Consolidated ReturnsLimitations on the Use of Certain Losses and Deductions

SUMMARY: This document contains final regulations regarding certain

deductions and losses, including built-in deductions and losses, of

members who join a consolidated group. The regulations provide rules

for computing the limitation with respect to separate return limitation

year (SRLY) losses, and the carryover or carryback of losses to

consolidated and separate return years. The regulations also eliminate

the application of the SRLY rules in certain circumstances in which the

rules of section 382 of the Internal Revenue Code also apply.

DATES: Effective Dates: These regulations are effective June 25, 1999.

Applicability Dates: For dates of applicability, see the ``Dates of

Applicability'' portion of this preamble.

FOR FURTHER INFORMATION CONTACT: Jeffrey L. Vogel, or Marie Milnes-

Vasquez at (202) 622-7770 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information in this final rule has been reviewed

and, pending receipt and evaluation of public comments, approved by the

Office of Management and Budget (OMB) under 44 U.S.C. 3507 and assigned

control number 1545-1237.

The collection of information in this regulation is in Sec. 1.1502-

21(b)(3). This information is required to ensure that an election to

relinquish a carryback period is properly documented, and will be used

for that purpose. The collection of information is required to obtain a

benefit (relating to the carryover of losses which would otherwise be

carried back). The likely respondents are consolidated groups.

Comments on the collection of information should be sent to the

Office of Management and Budget, Attn: Desk Officer for the Department

of the Treasury, Office of Information and Regulatory Affairs,

Washington, DC 20503, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.

Comments on the collection of information should be received by August

31, 1999.

Comments are specifically requested concerning: Whether the

collection of information is necessary for the proper performance of

the functions of the Internal Revenue Service, including whether the

information will have practical utility; The accuracy of the estimated

burden associated with the collection of information (see below); How

the quality, utility, and clarity of the information to be collected

may be enhanced; How the burden of complying with the collection of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of service to provide information.

Estimated total annual reporting burden: 2,000 hours.

Estimated average annual burden hours per respondent: 15 minutes.

Estimated number of respondents: 8,000.

Estimated annual frequency of responses: On occasion.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background and Explanation of Provisions

On February 4, 1991, the Treasury and the IRS issued three notices

of proposed rulemaking, C0-132-87 (56 FR 4194), CO-077-90 (56 FR 4183),

and CO-078-90 (56 FR 4228), setting forth amendments to the rules

regarding net operating losses, built-in deductions, and capital losses

of consolidated groups. Those proposed regulations also included rules

regarding the carryover and carryback of losses to consolidated return

years and separate return years, and rules regarding the application of

section 382 and 383 by consolidated groups and by controlled groups. A

public hearing regarding the three sets of proposed regulations was

held on April 8, 1991.

On June 27, 1996, the Treasury and the IRS published temporary

regulations regarding the separate return limitation year (SRLY)

limitation (TD 8677, 61 FR 33321). These regulations were substantially

identical to the proposed regulations. A notice of proposed rulemaking

cross-referencing the temporary regulations, the 1996 proposed SRLY

regulations, was published in the Federal Register on the same day (CO-

024-96, 61 FR 33393), and the proposed regulations published in 1991

were withdrawn. The Treasury and the IRS also published temporary

regulations (TD 8678, 61 FR 33335) setting forth rules regarding the

application of section 382 to affiliated groups of corporations filing

consolidated returns, and controlled group losses (TD 8679, 61 FR

33391). Notices of proposed rulemaking cross-referencing these

temporary regulations were published on the same day (CO-026-96, 61 FR

33395, and CO-025-96, 61 FR 33395), and the earlier proposed

regulations published in 1991 were withdrawn.

On August 10, 1998, the Treasury and the IRS issued Notice 98-38

(1998-32 I.R.B. 4). The Notice requested comments about the

advisability of adopting rules that would replace the existing SRLY

rules with an approach modeled on section 382.

As companions to this Treasury decision, which adopts the 1996

proposed SRLY regulations with certain revisions and modifications, the

Treasury and the IRS are also issuing final regulations relating to the

application of sections 382 and 383 by members of consolidated and

controlled groups. See TD 8824 and TD 8825 published elsewhere in this

issue of the Federal Register.

