. The general anti-avoidance rule under Prior Temp. Reg. 1.1502-

35T(g)(6) applied on or after April 10, 2007. See Prior Temp. Reg.
1.1502-35T(j)(2)(i).
- 107 -
V. EXAMPLES APPLYING THE UNIFIED LOSS RULES AND LOSS

DISALLOWANCE AND DUPLICATION RULES
A. Basis Redetermination Examples
1. Example 26 Basis Redetermination To Prevent Non-Economic Loss
(2)
1 Block 1 Share
Asset 1 Asset 2 Block 1 Asset 2 P Z
$80 Basis P $0 Basis 4 Shares P $0 Basis
$20
$80 Value $20 Value $20/sh Basis $20 Value
Block 1 Block 2
Asset 1 Block 1 Asset 2 Block 2

4 shares (1)
1 share
Asset 2
S X
$20
S S Asset 1 Asset 2
$80 Basis $0 Basis
$80 Value $20 Value
Asset 1
$80 Basis
$80 Value
a. Facts: P owns two assets, Asset 1 and Asset 2. On January 1, Year

1, P receives four shares of S common stock (the Block 1 shares)
in exchange for Asset 1, which has a basis and value of $80. The
exchange qualifies under section 351 and, therefore, under section
358, Ps aggregate basis in the Block 1 shares is $80 ($20 per
share). On July 1, Year 1, P receives another share of S common
stock (the Block 2 share) in exchange for Asset 2, which has a
basis of $0 and value of $20. This exchange also qualifies as a
section 351 exchange and, under section 358, Ps basis in the
Block 2 share is $0. Ps Block 1 and Block 2 shares are the only
outstanding shares of S stock. On October 1, Year 1, S sells Asset
2 for $20. On December 31, Year 1, P sells one of its Block 1
shares for $20.
b. Ps basis in each Block 1 share is $24 (Ps original $20 basis

increased under Reg. 1.1502-32 by $4, the shares allocable
portion of the $20 gain recognized on the sale of Asset 2). In
addition, Ps basis in its Block 2 share is $4 (Ps original $0 basis
increased under Reg. 1.1502-32 by $4 (the shares allocable
portion of the $20 gain recognized on the sale of Asset 2)). Ps
sale of the Block 1 share is a transfer of a loss share.
- 108 -
c. Application of Unified Loss Rules:
(1) Ps bases in all its shares of S stock are subject to

redetermination. Under Reg. 1.1502-36(b)(2)(i)(A), Ps
basis in the transferred loss share is reduced, but not below
value, by removing PIAs applied to the basis of the share.
Accordingly, Ps basis in the transferred Block 1 share is
reduced by $4 (the amount of the PIA applied to the share),
from $24 to $20. No further reduction to the basis of the
share is required because the basis of the share is then equal
to value. Reg. 1.1502-36(b)(3), Ex. 1(i).
(2) The PIA removed from the transferred loss share is

reallocated and applied to increase Ps bases in its S shares
in a manner that reduces basis disparity to the greatest
extent possible. Reg. 1.1502-36(b)(2)(ii)(B).
Accordingly, the $4 PIA removed from the Block 1 share is
reallocated and applied to the basis of the Block 2 share,
increasing it from $4 to $8. Id.
(3) After the application of the basis redetermination rule, the

Block 1 share is no longer a loss share, so the basis
reduction rule of Reg. 1.1502-36(c) and the attribute
reduction rule of Reg. 1.1502-36(d) do not apply. Id.
d. Application of Prior Rules:
(1) Because the sale of the Block 1 share is the transfer of a

loss share that does not result in a deconsolidation, the
basis redetermination rule of Prior Reg. 1.1502-35(b)(1)
would apply.
(2) The group members aggregate bases of $100 is allocated in

proportion to the fair market value of the common shares,
or $20 per share. Thus, the sale results in no gain or loss.
- 109 -
2. Example 27 Basis Redetermination To Prevent Duplicated Loss
(2)
1 Block 1 Share
Asset 1 Asset 3 Block 1 Asset 3 P Z
$80 Basis P $5 Basis 4 Shares P $5 Basis
$5
$80 Value $5 Value $20/sh Basis $5 Value
Block 1 Block 2
Asset 1 Block 1 Asset 3 Block 2

4 shares (1)
1 share
Asset 1
S X
$20
S S Asset 1 Asset 3
$80 Basis $5 Basis
$20 Value $5 Value
Asset 1
$80 Basis
$20 Value
a. Facts: The facts are the same as above, except that, at the time of
the second contribution, the value of Asset 1 had declined to $20
and so, instead of contributing Asset 2, P contributed Asset 3 to S
in exchange for the Block 2 share. At the time of that exchange,
Asset 3 had a basis and value of $5. On October 1, Year 1, S sells
Asset 1 for $20, recognizing a $60 loss that is absorbed by the
group. On December 31, Year 1, P sells one of its Block 1 shares
for $5.

decreased under Reg. 1.1502-32 by $12, the shares allocable
portion of the $60 loss recognized on the sale of Asset 1). Ps basis
in its Block 2 share is an excess loss account of $7 (its original
basis of $5 reduced by $12, the shares portion of the loss
recognized on Asset 1). Ps sale of the Block 1 share is a transfer
of a loss share.

redetermination. Ps basis in the transferred Block 1 share
is reduced, but not below value, by reallocating negative
investment adjustments from shares that are not transferred
loss shares. See Reg. 1.1502-36(b)(2)(i)(B). In total,
there were $48 of negative investment adjustments applied
to shares that are not transferred loss shares. Accordingly,
- 110 -
Ps basis in the Block 1 share is reduced by $3, from $8 to

its value of $5. Reg. 1.1502-36(b)(2), Ex. 1(ii).
(2) The negative investment adjustments applied to the

transferred share are reallocated from (and therefore cause
an increase in the basis of) S shares that are not transferred
loss shares in a manner that reduces basis disparity to the
greatest extent possible. See Reg. 1.1502-36(b)(2)(i)(B).
Thus, the $3 negative investment adjustment reallocated
and applied to the transferred Block 1 share is reallocated
entirely from the Block 2 share, increasing the basis in the
Block 2 share from an excess loss account of $7 to an
excess loss account of $4. Id.
(3) Because the Block 1 share is no longer a loss share, the

basis and attribute reduction rules of Reg. 1.1502-36(c)
and (d) are not applicable. Id.
(1) Because the sale of the Block 1 share is the transfer of a

loss share that does not result in a deconsolidation, the
basis redetermination rule of Prior Reg. 1.1502-35(b)(1)
would apply.

3. Example 28 Increase In Basis of Transferred Loss Share
(2)
1 Block 1 Share
1 Block 2 Share
P X
$10 / share
Block 1
5 Shares
$20 Basis/Share
Block 2
5 shares
$10 Basis/Share (1)
Asset 1
S Z
$100
Asset 1
$50 Basis
- 111 -
a. Facts: On January 1, Year 1, P owns all 10 outstanding shares of S

common stock. Five of the shares have a basis of $20 per share
(the Block 1 shares) and five of the shares have a basis of $10 per
share (the Block 2 shares). Ss only asset, Asset 1, has a basis of
$50. S has no other attributes. On October 1, Year 1, S sells Asset
1 for $100. On December 31, Year 2, S sells one Block 1 share and
one Block 2 share to X for $10 per share.

increased under Reg. 1.1502-32 by $5 (the shares allocable
portion of the $50 gain recognized on the sale of Asset 1)), and Ps
basis in each Block 2 share is $15 (Ps original $10 basis increased
by $5). Ps sale of the Block 1 and Block 2 shares is a transfer of
loss shares.

redetermination. Ps basis in the transferred Block 1 and
Block 2 shares is reduced, but not below value, by
removing the PIAs applied to the bases of the transferred
loss shares. See Reg. 1.1502-36(b)(2)(i)(A).
Accordingly, the basis of the Block 1 share is reduced by
$5, from $25 to $20. The basis of the Block 2 share is also
reduced by $5, from $15 to $10. (Although the Block 1
share is still a loss share, there is no reduction to its basis
under Reg. 1.1502-36(b)(2)(i)(B) because there were no
negative investment adjustments to shares that are not
transferred loss shares). Reg. 1.1502-36(b)(2), Ex. 2.
(2) The $10 of PIAs removed from the transferred loss shares
are reallocated and applied to increase Ps bases in its S
shares in a manner that reduces basis disparity to the
greatest extent possible. See Reg. 1.1502-36(b)(2)(ii)(B).
Accordingly, of the $10 PIAs to be reallocated, $6 is
reallocated and applied to the basis of the Block 2 share
(increasing it from $10 to $16) and $4 is reallocated and
applied equally to the basis of each of the four retained
Block 2 shares (increasing the basis of each from $15 to
$16). Ps basis in each retained Block 1 share is $25, Ps
basis in the transferred Block 1 share is $20, and Ps basis
in each Block 2 share, including the transferred Block 2
share, is $16. Reg. 1.1502-36(b)(2), Ex. 2.
(3) Because the Block 1 and Block 2 shares are still loss shares
after application of the basis redetermination rule, they are
subject to the basis reduction rule of Reg. 1.1502-36(c).
- 112 -
Under Reg. 1.1502-36(c), there is no adjustment to the

Block 1 share because the net PIA is $0. However, the
basis of the Block 2 share is reduced by $6 (the lesser of its
net PIA and its disconformity amount). Id.
(4) Because the Block 1 share is still a loss share after

application of the basis reduction rule, it is subject to the
attribute reduction rule of Reg. 1.1502-36(d). Under Reg.
1.1502-36(d), no adjustment is required because there is
no aggregate inside loss. Id.
(1) Because the sale of the Block 1 and Block 2 shares are
transfers of loss shares that do not result in a
deconsolidation, the basis redetermination rule of Prior
Reg. 1.1502-35(b)(1) would apply.

