Final Unified Loss Rule Published

By Martin Huck, J.D., LL.M., Washington, DC

Editor: David J. Kautter, CPA

In final regulations (T.D. 9424), the Service has addressed the tax consequences of a member’s transfer of loss shares of subsidiary stock. The final regulations adopt the unified loss rule (ULR) contained in the proposed regulations (REG-157711-02), with modifications, and generally apply to transfers made on or after September 17, 2008.

The portion of the proposed regulations (Prop. Regs. Secs. 1.1502-13(e)(4) and 1.1502-32(c)(1)(ii)) addressing the application of Sec. 362(e)(2) to certain intercompany transactions is withdrawn, and the final regulations instead provide that, subject to an anti-avoidance rule, Sec. 362(e)(2) generally does not apply to transactions between consolidated group members.

The final regulations adopt numerous related and unrelated regulatory amendments, so only the most significant aspects are summarized below.


The final regulations clarify that the ULR applies when a member transfers a share of subsidiary stock and, after taking the effects of all applicable rules into account (including those that would not apply until after the transfer), the transferred share is a loss share. While the determination of whether a transferred share is a loss share is made as of the transfer, the ULR applies as a whole, and any required adjustments under that rule are given effect, immediately before the transfer.

Deferred Recognition Transfers

The final regulations coordinate application of the ULR with Regs. Sec. 1.1502- 13’s intercompany transaction provisions. If a member transfers a share of subsidiary stock intercompany under Regs. Sec. 1.1502-13, the ULR applies to the transfer and any subsequent transfer when the intercompany item is taken into account and by treating the buying and selling members as divisions of a single corporation. Thus, appropriate adjustments will be made to intercompany item(s) and any member’s basis in the subsidiary’s share and/or attributes. Notwithstanding the final regulations’ coordination with intercompany transfers, other rules that defer the loss recognized on the sale of subsidiary stock generally do not defer application of the ULR.

Basis in Lower-Tier Stock

The Service considered several suggestions for simplifying application of the ULR to lower-tier stock, such as applying the rules based solely on the net inside attributes of lower-tier subsidiaries (the lookthrough approach), but they were rejected because including lower-tier stock basis in the ULR determinations better protects taxpayers’ interests while also providing adequate protections against abuse.

Nevertheless, the government is sympathetic to the difficulties. Various proposals remain under consideration and comments are requested.

Adjustments for Sec. 362(e)(2) Transactions

The final regulations provide that Sec. 362(e) generally does not apply to (1) intercompany transactions occurring on and after September 17, 2008, and (2) prior intercompany transactions, if the taxpayer chooses to apply the rules in the final regulations. The ULR retains rules for coordination with basis reductions required by Sec. 362(e)(2).

Transition Period

Consistent with Notice 2008-9, the final regulations provide that the final ULR applies to transfers on or after September 17, 2008, unless the transfer is made under a binding agreement between unrelated parties that was in effect before that date and at all times thereafter. Under the final regulations, the term “related party” has the same meaning as in Sec. 267(b).

Redetermination of Subsidiary Stock Basis

The final ULR does not reallocate positive investment adjustments applied to a subsidiary’s preferred shares under Regs. Sec. 1.1502-32 because these adjustments are generally based on economic changes in the shareholder’s investment. Reallocation of remaining investment adjustments is designed to reduce or eliminate artificial loss and loss duplication from transferred loss shares.

Two exceptions to the basis redetermination rule significantly limit its applicability. First, no redetermination is required if members’ bases in shares of S common stock are equal (that is, there is no disparity) and members’ bases in shares of S preferred stock reflect no gain or loss. Second, no redetermination is required if, in one fully taxable transaction: (1) members dispose of their entire interest in S stock to one or more nonmembers; (2) all members’ shares of S stock become worthless; or (3) all members’ shares of S stock are either worthless or disposed of to one or more nonmembers. Notwithstanding this latter exception, taxpayers can elect to redetermine basis (e.g., because it reduces gain or avoids the ULR for upper-tier shares).

When it applies, basis is redetermined in a manner that reduces the extent to which there is disparity in members’ bases, and “the overall application of the rule must reduce disparity among members’ bases in preferred shares of subsidiary stock (as provided in the applicable reallocation provisions) and among members’ bases in common shares of subsidiary stock, to the greatest extent possible” (T.D. 9424 preamble, §B(iii)).

Disallowance of Subsidiary Artificial Stock Loss

The final ULR effectively disallows loss on the transfer of a share of subsidiary stock by reducing the share’s basis immediately before a transfer, based on the lesser of two factors with respect to the share: (1) its net positive investment adjustment and (2) its disconformity amount. In computing disconformity, the final regulations clarify that the term “loss carryovers” means losses that are attributable to the subsidiary, including any losses that would be apportioned to it under the principles of Regs. Sec. 1.1502-21(b)(2) if it had a separate return year. Because a waiver under Regs. Sec. 1.1502-32(b)(4) affects only the extent to which a loss can be duplicated, the final regulations disregard this waiver for purposes of the disconformity amount (i.e., it is taken into account only “for purposes of applying the attribute reduction rule”).