On January 12, 1998, the Treasury and IRS issued temporary and

proposed regulations governing the use of tax credits of a consolidated

group and its members (TD 8751, 63 FR 1740). The Treasury and IRS

intend to finalize those regulations at a later date.

Operation of the Proposed and Temporary Regulations

The 1991 proposed regulations generally retained the approach of

the prior SRLY regulations in limiting a consolidated group's use of

attributes arising in or attributable to a SRLY, but altered the manner

in which the limitation is computed. While the pre-1991 regulations

determined the limitation separately for each member (fragmentation),

and under a year-by-year approach, the proposed regulations

[[Page 36093]]

introduced two new concepts: subgrouping and the cumulative register.

Subgrouping was added because fragmentation is in many ways

inconsistent with the single entity approach to the use of losses under

the consolidated return regulations. For example, if an entire

consolidated group were acquired by another group, under the

fragmentation approach, none of the losses of a former member of the

target group could be used to offset income of another former member of

the target group. However, had no acquisition occurred, those losses

could have been used to offset income within the target group.

The 1991 proposed regulations also introduced the concept of a

cumulative register to address certain issues resulting from the year-

by-year approach. The prior SRLY regulations based the limitation on

the SRLY member's annual contribution to the group's consolidated

taxable income. The SRLY limitation was computed by taking the

difference between the group's consolidated taxable income ``with'' the

SRLY member and ``without'' the SRLY member. This resulted in certain

anomalies. For example, if a SRLY member produced income in a tax year

but the group as a whole did not have income, the SRLY loss could not

be absorbed in that year. Because the member's contribution to income

was not carried over to later years, the SRLY losses also could not be

absorbed in a later year unless the member also contributed to the

group's taxable income in that year.

The cumulative register, rather than looking to a member's

contribution for the year, includes in the limitation computation a

member's complete income history while it is a member of a consolidated

group. The cumulative register is determined by aggregating a member's

net contribution of income in excess of losses absorbed during the

entire period the member was in the consolidated group. To the extent

that the cumulative register for a member is positive, that member's

SRLY net operating losses can be absorbed in a consolidated return year

(provided the group otherwise has taxable income) even though the

member might not have contributed to taxable income in that year. On

the other hand, if the cumulative register is negative, the absorption

of losses is precluded even though the member might have contributed to

taxable income in that consolidated return year.

Much of the complexity of the SRLY rules results from the subgroup

and cumulative register concepts. In fact, the preamble to the proposed

SRLY regulations acknowledged that the subgrouping approach was more

complex than the fragmentation approach and solicited comments about

whether the benefits provided by subgrouping outweigh and justify the

additional burdens required, and whether the fragmentation approach

should be retained. 1991-1 C.B. 759. No comments received in response

to this request advocated the elimination of subgrouping or the

cumulative register, and it was ultimately decided that these

principles would be retained.

Comments

Comments were received in response to the 1991 proposed

regulations, the 1996 temporary regulations and Notice 98-38. Some

comments addressed whether the SRLY rules should be retained. Other

comments addressed issues about the technical operation of the proposed

rules.

All of the comments were evaluated in finalizing these regulations.

Several suggestions were adopted while others were not. This preamble

describes some of the decisions that were made in finalizing the

regulations.

Elimination or Retention of SRLY

The preliminary issue considered in finalizing these regulations

was the extent, if any, to which the SRLY rules should be retained. The

comments were divided about whether to retain or eliminate SRLY. Some

commentators asserted that the amendment to section 382 in 1986

adequately addressed Congressional concerns regarding loss trafficking.

Therefore, it was argued, the SRLY rules should be eliminated because

they have become superfluous, add unwarranted complexity to the

consolidated return system, and are easily avoided. Other commentators

asserted that the SRLY rules should be retained because in their view,

policing loss trafficking is incidental to SRLY's function of resolving

a single entity/separate entity conflict in applying the consolidated

return regulations. A third group suggested a middle position by urging

the elimination of SRLY only in those circumstances in which the rules

of section 382 also apply.