4. Example 29 No Investment Adjustments; Basis Redetermination Under

Prior Rules But Not Unified Loss Rules
$100 Basis $120 Basis
(2)
S3 Preferred
S1 S2 X
S3 (1) S3
Common Preferred $20
$100 Asset A
$20 Value
S3 $50 Basis
a. Facts: P owns all of the stock of S1, with a value of $130 and a
basis of $100, and S2, with a value of $90 and a basis of $120. In
Year 1, S1 and S2 form S3. S1 contributes $100 cash to S3 in
exchange for all of the S3 common stock. S2 contributes Asset A,
with a value of $20 and a basis of $50 in exchange for all of the
- 113 -
preferred stock of S3. In Year 3, S2 sells the S3 preferred stock to

X for $20, and S3 remains a member of the P group.
b. Application of Unified Loss Rules:
(1) Neither the basis redetermination rule of Reg. 1.1502-

36(b) nor the basis reduction rule of Reg. 1.1502-36(c)
would apply because there have been no positive or
negative investment adjustments.
(2) However, the attribute reduction rule of Reg. 1.1502-

36(d) would result in a $30 reduction in S3s attributes.
Thus, the final Unified Loss Rules permit S2s loss upfront
at the expense of S3s later loss on its assets. Note that P
may make an election to further reduce the S2 stock basis
to avoid the application of the attribute reduction rule.
c. Application of Prior Rules:
(1) Because S2s basis in the S3 preferred stock exceeds its

value, the basis redetermination rule applies. Of the group
members total bases of $150 in the S3 stock, $20 is
allocated to the preferred stock (i.e., the fair market value
of the preferred stock on the date of the sale), and the
remaining $130 is allocated to the common stock. Thus,
S2s sale results in the recognition of no gain or loss. Prior
Reg. 1.1502-35(b)(1) & (e), Ex. 1.
(2) The redetermination of S1 and S2s bases in the stock of S3

results in adjustments to Ps basis in the S1 and S2 stock.
Specifically, Ps basis in the S1 stock is increased by $30 to
$130, and its basis in the S2 stock is decreased by $30 to
$90. Prior Reg. 1.1502-35(b)(5) & (e), Ex. 1.
d. What if, prior to S2s sale of the S3 preferred stock, S3 had

borrowed $500 and suffered an operating loss of $600? The loss
would be allocated to the S3 common stock held by S1, see Reg.
1.1502-32(c)(1), which would result in a ($500) ELA in the S3
common stock held by S1.
(1) Under the Unified Loss Rules, S1s negative $600

investment adjustment would be reallocated to the
transferred loss shares to the extent necessary to eliminate
S2s loss. Reg. 1.1502-36(b).
(2) Under the prior loss duplication rules, it is not clear how
the basis redetermination rules would apply in the situation
where the aggregate basis is negative.
- 114 -
(a) Applying the language of the regulations, the

aggregate ($450) ELA must be allocated first to the
preferred shares in proportion to, but not in excess
of, their value. Any remaining basis is allocated to
the common shares. Prior Reg. 1.1502-35(b)(1).
(b) There appear to be two ways to interpret this

language.
(i) First, since an ELA is treated as negative

basis for all federal income tax purposes,
Reg. 1.1502-19(a)(2)(ii), the preferred
stock could take a proportionate share of the
ELA. Arguably, the entire ELA is allocated
to the preferred stock, because the ELA will
always be less than the fair market value of
the stock. The entire ELA would be
triggered upon the sale of the preferred
stock.
(ii) Second, one could argue that the basis

redetermination rule was intended only to
reallocate positive basis. Under this
interpretation, only S2s positive basis
would be reallocated $20 to the preferred
stock (i.e., equal to its value) and the
remaining $30 to the common stock. Thus,
S2 would recognize no gain or loss on the
sale of the preferred stock, and S1s ELA in
the common stock would be reduced to
($470).
5. Example 30 Partial Duplicated Loss Allowed Under Prior Rules But Not
Unified Loss Rules
Year 3 1 Share
Year 1
P X
P
$20
4 Shares 1 Share
Asset A $20 Value $20 Value
$20 Value $20 Basis $50 Basis
S share
$50 Basis
S S
Asset A
$20 Value
$50 Basis
- 115 -
a. Facts: P owns four shares of the common stock of S with a value

and basis in each of $20. In Year 1, P contributes Asset A, with a
value of $20 and a basis of $50, to S in exchange for one additional
share of S common stock. In Year 3, P sells the new share to X for
$20, claiming a loss of $30.


36(d) would result in a $30 reduction in Ss attributes.
Thus, the final Unified Loss Rules permit Ps loss upfront
at the expense of Ss later loss on Asset A. Note that P may
make an election to further reduce the S stock basis to
avoid the application of the attribute reduction rule.
(1) Because Ps basis in the new share exceeds its value, the
basis redetermination rule applies. The total basis of $130
is allocated $26 to each share of S stock. As a result, P
recognizes loss of $6 on the sale of the new share.
(2) S can still sell Asset A at a $30 loss. P has thus been able to
duplicate $6 of loss.27
6. Example 31 No Deconsolidation; Economic Loss Disallowed Under

Prior Rules But Not Under Unified Loss Rules
1 Share
P X
$20
4 Shares 1 Share
$20 Value $20 Value
$0 Basis $50 Basis
27
Note that Ps $6 loss would not be suspended under the loss suspension rules, because
S has no overall duplicated loss.
- 116 -
Assets
$100 Value
$0 Basis
a. Facts: P owns five shares of common stock of S, four of which

have a value of $20 and a basis of $0 and one of which has a value
of $20 and a basis of $50. Ss assets have a value of $100 and a
basis of $0. P sells the loss share to X for $20, claiming a loss of
$30.

(2) In addition, the attribute reduction rule of Reg. 1.1502-

36(d) does not apply because Ss net inside attribute
amount is $0. Thus, Ps economic loss is allowed without
any reduction in Ss attributes.
- 117 -
(1) Because Ps basis in the sold share exceeds its value, the
basis redetermination rule applies. The total basis of $50 is
allocated $10 to each share of S stock.
(2) As a result, P recognizes gain of $10 on the sale of the new

share, notwithstanding the fact that S has no duplicated loss
because its inside asset basis is $0.
7. Example 32 Deconsolidation; Economic Loss Disallowed Under Prior

Rules But Not Under Unified Loss Rules
Year 1 Year 3 Year 4
Old Share
P
P P Y
New $50
Old (1) New $100 $150 Basis
Share $200 Share Old
$50 Basis
(2)
Asset A S S
S X
Asset A Asset A
$200 $100 Value $100 Value
a. Facts: In Year 1, P forms S by contributing $200 for one share of

common stock. S buys Asset A for $200, which subsequently
declines in value to $100. In Year 3, P contributes $100 to S in
exchange for one new share of S common stock. S loses the $100,
which results in a reduction of basis of $50 each for the old S share
and new S share. In Year 4, P sells the old S share to Y for $50,
recognizing a $100 loss.
(1) The transfer of Ss old share results in a deconsolidation of

S; accordingly, all of Ss shares are treated as transferred.
See Reg. 1.1502-36(f)(10)(i)(B).
(2) The basis redetermination rule of Reg. 1.1502-36(b) does

not apply because there have been no PIAs, and there are
no non-transferred shares from which negative adjustments
may be reallocated.
- 118 -
(3) In addition, the basis reduction rule of Reg. 1.1502-36(c)

does not apply because there have been no PIAs.

36(d) would result in a $100 reduction in Ss attributes,
which is the lesser of Ss aggregate stock loss of $100 and
Ss net inside attribute amount of $100. Thus, the final
Unified Loss Rules permit Ps loss upfront at the expense
of Ss later loss on Asset A. Note that P may make an
election to further reduce the S stock basis to avoid the
application of the attribute reduction rule.
(1) Immediately before Ss deconsolidation, the reallocable

basis amount is $50 (the lesser of $100, the gross loss
inherent in the loss share, and $50, the aggregate amount of
Ss items of deduction and loss that were previously taken
into account in adjusting the basis of the non-loss shares).
Thus, Ps basis in the old S share is reduced by $50 and its
basis in the new share is increased by $50.
(2) As a result, P recognizes a $50 loss on the sale of the old

share, notwithstanding the fact that P suffered an economic
loss of $100 resulting from the decline in the value of Asset
A.
8. Example 33 Basis Redetermination to Eliminate an ELA
(2)
S3 Preferred
S1 S2 X
(1) S3 $20
$100 Value Preferred
($10) Basis
Asset A
S3 $20 Value
$50 Basis
a. Facts: P owns all of the stock of S1 and S2. In Year 1, S1

contributes an asset with a basis and value of $50 to S3. The asset
increases in value to $100, and S3 generates operating losses of
$60, which are used by the P group, resulting in a ($10) ELA. In
Year 4, S2 contributes Asset A, with a value of $20 and a basis of
- 119 -
$50 to S3, in exchange for S3 preferred stock. In Year 5, S2 sells

the S3 preferred stock to X for $20, recognizing a $30 loss.
(1) $30 of the negative investment adjustments resulting in