Limitations on Loss Duplication

To simplify the ULR provisions limiting duplication of subsidiary stock loss:

  1. No attribute reduction is required if the total attribute reduction amount is less than 5% of the aggregate value of the subsidiary shares that are transferred
  2. by members in the transaction; and Taxpayers can elect not to apply the conforming limitation or the basis restoration provisions that operate to protect them (e.g., if their protections are outweighed by their administrative burden).

Taxpayers may nevertheless elect to apply the attribute reduction rule (i.e., to take advantage of the rule permitting the reattribution of subsidiary loss).

When it is required, the first attributes reduced are losses and deferred deductions in Categories A, B, and C (capital loss carryovers, net operating loss (NOL) carryovers, and deferred deductions, respectively), and the taxpayer may specify the allocation of attribute reduction amount among the attributes in those categories. If no order is specified, a default rule provides the following order of reduction: capital loss carryovers (oldest to newest); NOL carrryovers (oldest to newest); and deferred deductions (proportionately).

The next attribute reduced is asset basis in Category D other than Class I assets (cash and general deposit accounts, other than certificates of deposit held in depository institutions), and the reduction applies in the reverse order of asset classes specified in Regs. Sec. 1.338-6(b). But the attribute reduction amount applied to Category D must first be allocated between the subsidiary’s basis in any stock of lower-tier subsidiaries (treating all shares of any one lower-tier subsidiary as a deemed single share) and its other assets (treating the nonstock Category D assets as one asset) in the ratio of their basis. Only the portion not allocated to lower-tier subsidiary stock is applied under the reverse residual method.

If the attribute reduction amounts exceed the amount of reducible attributes, the excess is suspended and applied to reduce or eliminate subsequent attributes arising when the subsidiary or any other person takes the liabilities into account.

To promote flexibility, the final regulations allow taxpayers to elect to (or make a protective election to) reduce stock basis or reattribute attributes, or a combination thereof, in any amount that does not exceed the attribute reduction amount.

Attribute Reduction for Certain Dispositions

A special attribute elimination rule applies if:

  1. A member transfers subsidiary stock solely by reason of treating the stock as worthless under Sec. 165, the subsidiary remains a member of the group, and the member has a deduction or recognizes a loss on the transfer; or
  2. A member transfers subsidiary stock as a result of the subsidiary ceasing to be a member, the subsidiary has no separate return year, and the member recognizes a net deduction or loss on the transfer.

In either scenario, the subsidiary’s NOL carryovers, capital loss carryovers, and deferred deductions (including its share of the consolidated tax attributes) that are not otherwise reduced or reattributed, and the subsidiary’s credits (including its share of consolidated credits), are eliminated.

A parallel provision in Regs. Sec. 1.1502-19 applies these two principles to excess loss accounts and similarly eliminates the subsidiary’s tax attributes. The final regulations also provide that the elimination of attributes is not a noncapital, nondeductible expense under Regs. Sec. 1.1502-32.

Changes to Other Sections

Dispositions before September 17, 2008, that were subject to Regs. Sec. 1.1502-35 remain subject to the loss suspension and anti-loss reimportation rules of that regulation. A clarification provides that, if a loss is suspended under Regs. Sec. 1.1502-35(c) and the member with the suspended loss ceases to be a member, then immediately before it ceases to be a member, the common parent is treated as succeeding to the suspended loss under Sec. 381. Another clarification addresses how the 10-year period under the loss anti-reimportation rule is computed.

Uniform amendments are made to the whole-group exceptions in Regs. Secs. 1.1502-13(j)(5), 1.1502-19(c)(3), and 1.1502-33(e)(2), applying them without regard to whether the acquirer is a consolidated group member before the acquisition. Taxpayers may choose to apply each of those modified whole-group exceptions retroactively.

An overarching rule to prevent duplicative adjustments, inclusions, and all similar items is added in Regs. Sec. 1.1502- 80(a). It provides that, in determining the application of any specific rule, the purposes of the provisions and single-entity principles are taken into account.


The final regulations adopt the general approach of the proposed regulations, with helpful modifications. For example, taxpayers may make protective elections that will limit the effect of the loss duplication rules on unsuspecting buyers and have greater administrability and flexibility in identifying the attributes to be reduced (e.g., allowing taxpayers to specifically identify the reduced losses).

By making Sec. 362(e)(2) inapplicable, the final regulations generally eliminate the complex rules for Sec. 362(e)(2) that would have required specialized valuation and tracing of investment adjustments. Instead, the final regulations rely on the generally applicable investment adjustment rules and ULR to police loss duplication, and they add only a specific anti-avoidance rule.

Nevertheless, the final regulations remain quite complex, particularly in the context of lower-tier subsidiaries. The government considered simplification approaches (for example, the lookthrough approach) but rejected them because the more detailed approach better protects taxpayers’ interests while also providing adequate protections against abuse. To comply with these new rules, however, taxpayers must now engage in a whole new set of complicated asset and stock basis calculations.


David Kautter is a partner with Ernst & Young LLP in Washington, DC.

Contributors are members of or associated with Ernst & Young LLP.

For additional information about these items, contact Mr. Kautter at (202) 327-8878 or

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