Arguments for Elimination of SRLY

Some commentators urged elimination of the SRLY rules (either in

whole or in part) because, in their view, section 382 provides

sufficient protection against loss trafficking transactions. They

asserted that the rules of section 382 provide greater precision and

predictability about the consequences of a transfer of tax losses, and

that section 382 promotes neutrality between a buyer and seller of tax

benefits in a more efficient and more equitable way than do the SRLY

rules.

Section 382 and SRLY overlap to a large extent, and the rules

applying section 382 to consolidated groups are even more complex than

the SRLY rules. Thus, these commentators asserted that requiring a

taxpayer to run the SRLY gauntlet in addition to the section 382

gauntlet is unwarranted because any additional revenue that might be

gained from retaining a dual limitation is outweighed by the added

complexity of the SRLY rules.

These commentators argued that the complexity of the SRLY rules is

unwarranted because the impact of the SRLY rules is easily avoided by

various ``self-help'' techniques. For example, taxpayers can contribute

income-producing assets or built-in gain assets to the SRLY member to

minimize the effect of a SRLY limitation. They also argued that the

SRLY rules impose a meaningful limitation only in those cases in which,

for regulatory or other reasons, loss corporations cannot be combined

with other profitable businesses. Some commentators also argued that

the SRLY rules improperly discriminate between stock and asset

acquisitions. Other arguments urging the elimination of SRLY asserted

that section 382 supercedes the SRLY rules as a Congressionally

mandated rule for policing loss trafficking and that the SRLY rules are

inconsistent with treating the consolidated group as a single entity.

Arguments for Retention of SRLY

Notwithstanding the substantial area of overlap between section 382

and SRLY, section 382 does not always apply when SRLY does. In fact,

most commentators expressed concern about loss trafficking through

carryback transactions (to which section 382 does not apply) and

acknowledged the need for a rule to police those transactions. Many

urged retention of the existing SRLY rules at least for that purpose.

Moreover, some commentators speculated that elimination of the SRLY

rules would likely present new unforeseen opportunities for trafficking

in tax benefits.

Those commentators supporting retention of SRLY argued that the

objectives of section 382 and SRLY differ. Section 382, which seeks to

prevent loss trafficking, is based on the notion that the rate of loss

utilization following a change in ownership should be based on the

expected income generated if all of the assets were converted to tax-

exempt debt

[[Page 36094]]

instruments. Accordingly, section 382 permits a fixed amount of income

to be used each year to absorb a loss, regardless of the actual income

contribution of the loss corporation. Moreover, under section 382 and

in the absence of SRLY, the available loss can be used against any

member's income. SRLY, on the other hand, makes actual income

generation by the SRLY member the determinant of loss usage. Thus, SRLY

assures that the loss attributes that arose outside of the consolidated

group are not generally available to the other group members.

These commentators noted that the consolidated return system

combines single and separate entity treatment. The ability to offset

the income of one member with the losses of another member reflects

single entity treatment of the consolidated group. But, when a

corporation becomes a member of a consolidated group, it retains its

separate existence and individual status, its own accounting methods,

and its own separate attributes, including its losses that are carried

from a separate return year to a consolidated return year. These

aspects reflect treatment of each member of a consolidated group as a

separate entity. The carryover of losses from separate return years

reflects separate entity treatment, while the sharing of losses among

the members of a consolidated group reflects single entity treatment.

Thus, there is a conflict between single entity and separate entity

treatment. Single entity treatment in computing consolidated taxable

income is inconsistent with permitting a corporation's losses to

straddle consolidated and separate return years when it enters or

leaves a consolidated group. These commentators argued that the SRLY

rules present a resolution of this conflict and protect the integrity

of the consolidated return system by ensuring that attributes arising

in a separate return year belong to, and remain with, the SRLY member,

and attributes arising in a consolidated return year belong to the

group.

Through these rules, according to these commentators, SRLY seeks to

provide that the manner and extent to which a corporation's separate

tax attributes are absorbed or utilized should not vary based on

whether the corporation is inside or outside a consolidated group.

Unlike in the case of section 382, the policy objectives underlying

these rules do not hinge on whether the ownership of the corporation

changes upon its entrance into or departure from the group.