S1s ELA would be reallocated to S2s stock in S3 under
the basis redetermination rule, thus reducing S2s basis to
$20 and resulting in no gain or loss on the sale. As a result
of the reallocation, S1s ($10) ELA is increased to $20
positive basis. See Reg. 1.1502-36(b).
(1) Because S2s basis in the S3 preferred stock exceeds its

value, the basis redetermination rule applies. Of the group
members total bases of $40 in the S3 stock, $20 is
allocated to the preferred stock (i.e., the fair market value
of the preferred stock on the date of the sale), and the
remaining $20 is allocated to the common stock. Similar to
the Unified Loss Rules, although S2s sale results in the
recognition of no gain or loss, S1s ELA has been
eliminated.
B. Basis Reduction Examples
Note that the following examples involve no basis redetermination under Reg.
1.1502-36(b) either because members hold only one share of S stock, so
redetermination would not change any members basis, or because P transfers its
entire interest in S to a non-member in a fully taxable transaction. See Reg.
1.1502-36(b)(1)(ii).
- 120 -
1. Example 34 Son-of-Mirrors Transaction
(1)
S Stock S Stock
X P P Z
$100
$100
$100 basis
$140 basis
(2)
S S Asset 1 S
Y
$40
Asset 1 $40 Cash
$40 Value Asset 2
$0 Basis $60 Value
Asset 2 $60 Basis
$60 Value
$60 Basis
a. Facts: On January 1, Year 1, P purchases the sole outstanding
share of S stock for $100. At that time, S owns two assets, Asset 1
with a basis of $0 and a value of $40, and Asset 2 with a basis and
value of $60. In Year 1, S sells Asset 1 for $40. On December 31,
Year 1, P sells its S share for $100. Ps basis in the S share is $140
(Ps original $100 basis increased under 1.1502-32 to reflect the
$40 gain recognized on the sale of Asset 1). Ps sale of the S share
is a transfer of a loss share.
(1) Ps basis in the S share is reduced, but not below value, by

the lesser of the shares net PIA and disconformity amount.
The shares net PIA is the greater of zero and the sum of all
investment adjustments applied to the basis of the share.
The only investment adjustment to the share is the $40
adjustment attributable to the gain recognized on the sale of
Asset 1. Thus, the shares net PIA is $40.
(2) The shares disconformity amount is the excess, if any, of

its basis ($140) over its allocable portion of Ss net inside
attribute amount. Ss net inside attribute amount is the sum
of Ss money ($40 from the sale of Asset 1) and Ss basis in
Asset 2 ($60), or $100. The share is the only outstanding S
share and so its allocable portion of the $100 net inside
attribute amount is the entire $100. Thus, the shares
disconformity amount is $40, the excess of $140 over $100.
- 121 -
(3) The lesser of the net PIA ($40) and the shares
disconformity amount ($40) is $40. Accordingly, the basis
in the share is reduced by $40, from $140 to $100,
immediately before the sale and no gain or loss is
recognized. Reg. 1.1502-36(c)(8), Ex. 1(i).
(1) Because Ps $40 loss is attributable to the recognition of

built-in gain on the disposition of an asset by S, the entire
$40 loss is disallowed under Prior Reg. 1.337(d)-2. See
Prior Reg. 1.337(d)-1(a)(5), Ex. 1, 1.1502-20(a)(5), Ex.
1.
(2) The result is the same under the basis disconformity

approach of Notice 2004-58 because the loss is disallowed
to the extent of the least of (i) the gain amount, or $40, (ii)
the disconformity amount, or $40 (i.e., $140 S stock basis
less $100 S net asset basis), and (iii) the PIA amount, or
$40.
2. Example 35 Wasting Asset
a. Facts: Same facts as Example 34 above, except that, instead of

selling Asset 1, the value of Asset 1 is consumed in the production
of $40 of income in year 1 (reducing the value of Asset 1 to $0).
b. Application of Unified Loss Rules: Because the net PIA includes

items of income as well as items of gain, the result is the same as
Example 34 above. Reg. 1.1502-36(c)(8), Ex. 1(ii).
c. Application of Prior Rules: Because the loss on the S stock was

not attributable to the recognition of built-in gain on the disposition
of an asset, the loss is not disallowed under Prior Reg. 1.337(d)-
2.
3. Example 36 - Post-Acquisition Appreciation Eliminates Stock Loss
a. Facts: Same facts as Example 34 above, except that, in addition,

the value of Asset 2 increases to $100 before the stock is sold. As
a result, P sells the S share for $140.
b. Application of Unified Loss Rules: Because Ps sale of the S share

is not a transfer of a loss share, the basis reduction rule does not
apply to the transfer, notwithstanding that Ps basis in the S share
was increased by the gain recognized on Asset 1. Reg. 1.1502-
36(c)(8), Ex. 1(iii).
- 122 -
c. Application of Prior Rules: Similarly, Prior Reg. 1.337(d)-2 only

applies to a disposition of S stock at a loss.
4. Example 37 Distributions
a. Facts: Same facts as Example 34 above, except that, in addition, S

distributes a $10 dividend before the end of year 1. As a result, the
value of the share decreases and P sells the share for $90. Ps basis
in the S share is $130 (Ps original $100 basis increased by $30
under Reg. 1.1502-32 (the net of the $40 gain recognized on the
sale of Asset 1 and the $10 dividend)). Ps sale of the S share is a
transfer of a loss share.
(1) Ps basis in the S share is reduced, but not below value, by

the lesser of the shares net PIA and disconformity amount.
The shares net PIA is $40 (the sum of all investment
adjustments applied to the basis of the share, computed
without taking distributions into account).
(2) The shares disconformity amount is the excess of its basis

($130) over its allocable portion of Ss net inside attribute
amount. Ss net inside attribute amount is the sum of Ss
money ($30, the $40 sale proceeds minus the $10
distribution) and Ss basis in Asset 2 ($60), or $90. The
share is the only outstanding S share and so its allocable
portion of the $90 net inside attribute amount is the entire
$90.
(3) The lesser of the shares net PIA ($40) and its
immediately before the sale and no gain or loss is
recognized. Reg. 1.1502-36(c)(8), Ex. 1(iv).
(1) Because the entire $40 loss is attributable to the disposition

of Ss built-in gain asset, the loss is disallowed under Prior
Reg. 1.337(d)-2.

approach of Notice 2004-58 because the loss is disallowed
to the extent of the least of (i) the gain amount, or $40, (ii)
the disconformity amount, or $90, and (iii) the PIA amount
(excluding distributions), or $40.
- 123 -
5. Example 38 Loss Attributable to Post-Acquisition Loss
(1)
S Stock S Stock
X P P Y
$100 $60
$100 basis
$100 basis
S S S
Asset 1 Asset 1
$40 Value $0 Value
$0 Basis $0 Basis
Asset 2 Asset 2
$60 Value $60 Value
$60 Basis $60 Basis

share of S stock for $100. At that time, S owns two assets, Asset 1
with a basis of $0 and a value of $40, and Asset 2 with a basis and
value of $60. The value of Asset 1 declines to $0 and P sells its S
share for $60. Ps basis in the S share remains $100. Ps sale of
the S share is a transfer of a loss share.
(1) Ps basis in the S share ($100) is reduced immediately

before the sale, but not below value ($60), by the lesser of
the shares net PIA and disconformity amount. There were
no adjustments to Ps basis in the share and so the shares
net PIA is $0.
(2) Thus, although the shares disconformity amount is $40

(the excess of Ps basis in the share ($100) over the shares
allocable portion of Ss net inside attribute amount ($60)),
no basis reduction is required under Reg. 1.1502-36(c)
(because the PIA amount is less), and the $40 loss is
allowed. Reg. 1.1502-36(c)(8), Ex. 2.
(3) Note that the attribute reduction rule would not apply
because S does not have an aggregate inside loss, so there
is no duplicated loss.
- 124 -
(1) Because S did not dispose of its built-in gain asset, Ps $40
loss is allowed under Prior Reg. 1.337(d)-2(c)(2). See
2.

approach of Notice 2004-58 because the gain and PIA
amounts are both $0.
6. Example 39 Built-In Gain Asset Depreciates in Value
(1)
S Stock S Stock
X P P Z
$50
$100
$100 basis
$100 basis
(2)
S S Asset S
Y
$50
Asset $50 Cash
$100 Value
$50 Basis
a. Facts: In Year 1, P acquires the stock of S for $100. S has a built-

in gain asset with a value of $100 and a basis of $50. The asset
depreciates in value to $50, and in Year 2, S sells the asset to Y for
$50. P subsequently sells all of the S stock to Z for $50. Because
S recognized no gain or loss on the sale of the asset, Ps basis in
the S stock remains $100. Thus, when P sells its S stock, it

the shares net PIA and disconformity amount. There were
no adjustments to Ps basis in the share and so the shares
net PIA is $0.
(2) Thus, although the shares disconformity amount is $50

(the excess of Ps basis in the share ($100) over the shares
allocable portion of Ss net inside attribute amount ($50)),
no basis reduction is required under Reg. 1.1502-36(c)
- 125 -
(because the PIA amount is less), and the $50 loss should
be allowed.
(3) Note that the attribute reduction rule would not apply
because S does not have an aggregate inside loss, so there
is no duplicated loss.
(1) Even though S had a built-in gain asset when P acquired the
S stock, and S disposed of that asset, none of the built-in
gain was recognized because of the depreciation in value.
Thus, Ps $50 loss should be allowed under Prior Reg.
1.337(d)-2(c).

