The IRS issued guidance on May 8 (Notice 2018-30
) that disallows the use of 100% bonus depreciation when using the safe harbor method in Notice 2003-65 to calculate built-in gain or loss after a change in control.
The inability to use bonus depreciation in the safe harbor calculation will potentially reduce the amount of recognized built-in gain that can be used to increase the limit on net operating losses (NOLs) for corporations with net built-in-gain after a change in control. The notice is effective for ownership changes occurring after May 8, 2018.
Section 382 limits the amount of NOLs that can be used by a corporation after a change in control. This limit is adjusted by a corporation’s built-in gain or loss on its assets. The company must calculate the net amount of built-in gain or loss on an aggregate basis (NUBIG or NUBIL) and, as applicable, each asset’s individual recognized built-in gain or loss (RBIG or RBIL).
Notice 2003-65 provides two safe harbor methodologies for determining NUBIG or NUBIL and RBIG or RBIL: the Section 1374 approach and the Section 338 approach. The Section 338 method applies a hypothetical asset-sale model. Under this safe harbor, RBIG can arise not only when an asset is disposed of, but also from the deemed exploitation of a wasting asset. In the latter instance, RBIG is based on the difference between the basis that would be recovered by a buyer in a deemed asset sale versus the corporation’s actual basis recovery of the asset.
The Tax Cuts and Jobs Act increased bonus depreciation to 100% for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023, and made used property eligible for the first time. So in a deemed asset sale, the hypothetical cost recovery would be 100%, potentially increasing RBIG based on the plain language of the safe harbor calculation under Notice 2003-65.
Calculating safe harbor method
A calendar-year corporation experiences a change in ownership in the middle of the year. The only asset of the company is a piece of seven-year property with a fair market value of $10 million and an adjusted basis of $3 million immediately before the ownership change. Thus, the company has a NUBIG of $7 million. This is the maximum amount of RBIG that can arise in the five-year recognition period after an ownership change.
If the asset were sold a week later for $11 million, the RBIG would be limited to the $7 million of NUBIG even though the total gain realized was $8 million. Even if the asset is not sold, RBIG is allowed based on the exploitation of the asset. The calculation of RBIG under the Section 338 deemed an asset approach of Notice 2003-65 would be as follows without bonus depreciation:
The calculation of RBIG under the Section 338 deemed asset approach of Notice 2003-65 with bonus depreciation increases the hypothetical depreciation amount, and therefore the amount of RBIG:
Changes under Notice 2018-30
Notice 2018-30 provides that bonus depreciation under Section 168(k) is not applicable to the deemed asset sale under the Section 338 approach in Notice 2003-65. The hypothetical depreciation amount cannot include any bonus depreciation amount, potentially reducing the RBIG and the adjustment to the NOL limit. The IRS claimed that the legislative history to Section 168(k) amendments were to incentivize capital investment and were not meant to reflect an estimate of income or expenses generated by such assets. The notice also provides that Section 168(k) is not applicable when applying the Section 1374 approach and considering items of RBIL.
The notice applies prospectively for ownership changes occurring after May 8, 2018, and taxpayers should consider it for transactions after that date. For changes in control between Sept. 27, 2017, (when bonus depreciation was first extended to used property) and May 7, 2018, the notice is not technically in effect.
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