Moreover, commentators urging the retention of SRLY pointed out

that the rules of section 381 dictate the circumstances under which one

corporation can use the tax attributes of another corporation. In

certain reorganizations, section 381 allows the tax attributes of one

corporation to be used by another corporation after an acquisition, but

in those transactions generally stock basis is also lost. By contrast,

in a taxable stock purchase where the stock takes a cost basis and the

corporation retains its existence, including its underlying attributes,

there is no policy reason for those attributes to be freely available

to the purchaser. In essence, these commentators argued, the SRLY

limitation prevents the benefits provided by section 381 in certain

reorganization transactions from being extended to acquisitions and

restructurings that do not involve the commingling of assets in one

entity that section 381 transactions generally require. A consolidated

group's acquisition of the stock of a corporation should not be treated

the same way as an asset acquisition.

Notice 98-38

Notice 98-38 announced that the Treasury and the IRS were

considering an approach that would model the SRLY limitation on the

mechanism of section 382. One intended advantage of this approach was

to reduce complexity in cases of overlap of the SRLY rules with section

382. In those cases, the SRLY limitation would be the same as the

section 382 limitation, and consolidated groups would not need to make

two computations to determine how much income could be used to absorb a

loss. A second intended advantage was to address concerns that the

impact of a SRLY limitation can be minimized by stuffing transactions

(e.g., transferring income-producing assets to the loss corporation)

which could not be used to affect the section 382 limitation.

Although many commentators favor the elimination of a separate SRLY

limitation in the case where section 382 also applies, commentators did

not favor adoption of the section 382 mechanism in cases where section

382 does not otherwise apply. Commentators argued that imposing a

limitation based on section 382 in a case where section 382 would not

otherwise apply would be inordinately burdensome. Because (absent an

ownership change) the owners of a loss corporation held outside a

consolidated group could engage in a stuffing transaction in order to

increase that corporation's loss absorption, commentators argued that a

SRLY limitation that could not be increased through stuffing

transactions would violate the objective of providing that the extent

of a corporation's loss absorption should not vary based on whether it

is inside or outside a consolidated group.

In light of these concerns, the Treasury and the IRS decided not to

impose a SRLY limitation based on the mechanism of section 382.

The Overlap Rule

The Treasury and the IRS believe that limitations on the extent to

which a consolidated group can use attributes arising in a separate

return limitation year remain necessary. However, the Treasury and the

IRS remain concerned about complexity in applying the current SRLY

rules, particularly with respect to situations where both the SRLY

rules and section 382 apply. As described above, the SRLY limitation is

based on the member's (or subgroup's) actual contribution to

consolidated taxable income. The section 382 limitation is based on the

expected income generation of the member (or subgroup) determined with

reference to its value on the change date. On balance, the Treasury and

the IRS believe that the simultaneous or proximate imposition of a

section 382 limitation reasonably approximates a corresponding SRLY

limitation. Accordingly, these regulations generally eliminate the SRLY

limitation in circumstances in which its application overlaps with that

of section 382.

In the majority of cases, the date on which a corporation becomes a

member of a consolidated group (and thus subject to the SRLY rules) is

also a ``change date'' as defined in section 382(j), determined as a

result of an ownership change as defined in section 382(g). In this

situation, under the temporary regulations, taxpayers must calculate

two separate limitations for loss carryovers--the SRLY limitation and

the section 382 limitation. The final regulations provide an overlap

rule which eliminates the application of the SRLY rules in this

situation. As a result, the final regulations remove the burden of

determining two limitations, and simplify the loss limitation rules

applicable to consolidated groups in most instances in which both the

SRLY and the section 382 limitations would otherwise arise.

To address situations in which not all of an acquisition occurs

simultaneously, the overlap rule also applies if the acquisition

results in a corporation joining the consolidated group on a date other

than the ``change date'', provided the transactions are separated by no

more than six months. Additional rules have been included to prevent

the

[[Page 36095]]

inappropriate operation of the overlap rule in certain cases involving

the acquisition of multiple corporations.

Net Operating Losses

Generally, to qualify for the net operating loss overlap rule, a

corporation must become a member of a consolidated group (a SRLY event)

within six months of the change date of an ownership change that gives

rise to a section 382(a) limitation with respect to that carryover (a

section 382 event). For net operating losses, an overlap also will

generally include situations in which a net operating loss arises in

the maximum six month period after the section 382 event but before the

SRLY event.