approach because both the gain and PIA amounts are $0.
7. Example 40 Built-In Gain Asset Appreciates in Value
(1)
S Stock S Stock
X P P Z
$150
$100
$100
basis $200
basis
(2)
Asset S
S S Y
$150
Asset $150 Cash
$100 Value
$50 Basis

in gain asset with a value of $100 and a basis of $50. The asset
appreciates in value to $150, and in Year 2, S sells the asset to Y
for $150. P subsequently sells all of the S stock to Z for $150.
Under the investment adjustment rules, Ps basis in the S stock is
increased by Ss $100 gain in Year 2. Reg. 1.1502-32(b)(2)(i).
Thus, when P sells its S stock, it recognizes a $50 loss.
- 126 -

the shares net PIA and disconformity amount.
(2) The only investment adjustment to the share is the $100

adjustment attributable to the gain recognized on the sale of
the asset. Thus, the shares net PIA is $100.
(3) The shares disconformity amount is the excess, if any, of

its basis ($200) over its allocable portion of Ss net inside
attribute amount ($150 from the sale of the asset), or $50.
(4) The lesser of the net PIA ($100) and the shares
immediately before the sale, and no gain or loss is
recognized.
(1) Loss is generally treated as first attributable to recognized

built-in gain. See Prior Reg. 1.337(d)-1(a)(5), Ex. 3.
Thus, under a pure tracing approach, because S had a built-
in gain of $50 at the time P acquired the S stock, Ps $50
loss is attributable to the recognition of built-in gain on the
disposition of an asset by S, the entire $50 loss is
disallowed under Prior Reg. 1.337(d)-2.

approach of Notice 2004-58, because the disconformity
amount is $50 (i.e., $100 S stock basis less $50 S net asset
basis), which is less than the $100 gain and PIA amounts.
- 127 -
8. Example 41 Built-In Gain in After-Acquired Asset
S Stock S Stock
W P P Z
$100
$100
$100 basis
$140 basis
Asset 3
S S S Y
$40
Asset 1 Asset 1 Asset 3
Asset 2 Asset 2
$60 Value $60 Value
$60 Basis $60 Basis

share of S stock for $100. At that time, S owns two assets, Asset 1,
with a basis of $0 and a value of $40, and Asset 2, with a basis and
value of $60. In Year 1, the value of Asset 2 declines to $20. In
year 2, the value of Asset 1 declines to $0, the value of Asset 2
returns to $60, and S creates Asset 3 (with a basis of $0). In Year
3, S sells Asset 3 for $40. On December 31, year 3, P sells its S
share for $100. Ps basis in the S share is $140 (Ps original $100
basis increased under 1.1502-32 to reflect the $40 gain
recognized on the sale of Asset 3 in Year 3).

the shares net PIA and disconformity amount. The shares
net PIA is $40 (the Year 3 investment adjustment). The
shares disconformity amount is the excess of its basis
amount. Ss net inside attribute amount is $100, the sum of
Ss money ($40 from the sale of Asset 3) and its basis in its
assets ($60 (the sum of Asset 1s basis of $0 and Asset 2s
basis of $60)). Ss $100 net inside attribute amount is
allocable entirely to the sole outstanding S share.
- 128 -
(2) Thus, the shares disconformity amount is the excess of

$140 over $100, or $40. The lesser of the shares net PIA
($40) and its disconformity amount ($40) is $40.
Accordingly, the basis in the share is reduced by $40, from
$140 to $100, immediately before the sale and no gain or
loss is recognized. Reg. 1.1502-36(c)(8), Ex. 3(ii).
(1) Gain is built-in if it is attributable to an excess of value

over basis that is reflected, before the disposition of the
asset, in the basis of the share. Prior Reg. 1.337(d)-2(c)
(2). The reference to the disposition of the asset appears
to require that the built-in gain reflected in the stock basis
be with respect to the same asset that is disposed of at a
gain. Before S disposed of the first asset, the original
amount of built-in gain was reflected in Ps basis in S.
However, S never recognized the built-in gain in that asset
because it depreciated in value. The excess of value over
basis recognized by S on the disposition of the new asset
was not the same gain reflected in Ps basis in S. Ps loss
thus should not be disallowed under a pure tracing
approach.
(2) Under the basis disconformity approach of Notice 2004-58,

however, Ps $40 loss would be disallowed, since the gain,
disconformity, and PIA amounts are all $40.
(3) Thus, the original built-in gain taint is preserved under the
basis disconformity approach to attach to any after-acquired
asset. This result seems inconsistent with the language of
Prior Reg. 1.337(d)-2(c)(2), and arguably disallows an
economic loss for the loss in value of the original asset.
The built-in gain taint is similarly preserved under the
Unified Loss Rules.
- 129 -
9. Example 42 Lower-Tier Subsidiary/No Transfer of Lower-Tier Stock

(2)
S Share
P Y
$160
$160 Basis
Asset A
$100 Value S
$100 Basis
$60 Basis (1)

Asset 1
S1 X
Asset 1 $60
$60 Value
$20 Basis
a. Facts: P owns the sole outstanding share of S stock with a basis of

$160. S owns two assets, Asset A with a basis and value of $100,
and the sole outstanding share of S1 stock with a basis of $60. S1
owns one asset, Asset 1, with a basis of $20 and value of $60. In
Year 1, S1 sells Asset 1 to X for $60, recognizing $40 of gain. On
December 31, Year 1, P sells its S share to Y, a member of another
consolidated group, for $160. Ps basis in the S share is $200 (Ps
original $160 basis increased under Reg. 1.1502-32 by $40 (to
reflect the tiering up of the increase to Ss basis in S1 under Reg.
1.1502-32 by $40 (to reflect the gain recognized on S1s sale of
Asset 1)). Ps sale of the S share is a transfer of a loss share. S
does not transfer the S1 share because S and S1 are members of the
same group following the transfer.

the shares net PIA and disconformity amount. The S
shares net PIA is $40. The shares disconformity amount
is the excess, if any, of the basis of the share ($200) over
the shares allocable portion of Ss net inside attribute
basis in Asset A ($100) plus Ss basis in the S1 share.
(2) Although Ss actual basis in the S1 share is $100 (Ss

original $60 basis increased by S1s year 1 $40 PIA), for
purposes of computing the S shares disconformity amount,
- 130 -
Ss basis in the S1 share is tentatively reduced by the lesser

of the S1 shares net PIA and its disconformity amount.
The S1 shares net PIA is $40 (the year 1 PIA). The S1
shares disconformity amount is the excess, if any, of its
basis ($100) over its allocable portion of S1s net inside
attribute amount. S1s net inside attribute amount is $60
(its cash received on the sale of Asset 1) and it is entirely
attributable to Ss S1 share. The S1 shares disconformity
amount is therefore the excess of $100 over $60, or $40.
The lesser of the S1 shares net PIA ($40) and its
disconformity amount ($40) is $40. Accordingly, for
purposes of computing the disconformity amount of the S
share, Ss basis in its S1 share is tentatively reduced by
$40, from $100 to $60.
(3) Disconformity Amount of Ps S Share: Ss net inside

attribute amount is treated as the sum of its basis in Asset A
($100) and its (tentatively reduced) basis in its S1 share
($60), or $160. Ss net inside attribute amount is allocable
entirely to Ps S share. Thus, the S shares disconformity
amount is the excess of $200 over $160, or $40.
(4) Amount of Reduction: Ps basis in its S share is

reduced by the lesser of the S shares net PIA ($40) and
disconformity amount ($40), or $40. Accordingly, Ps basis
in the S share is reduced by $40, from $200 to $160,
immediately before the sale, and no gain or loss is
recognized.
(5) Effect on Ss Basis in its S1 Share: The transaction has no

effect on Ss basis in the S1 sharethe tentative reduction
is only for purposes of computing Ss net inside attribute
amount. Thus, S owns the S1 share with a basis of $100,
Ss original $60 basis in the share plus the $40 adjustment
for the gain recognized on the sale of Asset 1 in Year 1.
Reg. 1.1502-36(c)(8), Ex. 7.
c. Application of Prior Law:
(1) The built-in gain is reflected in Ps basis and must be taken

into account in determining whether any loss realized by P
on the sale of its S stock is allowed. See Prior Reg.
1.337(d)-2(c)(4), Example. The result was the same
under the prior regulations. See Prior Reg. 1.1502-20(c)
(5), Ex. 5.28
28
Similar to Prior Reg. 1.337(d)-2(c)(2), Prior Reg. 1.1502-20(c)(2)(iii) provided that
extraordinary gain and positive investment adjustments were taken into account only to the
- 131 -
10. Example 43 Carryover Basis in Stock
A
A (1)
P Stock
$60 basis S Stock
S Stock
P Y
S P
$90
$60 basis (2) $160 basis
S Asset
X
S
$100
Asset
$100 Value New Asset
$0 Basis $90 Value
$100 Basis
a. Facts: Individual A owns all of the stock of S and has a $60 basis
in such stock. S has a built-in gain asset with a value of $100 and
a basis of $0. In Year 1, P acquires the stock of S from A in a
section 351 exchange. Section 362(a)(1). In Year 2, S sells the
asset to X for $100. S reinvests the proceeds in New Asset, and
New Asset declines in value to $90. In Year 3, P sells the stock of
S to Y for $90. When P acquires the S stock from A, P takes a $60
carryover basis in such stock. Under the investment adjustment
rules, Ps basis in the S stock is increased by Ss $100 gain in Year
2, to $160. Reg. 1.1502-32(b)(2)(i). Thus, when P sells its S
stock in Year 3, it recognizes a $70 loss.
(1) Ps basis in the S stock ($160) is reduced immediately