For example, if a section 382 event occurs on April 1 and a SRLY

event occurs on September 1, any losses that arise between April 1 and

September 1 would not be subject to a section 382 limitation because

they would be allocable to the post-change period. However, in the

absence of the overlap rule, those losses would be subject to a SRLY

limitation. The overlap rule of the final regulations eliminates the

application of SRLY to those post-change losses. In cases of an

acquisition of a single corporation, the elimination of SRLY has been

determined to be an appropriate result and is a trade-off to promote

simplicity in the consolidated return regulations.

The final regulations provide special overlap rules for subgroups.

In general, the overlap rule applies to the subgroup and not separately

to the members of the subgroup. However, the overlap rule does not

apply unless the SRLY subgroup is coextensive with the section 382 loss

subgroup. This rule is necessary because a section 382 subgroup

limitation that is computed with respect to the expected income

generation of a group of corporations does not reasonably approximate a

limitation that would be based on the actual contribution to

consolidated taxable income by a smaller number of corporations. In the

reverse case, where the SRLY subgroup is larger than any corresponding

section 382 loss subgroup or single new loss member, and particularly

with respect to built-in losses, it is unclear in certain circumstances

how the overlap rule could be applied. To address such circumstances in

which a SRLY subgroup would otherwise be larger than the corresponding

section 382 subgroup or single new loss member, the accompanying final

regulations relating to the application of sections 382 and 383 provide

for an election effectively to expand a newly-formed section 382

subgroup to conform with a SRLY subgroup.

For example, assume that the S consolidated group (composed

entirely of S and T) has a $200 consolidated net operating loss, of

which $100 is attributable to S and $100 is attributable to T. If the M

group acquires the S group, S and T compose both a SRLY subgroup as

well as a section 382 loss subgroup. Because the subgroups are

coextensive, the overlap rule applies to eliminate the application of

SRLY in the M group for the $200 consolidated net operating loss.

The overlap rule will not apply, however, if all the corporations

included in a section 382 loss subgroup are not also included in a SRLY

subgroup. For example, in Year 1, T joins the S group with a net

operating loss carryover in a transaction that is not subject to

section 382, and T does not subsequently have an ownership change.

Under Sec. 1.1502-96 (relating to the end of separate tracking), after

five years, T's net operating loss becomes an attribute of the S group

(also referred to as a ``fold-in'') for section 382 purposes. If the P

group later acquires S in a transaction to which section 382 applies,

the section 382 loss subgroup with respect to the T loss would include

S and T, but for SRLY purposes there would be no subgroup. In this

situation, the overlap rule would not apply, and the limitations under

both SRLY and section 382 would continue to apply.

To preserve the effect of the elimination of SRLY under the overlap

rule as corporations move from group to group, the final regulations

also provide a special rule expanding the definition of SRLY subgroups.

Under this rule, a SRLY subgroup includes a member carrying over a loss

that was subject to the overlap rule in a former group, and all members

of that former group who become a member of the current group at the

same time as the loss member. The effect of this rule is to increase

the number of circumstances in which SRLY subgroups and section 382

subgroups will be coextensive as corporations move from group to group.

However, SRLY and section 382 subgroups may not be coextensive with

respect to losses that were carried into a former group in a

transaction to which the overlap rule does not apply. Subgroups may not

be coextensive, as demonstrated above, if for purposes of section 382,

such losses ``fold-in'' to the former group by virtue of an ownership

change occurring more than six months after the SRLY event or because

the loss member remains a member of the former group for at least five

years.

Operating Rules

If the section 382 event occurs on the same date as the SRLY event

or precedes the SRLY event, the overlap rule, and therefore the

elimination of SRLY, is applicable to the tax year that includes the

SRLY event. If the SRLY event precedes the section 382 event, the

elimination of SRLY is delayed until the first tax year that begins

after the section 382 event. The delay is necessary to ensure that an

adequate limitation is always in effect for a net operating loss

carryover.