before the sale, but not below its value ($90) by the lesser
of the net PIA and disconformity amount. The net PIA is
$100. The disconformity amount is the excess of the basis
of the share ($160) over the shares alocable portion of Ss
net inside attribute amount. Ss net inside attribute amount
is $100, its basis in the New Asset. Thus, the shares
disconformity amount is the excess of $160 over $100, or
$60.
(2) The lesser of the shares net PIA ($100) and its
disconformity amount ($60) is $60. Accordingly, P must
extent they are reflected in the basis of the share, directly or indirectly, immediately before the
disposition or deconsolidation.
- 132 -
reduce its basis from $160 to $100, and P recognizes a $10

loss on the transfer of the S share.
(3) Because the S share is still a loss share, the attribute

reduction rule applies. S must reduce its attributes by the
lesser of the net stock loss and the aggregate inside loss. In
this case, the net stock loss (after basis reduction) and the
aggregate inside loss are both $10. Because S has no other
attributes, S must reduce its basis in the New Asset from
$100 to $90. Note that P may make an election to further
reduce its basis in the S stock basis to avoid the application
of the attribute reduction rule.
(1) Even though Ps basis in the S stock was increased by $100

as a result of Ss built-in gain, only $60 of the $70 loss on
the sale of S stock is reflected in Ps basis (and $60 is the
amount of the basis disconformity, which is less than the
$100 gain and PIA amounts). Accordingly, only $60 of the
$70 loss is disallowed under Prior Reg. 1.337(d)-2. See
Prior Reg. 1.337(d)-1(a)(5), Ex. 5.
- 133 -
11. Example 44 Unrecognized Loss Reflected in Stock Basis
(2)
S Share
P Y
$100
$100 Basis
(1)
S Asset 1 X
$60
Asset 1
$60 Value
$20 Basis
Asset 2
$40 Value
$60 Basis

$100. S owns two assets, Asset 1 with a basis of $20 and a value
of $60, and Asset 2 with a basis of $60 and a value of $40. In Year
1, S sells Asset 1 for $60. On December 31, Year 1, P sells the S
share for $100. Ps basis in the S share is $140 (Ps original $100
basis increased under Reg. 1.1502-32 to reflect the $40 gain
recognized on the sale of Asset 1). Ps basis is unaffected by the
unrealized post-acquisition decline in the value of Asset 2. Reg.
1.1502-32(b)(2)(i). When P sells its S stock, it recognizes a $40
loss. Ps sale of the S share is a transfer of a loss share.

money ($60 from the sale of Asset 1) and Ss basis in Asset
2 ($60), or $120. Ss net inside attribute amount is
allocable entirely to the sole outstanding S share.

- 134 -
Accordingly, the basis in the share is reduced by $20, from

$140 to $120, immediately before the sale and P recognizes
a $20 loss. Reg. 1.1502-36(c)(8), Ex. 4.
(3) Because the S share is still a loss share, the attribute

reduction rule applies. S must reduce its attributes by the
lesser of the net stock loss ($20) and the aggregate inside
loss ($20), or $20. Because S has no other attributes, it
must reduce its basis in Asset 2 fom $60 to $40. Note that
P may make an election to further reduce its basis in the S
stock basis to avoid the application of the attribute
reduction rule.
(1) Even though S had a $20 built-in loss, which was reflected
in Ps basis, Ps loss on the sale of the S stock is treated
first as attributable to the recognized built-in gain on Asset
1. Thus, under a pure tracing Ps $40 loss is disallowed.
See Prior Reg. 1.337(d)-1(a)(5), Ex. 3.
(2) However, under the basis disconformity approach of Notice

2004-58, only $20 of Ps loss should be disallowed because
the disconformity amount is $20. Thus, the unrecognized
built-in loss effectively offsets the recognized built-in gain
under the disconformity approach, but not tracing.
- 135 -
12. Example 45 Post-Acquisition Appreciation Removes Taint of Built-In

Gain
(1)
S Stock S Stock
X P P Z
$180
$100
$100 basis
$200 basis
(2)
Asset
S S Y S
$100
Asset New Asset
$0 Basis $100 Basis

in gain asset with a value of $100 and a basis of $0. In Year 2, S
sells the asset to Y for $100, and reinvests the proceeds in New
Asset. New Asset appreciates in value to $180. In Year 7, P sells
all of the S stock to Z for $180. Under the investment adjustment
rules, Ps basis in the S stock is increased by Ss $100 gain in Year
2. Reg. 1.1502-32(b)(2)(i). As a result, when P sells its S stock
in Year 7 for $180, it recognizes a $20 loss.

amount. Ss net inside attribute amount is Ss basis in New
Asset, or $100. Ss net inside attribute amount is allocable
entirely to the sole outstanding S share.

Accordingly, the basis in the share is reduced to its value,
from $200 to $180, immediately before the sale.
- 136 -
(1) S had a $100 built-in gain reflected in Ps basis, all of

which was recognized. However, the post-acquisition
appreciation of New Asset has the effect of reducing Ps
disallowed loss. So, under the prior rules, the entire $20
loss would be disallowed under the tracing approach. See
2.
(2) Similarly, under the basis disconformity approach of Notice

2004-58, the $20 loss would be disallowed, because all of
the gain, PIA, and disconformity amounts are $100.
d. The Service has permitted this taxpayer-favorable result since the

original loss disallowance regulations, because it determined that
administratively burdensome tracing would be required to reverse
the PIA attributable to the sold built-in gain asset.
e. As a result, a consolidated group could transfer assets that are

expected to appreciate to a subsidiary with built-in gain assets
subject to the anti-stuffing rule, anti-avoidance rule, and section
269.
(1) If a subsidiary is stuffed with assets with a high value

and low basis, the anti-abuse rule of the Unified Loss Rules
would likely apply. Reg. 1.1502-36(g). Under the prior
rules, the anti-stuffing rule could apply if the subsidiary
stock is sold or deconsolidated within two years of the
assets transfer. Prior Reg. 1.1502-20(e)(2).
(2) If the subsidiary is transferred an asset with a basis equal to

its value, which it expects to appreciate, on its face the anti-
abuse (or anti-stuffing) rule may apply. However, the mere
hope that an asset will appreciate seems to be a slender reed
on which to apply the anti-abuse (or anti-stuffing) rule.
- 137 -
13. Example 46 - Post-Acquisition Appreciation Removes Taint of Built-In

Gain Lower Tier Subsidiary
(4)
S Stock
P P Y
$110
$75 basis $120 basis (3)
(1) T Stock
Purchase T, S S X
U, and V $70
Stock for $25
Each $45 basis
T U V T U V
Asset 1
$5 Value
$20 Cash
$0 Basis (2)
Sell Asset 1 for Asset 3
Asset 2
$15 Value $5 and Asset 2 $50 Value
$0 Basis for $15 $5 Basis
Asset 3
$5 Value
$5 Basis
a. Facts: In Year 1, P forms S with $75 cash and thus has an original
basis of $75 in S. S purchases all of the stock of three
corporations, T, U, and V, each at a price of $25. T owns three
assets: Asset 1 with a value of $5 and basis of $0, Asset 2 with a
value of $15 and a basis of $0, and Asset 3 with a value of $5 and a
basis of $5. In Year 2, T sells Asset 1 for $5 and Asset 2 for $15.
Asset 3 then appreciates in value to $50. In Year 3, S sells all of
the stock of T to X for $70. The value of U then depreciates to
$15. In Year 4, P sells all of the stock of S to Y for $110.
T recognizes gain of $5 and $15 on Asset 1 and Asset 2,

respectively. Under the investment adjustment rules, S increases
its basis in T by $20 to $45. Reg. 1.1502-32(b)(2)(i). P, in turn,
increases its basis in S by $20 to $95. Reg. 1.1502-32(a)(3)(iii).
The value of T increases to $70 when Asset 3 appreciates (i.e., $20
cash + $50 Asset 3). When S sells its T stock in Year 3, it
recognizes a $25 gain. P increases its basis in S by the $25 gain to
$120. Reg. 1.1502-32(b)(2)(i). The value of S decreases to $110
when the value of U depreciates (i.e., $15 U + $25 V + $70 cash
from sale of T). When P sells its S stock in Year 4, it is transfer of
a loss share. Ps basis is $120 and the value of the S stock is $110.
- 138 -
(1) Under the basis reduction rule, Ps basis in the S share

($120) is reduced immediately before the sale, but not
below value ($110), by the lesser of the shares net PIA and
disconformity amount. The shares net PIA is $45 (the
Year 2 investment adjustment plus the Year 3 investment
adjustment). The shares disconformity amount is the
excess of its basis ($120) over its allocable portion of Ss
net inside attribute amount. Ss net inside attribute amount
is the sum of Ss money ($70 from the sale of T) and Ss
basis in the lower-tier subsidiary shares.
(2) Under Reg. 1.1502-32(c)(6), Ss net inside attribute

amount is determined by treating the lower tier subsidiary
shares as tentatively reduced by the lesser of their net PIA
and the disconformity amount. U and V have no net PIAs,
so there is no tentative reduction. Thus, Ss basis in its
lower tier subsidiaries is $50 - U ($25) and V ($25). As a
result, Ss net inside attribute amount is $120, which is
allocable entirely to the sole outstanding S share. Thus, the
shares disconformity amount is the excess of $120 over
$120, or $0. The lesser of the shares net PIA ($45) and its
disconformity amount ($0) is $0. Accordingly, the basis in
the share is not reduced immediately before the sale.
(3) Under the attribute reduction rule, Ss attribution reduction

amount is the lesser of Ps net stock loss and Ss aggregate
inside loss. Ps net stock loss is $10 ($120 basis over $110
value). For purposes of computing Ss aggregate inside
loss, the Unified Loss Rules look through S to determine
Ss deemed basis in the U and V stock. See 1.1502-36(d)
(3)(iii)(B) and (5)(i)(B). The regulations then treat the
stock of Ss subsidiaries as Category D attributes. Since S
has no other Category A, B, C, or D attributes, the
attribution reduction amount would first be applied to the
bases of the U and V stock, then is tiered down to reduce U
and Vs attributes. Reg. 1.1502-36(d)(5)(iii), (v).
(1) Even though T sold built-in gain assets, and the PIAs tiered
up to S and P, Ss sale of T at a gain due to an appreciated
asset removes the taint of the built-in gain. See T.A.M.
200138005 (May 4, 2001). This is because Ps $10 loss
was attributable to the appreciation of T and not the
- 139 -
disposition of Ts built-in gain assets. This can be

illustrated with a modification of the facts of Example 46.
(2) Assume the same facts as Example 46, except that T did
not dispose of Asset 1 and Asset 2. Asset 3 appreciates in
value to $50, and S sells the T stock for $70, recognizing a
gain of $45 (i.e., $70 value - $25 basis). P thus increases its
basis in S by $45 to $120. When the value of U
depreciates, S is worth $110, and P still recognizes a $10
loss on the sale of S. Id.
C. Duplicated Loss Examples
Note that the following examples involve no basis redetermination under Reg.
1.1502-36(b) because there is no basis disparity and involve no basis reduction
under Reg. 1.1502-36(c) because there are no net PIAs.
1. Example 47 Computation of Attribute Reduction Amount/Transfer of All

S Shares
P 30 S Shares X
$30
100 Shares
$2 Basis/Share
$1 Value/Share
100 Basis in Land

$120 Loss Carryover
a. Facts: P owns all 100 of the outstanding shares of S stock with a

basis of $2 per share. S owns land with a basis of $100, has a $120
loss carryover, and has no liabilities. Each share has a value of $1.
P sells 30 of the S shares to X for $30. As a result of the sale, P
and S cease to be members of the same group. Accordingly, P is
treated as transferring all 100 S shares. Ps transfer of the S shares
is a transfer of loss shares.
(1) Ss attributes are reduced by Ss attribute reduction amount.

Under Reg. 1.1502-36(d)(3), Ss attribute reduction
amount is the lesser of the net stock loss and Ss aggregate
- 140 -
inside loss. The net stock loss is the excess of the

aggregate bases of the transferred shares ($200) over the
aggregate value of the transferred shares ($100), or $100.
Ss aggregate inside loss is the excess of its net inside
attribute amount ($220, the sum of the $100 basis of the
land and the $120 loss carryover) over the value of all
outstanding S shares ($100), or $120.
(2) The attribute reduction amount is therefore the lesser of the

net stock loss ($100) and the aggregate inside loss ($120),
or $100. Under Reg. 1.1502-36(d)(4), Ss $100 attribute
reduction amount is allocated and applied to reduce Ss
$120 loss carryover to $20. Reg. 1.1502-36(d)(8), Ex.
1(i).
c. Application of Prior Rules: The loss suspension rule does not

apply because P and S are deconsolidated. Prior Reg. 1.1502-
35(c)(1).
2. Example 48 Transfer of less than all S shares
a. Facts: Same facts as above, except that P only sells 20 S shares to

X. Ps sale of the 20 S shares is a transfer of loss shares, but there
is no transfer of Ss remaining shares because they remain
members of a consolidated group.
(1) Under Reg. 1.1502-36(d), Ss attributes are reduced by

Ss attribute reduction amount. Under Reg. 1.1502-36(d)
(3), Ss attribute reduction amount is the lesser of the net
stock loss and Ss aggregate inside loss. The net stock loss
is the excess of the aggregate bases of the transferred shares
($40) over the aggregate value of the transferred shares
($20), or $20. Ss aggregate inside loss is the excess of its
net inside attribute amount ($220) over the value of all
outstanding S shares ($100), or $120. The attribute
reduction amount is therefore the lesser of the net stock loss
($20) and the aggregate inside loss ($120), or $20.
(2) Under Reg. 1.1502-36(d)(4), Ss $20 attribute reduction

amount is allocated and applied to reduce Ss $120 loss
carryover to $100. Reg. 1.1502-36(d)(8), Ex. 1(ii).
(1) The loss suspension rule applies at the time of Ps sale of S

stock. The duplicated loss amount with respect to the sold
- 141 -
shares is $24 (i.e., 20 percent of $220 inside attributes - $20

value of S stock). Thus, the entire $20 loss is suspended.
The suspended loss is reduced by losses and deductions
absorbed by the P group, and any remaining loss may be
recognized upon the sale of the remaining S stock or 10
years, whichever is earlier. Prior Reg. 1.1502-35(c).
3. Example 49 Multiple Dispositions of S Stock
(1) (4)
20 shares 80 shares
P P W P Z
$4 $48
100 Asset A $140 $132

shares $20 Value Basis Basis (3)
$100 Basis
Asset B
(2) $50 $40 Value
S S X S Y
$50 Basis
Asset B $40
Asset A $50 Value Asset A
$20 Value $50 Basis $20 Value
$40 Cash
a. Facts: In Year 1, P forms S by transferring Asset A, with a value of

$20 and a basis of $100, in exchange for 100 shares of S stock. In
Year 3, P sells 20 shares of S common stock to W for $4,
recognizing a $16 loss. In Year 5, S earns $50 and purchases Asset
B from X. In Year 7, S sells Asset B to Y for $40, recognizing a
$10 loss. Under the investment adjustment rules, P increases its
basis in the S shares by 80% of Ss $50 income in Year 5 and $10
loss in Year 7. In Year 8, P sells the remaining 80 shares of S stock
to Z for $48, recognizing a $84 loss.
(1) Under Reg. 1.1502-36(d), Ss attributes are reduced by

Ss attribute reduction amount. Under Reg. 1.1502-36(d)
(3), Ss attribute reduction amount is the lesser of the net
stock loss and Ss aggregate inside loss.
(2) In Year 3, P would recognize a $16 loss. However, S would

be required to reduce its attributes by $16 (i.e. the lesser of
Ps loss or Ss duplicated loss of $80 ($100 asset basis less
$20 value)).
- 142 -
(3) In Year 8, P would recognize a $84 loss. However, S would

be required to reduce its attributes by $84 (i.e. the lesser of
Ps loss or Ss duplicated loss of $92 ($40 cash plus $100
asset basis less $48 value)).
(1) Although the basis redetermination rule technically applies

when P sells the 20 S shares at a loss in Year 3, its
application does not result in any shift in basis.
(2) However, the loss suspension rule applies at that time. The
duplicated loss amount with respect to the sold shares is
$16 (i.e., 20 percent of $100 basis in Asset A - $20 value of
S stock). Thus, the entire $16 loss is suspended. The
suspended loss is reduced by losses and deductions
absorbed by the P group. However, P should be able to
establish that the $10 loss on Asset B, which was not
acquired until after the sale of the S stock, was not part of
the duplicated loss. The entire $16 suspended loss should
thus be allowed in Year 8 when S leaves the group.
(3) Assume that S purchased Asset B before P sold the 20

shares of S stock, and Asset B increased in value to $60.
The duplicated loss with respect to the sold shares would be
$14 (i.e., 20 percent of $100 basis in Asset A + $50 basis in
Asset B - $80 value of S stock). Thus, only $14 of the $16
loss would be suspended. The duplicated loss computation
essentially permits Ss unrealized gains to offset its
unrealized losses and limits the duplicated loss to the net
loss.
- 143 -
4. Example 50 Allocation of Attribute Reduction Amount Among Category

D Assets
S Shares
P X
$90
$150
Basis
$60 Basis in land

$30 Basis in factory
$30 Basis in publicly traded securities
$30 Basis in goodwill

$150. S owns land with a basis of $60, a factory with a basis of
$30, publicly traded securities with a basis of $30, and goodwill
with a basis of $30. P sells its S share for $90. Ps sale of the S
share is a transfer of a loss share.
(1) Under Reg. 1.1502-36(d)(3), Ss attribute reduction

amount is determined to be $60, the lesser of the net stock
loss ($150 basis over $90 value) and Ss aggregate inside
loss ($60, the excess of Ss $150 net inside attribute amount
(the $60 basis of the land, plus the $30 basis of the factory,
plus the $30 basis of the publicly traded securities, plus the
$30 basis of the goodwill) over the $90 value of the S
share).
(2) Under Reg. 1.1502-36(d)(4), the $60 attribute reduction

amount is allocated and applied proportionately to reduce
Ss attributes (all Category D) in reverse section 1060 order
as follows (Reg. 1.1502-36(d)(8), Ex. 2):
- 144 -
Available Attributes Attribute Amount Allocable Portion Adjusted

of Attribute Attributes
Reduction Amount Amount
Class VII $30 $30 $0
Basis of Goodwill
Class V
Basis of Land $60 (60/90 x $60) $40 $20
Basis of Factory $30 (30/90 x $60) $20 $10
Total Class V $90 $60 $30
Class II $30 $0 $30
Basis of Publicly
Traded Securities
Totals $150 $60 $90

35(c)(1).
5. Example 51 Allocation of Attribute Reduction Amount to Category A,

Category B, and Category C Assets
$1,000 Basis
S Share
M X
$100
$210 Basis
$10 Capital Loss Carryover

$200 NOL Carryover
$40 Deferred Deduction
$50 Basis in land
- 145 -
a. Facts: P owns the sole outstanding share of M stock with a basis

of $1,000 and M owns the sole outstanding share of S stock with a
basis of $210. M sells its S share to X for $100. Ms sale of the S
share is a transfer of a loss share. At the time of the sale, S has no
liabilities and the following attributes:
Category Attribute Attribute Amount

Category A Capital Loss Carryover $10
Category B NOL Carryover $200
Category C Deferred Deductions $40
Category D, Class V Basis in Land $50
Total Attributes $300
(1) Under Reg. 1.1502-36(d)(3), Ss attribute reduction

amount is $110, the lesser of the net stock loss ($210 basis
over $100 value) and Ss aggregate inside loss ($200, the
excess of Ss $300 net inside attribute amount (the $10
capital loss carryover, plus the $200 NOL carryover, plus
the $40 deferred deductions, plus the $50 basis in land) less
the $100 value of all outstanding S shares).
(2) Under Reg. 1.1502-36(d)(4)(ii)(A)(1), the $110 attribute

reduction amount is allocated and applied to reduce Ss
attributes as follows (Reg. 1.1502-36(d)(8), Ex. 3(i)):
Category Available Attribute Application of Adjusted

Attributes Amount Attribute Attribute
Reduction Amount
Amount
A Capital Loss $10 $10 $0
Carryover
B NOL Carryover $200 $100 $100
C Deferred $40 $0 $40
Deductions
D Basis in Land $50 $0 $50
Totals $300 $110 $190
- 146 -
(3) P could also elect to allocate the attribute reduction amount

to, for example, eliminate the $40 deferred deductions,
preserve the capital loss carryover, and reduce NOLs to
$130. Reg. 1.1502-36(d)(8), Ex. 3(ii).

apply because M and S are deconsolidated. Prior Reg. 1.1502-
35(c)(1).
6. Example 52 Wholly Owned Lower-Tier Subsidiary
S Share
P P1
$50
$250 Basis
Share A
Asset $40 Basis
$100 Basis Share B
$60 Basis
S1
Asset 1
$50 Basis

$250. S owns Asset with a basis of $100 and the only two
outstanding shares of S1 stock (Share A has a basis of $40 and
Share B has a basis of $60). S1 owns Asset 1 with a basis of $50.
P sells its S share to P1, the common parent of another
consolidated group, for $50. The sale is a transfer of a loss share.
(1) Computation of Attribute Reduction Amount:
(a) Under Reg. 1.1502-36(d)(3), Ss attribute

reduction amount is the lesser of Ps net stock loss
and Ss aggregate inside loss. Ps net stock loss is
$200 ($250 basis minus $50 value). Ss aggregate
inside loss is the excess of Ss net inside attribute
amount over the value of the S share. Under Reg.
1.1502-36(d)(3)(iii)(B) and (d)(5)(i)(B), Ss net
- 147 -
inside attribute amount is $200, computed as the

sum of Ss basis in Asset ($100) and its deemed
basis in the S1 stock (treated as a single share)
($100, computed as the greater of Ss $100 total
basis in the S1 shares and S1s $50 basis in Asset 1).
(b) Ss aggregate inside loss is therefore $150 ($200 net

inside attribute amount minus $50 value of the S
share). Accordingly, Ss attribute reduction amount
is $150, the lesser of the net stock loss ($200) and
the aggregate inside loss ($150). Reg. 1.1502-
36(d)(8), Ex. 5(i).
(2) Allocation of Ss Attribute Reduction Amount:
(a) Under Reg. 1.1502-36(d)(4) and (d)(5)(ii), Ss

$150 attribute reduction amount is allocated
proportionately (by basis) between Asset (basis
$100) and the S1 stock (treated as a single share)
(deemed basis $100). Accordingly, $75 of the
attribute reduction amount ($100/$200 $150) is
allocated to Asset and $75 of the attribute reduction
amount ($100/$200 $150) is allocated to the S1
stock.
(b) The $75 allocated to Asset is applied to reduce Ss

basis in Asset to $25.
(c) The $75 allocated to the S1 stock is first

apportioned between the shares in a manner that
reduces disparity to the greatest extent possible.
Thus, of the total $75 allocated to the S1 stock,
$27.50 is apportioned to Share A and $47.50 is
apportioned to Share B. The application of the
apportioned amounts reduces the basis of each share
to $12.50.
(d) As a result of the application of Ss attribute

reduction amount, Ss basis in Asset is $25 and Ss
basis in each of the S1 shares is $12.50. Id.
(3) Tier Down of Ss Attribute Reduction Amount (Application

of Conforming Limitation):
(a) Under Reg. 1.1502-36(d)(5)(v)(A), any portion of

Ss attribute reduction amount allocated to S1 stock
is an attribute reduction amount of S1 (regardless of
the extent to which it is applied to reduce the basis
- 148 -
of any shares of S1 stock). Under Reg. 1.1502-

36(d), the $75 allocated to the S1 stock would be
applied to reduce S1s basis in Asset 1 to $0.
(b) However, under Reg. 1.1502-36(d)(5)(v)(B), the

reduction of S1s attributes as a result of tier down
attribute reduction is limited to $25. This represents
the excess of the portion of S1s net inside attribute
amount that is allocable to all S1 shares held by
members immediately before the transaction ($50)
over the sum of aggregate value of S1 shares
transferred by members in the transaction (none)
and the aggregate amount of members bases in
nontransferred S1 shares after reduction under Reg.
1.1502-36(d)(5)(v)(A) ($25). Therefore, of S1s
$75 tier down attribute reduction amount, only $25
is applied to reduce S1s basis in Asset, from $50 to
$25. The remaining $50 of attribute reduction
amount has no further effect. Id.
(4) Basis Restoration:
(a) Assume the same facts as Example 52, except that

Ss basis in Share A is $15, Ss basis in Share B is
$35, and S1s basis in Asset 1 is $100.
(b) Reg. 1.1502-36(d) applies in the same manner as

in Example 52, except that the application of the
apportioned amounts ($27.50 to Share A and $47.50
to Share B) result in an ELA in each share of
($12.50).
(c) Under Reg. 1.1502-36(d)(5)(iv)(A), after Reg.

1.1502-36(d) has been applied with respect to all
transfers of subsidiary stock, any reduction made to
the basis of a share of subsidiary stock under Reg.
1.1502-36(d)(5)(iii) is reversed to the extent
necessary to conform the basis of that share to the
shares allocable portion of the subsidiarys net
inside attribute amount. S1s net inside attribute
amount after the application of Reg. 1.1502-36(d)
is $25 and thus each of the two S1 shares allocable
portion of S1s net inside attribute amount is
$12.50.
(d) Accordingly, the basis of each share (as reduced by

Reg. 1.1502-36(d)(5)(iii)) are reversed to the
- 149 -
extent necessary to restore the basis of each share to

$12.50. Thus, $25 of the $27.50 of reduction to the
basis of share A, and $25 of the $47.50 of reduction
to the basis of share B is reversed, restoring the
basis of each share to $12.50. Reg. 1.1502-36(d)
(8), Ex. 5(ii).

35(c)(1).
D. Intercompany Transfers of Subsidiary Stock Examples
1. Example 53 Intercompany Sale with Duplicated Loss
P P
S share
M1 X
M
S share $80
M M1
$70
$60
$100 Basis
Basis
S S
Asset Asset
a. Facts: M owns the sole outstanding share of stock of S with a

basis of $100. S has one asset with a basis of $100. M sells the S
share to M1 for $70, recognizing a loss of $30. While owned by
M1, S recognizes $10 of depreciation deductions that are absorbed
by the group. S's basis in the asset is reduced by $10, from $100 to
$90. M1's basis in the S stock is therefore reduced by $10, from
$70 to $60. Later, M1 sells the S share to X, an unrelated person,
for $80.
b. M's sale of its S share to M1 is a transfer of a loss share, so the

Unified Loss Rules would apply when M's intercompany item is
taken into account under Reg. 1.1502-13, as if M and M1 were
divisions of a single corporation. If M and M1 were divisions of a
- 150 -
single corporation, the S share's basis would be $90, $100 reduced

by $10 for the depreciation deductions absorbed by the group, and
the group would recognize a $10 loss on the sale of the share that
is potentially subject to this section. Thus, the sale would be a
transfer of a loss share, subject to the Unified Loss Rules, to the
extent of $10.
(1) There is no adjustment under the basis redetermination rule

because S has only one share outstanding and so there is no
disparity in bases of common shares and no unrecognized
gain or loss with respect to preferred shares.
(2) There is no adjustment under the basis reduction rule

because S has no net PIAs.
(3) Under the attribute reduction rule, S would be subject to

$10 of attribute reduction (the lesser of the $10 net stock
loss and S's $10 aggregate inside loss), allocable to the
basis in S's asset.
(4) S's basis in its asset is reduced by $10, from $90 to $80, M
takes its $30 intercompany stock loss into account, and M1
recognizes a $20 stock gain. See Reg. 1.1502-36(e)(3)
(iii), Ex. 1(i).
c. If M ceases to be a member of the group before M1 sells the S

share, Ms intercompany loss must be taken into account, and the
Unified Loss Rules apply, at that time. Assuming that the value of
the S share is $80 when M deconsolidates, S's basis in its asset is
reduced from $90 to $80, M takes its $30 intercompany stock loss
into account, and M1 holds the S stock with a basis of $60 (and an
unrecognized gain of $20). See Reg. 1.1502-36(e)(3)(iii), Ex.
1(ii).
- 151 -
2. Example 54 Intercompany Sale of Built-in Gain Stock
P P
S share
M1 X
(2) M
S share $120
M M1
$100
$100
$200 Basis
Basis
(1)
Asset S
S Z
$100
Asset
$0 Basis

basis of $100. S's sole asset has a basis of $0. S sells its asset for
$100 and recognizes a $100 gain that increases M's basis to $200.
M sells the S share to M1 for $100 and recognizes a $100
intercompany loss. Later, M1 sells the S share to X, an unrelated
person, for $120.
b. M's sale of its S share to M1 is a transfer of a loss share, so the

single corporation, the S share's basis would be $200 ($100
increased by $100 for the gain recognized on the sale of the asset)
and the group would recognize an $80 loss on the sale of the share.
Thus, the sale would be a transfer of a loss share and would be
subject to the Unified Loss Rules to the extent of the $80 loss.

(2) Under the basis reduction rule, the basis in the S share
would be reduced, but not below its $120 value, by the
lesser of the $100 disconformity amount and the $100 net
- 152 -
PIA that was applied to the share when held by M. The

basis in the S share would be reduced by $80, to $120.
(3) Because the S share would not be a loss share after the
application of the basis reduction rule, the attribute
reduction rule would not apply.
(4) M's intercompany item is adjusted to reflect what it would

have been had M's basis in its S share been reduced by $80
immediately before its sale to M1. Thus, M's intercompany
loss is reduced to $20 and M takes this loss into account,
and M1 recognizes a gain of $20. See Reg. 1.1502-36(e)
(3)(iii), Ex. 2.
3. Example 55 Intercompany Sale Creates Built-in Gain Stock
P P
(2)
S Share S Share
M M1 M M1 X
$100 $120
$0 Basis $200 Basis

(1)
Asset
S S Z
$100
Asset Asset
$0 Basis $0 Basis

basis of $0. S's sole asset has a basis of $0. M sells the S share to
M1 for $100 and recognizes a $100 intercompany gain. While
owned by M1, S sells its asset for $100, recognizing a $100 gain
that increases M1's basis in the S share to $200. Later, M1 sells
the S share to X for $120.
b. M's sale of its S share to M1 is a transfer of a share, so the Unified

Loss Rules would apply when M's intercompany item is taken into
account under Reg. 1.1502-13, as if M and M1 were divisions of
a single corporation. If M and M1 were divisions of a single
corporation, the S share's basis would be $100 ($0 increased by
- 153 -
$100 for the gain recognized on the sale of the asset) and the group
would recognize a $20 gain on the sale of the share. Thus, the sale
would not be a transfer of a loss share and the Unified Loss Rules
would not apply. As a result, no portion of M1s $80 loss is subject
to the Unified Loss Rules. M takes its $100 intercompany stock
gain into account, and M1 recognizes an $80 loss. See Reg.
1.1502-36(e)(3)(iii), Ex. 3.
4. Example 56 Subsidiary with Built-in Gain and Built-in Loss Assets
P P
S Share S Share
M M1 M M1 X
$90 $90
(1)
Asset 1
S S Z
$60
Asset 1 Asset 2 Asset 2

basis of $100. S has two assetsAsset 1 with a basis of $0 and
Asset 2 with a basis of $80. M sells the S share to M1 for $90 and
recognizes a $10 intercompany loss. While owned by M1, S sells
Asset 1 for $60, recognizing a $60 gain that increases M1's basis in
the S share to $150. Later, M1 sells the S share to X for $90.
b. M's sale of the S share to M1 is a transfer of a loss share, so the

single corporation, the S share's basis would be $160 ($100
increased by $60 for the gain recognized on the sale of Asset 1)
and the group would recognize a $70 loss on the sale of the share.
Thus, the sale would be a transfer of a loss share, and would be
subject to the Unified Loss Rules to the extent of the $70 loss.

- 154 -

(2) Under the basis reduction rule, the basis in the S share
would be reduced, but not below its $90 value, by the lesser
of the $20 disconformity amount ($160 stock basis over
$140 net inside attribute amount) and the $60 net PIA that
was applied to the share when held by M1. The basis in the
S share would be reduced by $20, to $140.
(3) Under the attribution reduction rule, S would have an

attribute reduction amount of $50, the lesser of the $50 net
stock loss ($140 basis over $90 value) and S's $50
aggregate inside loss (the excess of the sum of S's $80 basis
in Asset 2 and S's $60 cash from the sale of Asset 1, over
the $90 value of the S share).
(4) Because the positive adjustment was applied to the share

when held by M1, the $20 basis reduction required under
the attribution reduction rule is applied to M1's basis in its
S share immediately before its sale to X, reducing it from
$150 to $130. In addition, S's basis in Asset 2 is reduced by
$50, from $80 to $30. M takes its $10 intercompany stock
loss into account and M1 recognizes a loss of $40. See
Reg. 1.1502-36(e)(3)(iii), Ex. 5(i).

36 Loss Disallowance

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

36 Loss Disallowance

Uploaded by

Copyright:

Available Formats

PRACTISING LAW INSTITUTE

TAX STRATEGIES FOR CORPORATE ACQUISITIONS,

The Consolidated Unified Loss Rules

Copyright 2013 Mark J. Silverman, All Rights Reserved.

I. BACKGROUND AND HISTORY OF LOSS DISALLOWANCE AND LOSS

D. Coordination with Loss Deferral and Other Loss Disallowance Rules.................

Example 1 Basic Investment Adjustment Rules........................................................................2

Example 41 Built-In Gain in After-Acquired Asset.................................................................132

A. Investment Adjustment Rules

1. The investment adjustment rules under Reg. 1.1502-32 require that

a. Specifically, basis is increased by Ss taxable income and tax-

b. If S has more than one class of stock outstanding, the adjustments

c. The investment adjustment rules of Reg. 1.1502-32 are based on

d. The adjustments are designed to ensure that consolidated group

2. Example 1 - Basic Investment Adjustment Rules

a. Facts: P acquires all of the stock of S for $100. P and S elect to

b. Under the investment adjustment rules, Ps basis in its S stock is

c. Then, when P sells S in Year 2, it recognizes no gain or loss.

1. Problems Relating to the Repeal of General Utilities

a. Son of Mirrors Transaction

(2) After the repeal of the General Utilities doctrine, the

(3) Example 2 - Basic Son of Mirrors Transaction

(a) Facts: P purchases the stock of S from X for $200.

$200 basis $400 basis

Ss only asset is land with a value of $200 and a

(b) S recognizes $200 gain on the sale of the land to Y.

(c) When P subsequently sells S, it recognizes a $200

(4) Example 3 - Son of Mirrors Transaction - Bust Up

Unwanted Asset Unwanted Asset

(a) Facts: P purchases the stock of S from X for $200.

(b) When S distributes Wanted Asset to P, it results in

(c) Ps subsequent sale of S stock triggers Ss $50

(5) In these examples, Ss built-in gain in its asset was already

(6) Arguably, the lack of a tax on the disposition of Ss asset in

(7) However, the lack of a tax is inconsistent with the purpose

b. Wasting Assets Problem

(1) The Internal Revenue Service (the Service) became

(2) Example 4 - Wasting Assets

$200 basis $300 basis

(a) Facts: P purchases the stock of S from X for $200.

(b) Under the investment adjustment rules, P increases

(c) When P subsequently sells S, it recognizes a $100

2. Loss Duplication Problem

a. The Service is also concerned with the ability to duplicate losses of

b. Example 5 - Loss Duplication: Unrelated Taxpayers

$100 S Stock $100

$60 NOL $60 NOL

(1) Facts: P forms S with a contribution of $100. S has an

(2) Ps basis in its S stock remains at $100, because Ss loss

(3) When P sells the S stock to X for $40, P recognizes a $60

(4) Ps loss on the sale of S is thus duplicated when S uses its

(5) Loss duplication can also occur if S uses the $100

(6) This sort of loss duplication is not unique to consolidated

sections 382, 384, and 269 (not to mention the Treasurys

c. Example 6 - Loss Duplication: Stuffing/Outside Loss Recognized

(1) Facts: In Year 1, P forms S with a contribution of $100 in

(2) P recognizes a $30 loss on the sale of the S preferred stock.

(4) Loss Acceleration In the context of this fact pattern, the

loss before S recognizes its inside loss. See Notice 2002-

d. Example 7 - Loss Duplication: Stuffing/Inside Loss Recognized

(1) Facts: Same facts as in Example 6, except that S sells its

(3) P then recognizes a $30 loss on the sale of the S preferred

(4) Note that if P subsequently disposes of the S common