For example, for a calendar year consolidated group, if the SRLY

event occurs December 1, Year 1, but the section 382 event occurs on

April 1, Year 2, it is necessary to maintain the application of the

SRLY rules between such dates because otherwise no limitation would be

applicable and the separate attributes could be freely absorbed during

that period.

Built-in Losses

The overlap rule for built-in losses is very similar to the overlap

rule for net operating losses. Generally, to qualify for the built-in

loss overlap rule, a SRLY event must occur within six months of the

change date of an ownership change that gives rise to a section 382(a)

limitation that would apply to recognized built-in losses (a section

382 event). However, the overlap rule does not apply (even with respect

to assets held on the date of the section 382 event) if assets are

transferred to a corporation after the section 382 event and before the

SRLY event that exceed the de minimis threshold of section 382(h). In

that case, both the SRLY rules and the section 382 rules will apply.

Even after the application of the overlap rule, the SRLY rules for

built-in losses apply to asset acquisitions by an acquired corporation

that occur after the latter or the SRLY event or section 382 event.

Special Subgroup Rule for Built-in Losses

The temporary regulations provide that, for purposes of built-in

losses, a SRLY subgroup consists of those members that have been

continuously affiliated for the 60-month period ending immediately

before they become members of the group in which the loss is

recognized. Generally, the final regulations maintain the subgroup rule

provided by the temporary regulations. The final regulations, however,

modify the subgroup rules to take account of the overlap rule. These

modifications, in effect, conform the SRLY subgroup rules to adopt

principles contained in

[[Page 36096]]

Sec. Sec. 1.1502-91 through 1.1502-98 (regarding the application of

section 382 to consolidated groups) where necessary to preserve the

effect of an overlap transaction in a former group and to increase the

number of SRLY and section 382 subgroups that are coextensive and

eligible for future operation of the overlap rule as corporations move

from group to group.

The final regulations provide that after a corporation joins a

group in an overlap transaction, it is deemed to have been affiliated

with the common parent of the acquiring group for 60 consecutive

months. Those corporations that join the group in the same transaction,

but that were not part of a subgroup eligible for the overlap rule,

begin measuring the period of their affiliation immediately after

joining the group, notwithstanding their actual affiliation history.

This rule may prevent some corporations from subsequently qualifying as

a SRLY subgroup, notwithstanding their actual affiliation history. For

example, assume that after four years of affiliation, S and T join the

P group without any net operating loss carryovers. S, which has a net

unrealized built-in loss, and T, which has a net unrealized built-in

gain, would not qualify as a SRLY subgroup with respect to their built-

in items because they do not have the requisite affiliation history.

Therefore, S and T are tested separately under section 382 and

Sec. 1.1502-15. The acquisition results in S becoming subject to

section 382 (but owing to the overlap rule, not to the limitation

contained in Sec. 1.1502-15(a)). T is not subject to either. Because S

joined the P group in a transaction subject to the overlap rule, it is

deemed to have been affiliated with P for 60 consecutive months. T,

however, is required to begin measuring its affiliation with P and S

from the date it joined the group, notwithstanding its historic

affiliation with S.

Other Substantive Changes

Predecessors and Successors

Material Difference Requirement

The temporary regulations provide that a reference to a corporation

or member also includes, as the context may require, a reference to a

successor or predecessor. See, Sec. 1.1502-15T(e) and Sec. 1.1502-

21T(f). The definition of predecessor is provided in Sec. 1.1502-

1(f)(4). In general, a predecessor is any transferor of assets in a

section 381(a) transaction. A predecessor also includes any transferor

of assets in a transaction in which the basis of assets to the

transferee (successor) is determined by reference to the transferor's

basis, but only if there is a ``material difference'' between the basis

and the value of assets. Thus the application of the predecessor rule

to a section 351 transaction is dependent upon the specific assets

transferred, and consequently a transferor in a section 351 transaction

might not qualify as a predecessor. Also, in the case of such a section

351 transaction, the temporary regulations provided that there be a

maximum of one predecessor to, or successor of, any member.

Commentators objected to the ``material difference'' requirement

and suggested that a section 351 transferee should not be excluded from

successor status solely because there was no material difference

between the basis and value of the assets transferred. The final

regulations eliminate both the material difference and the single

predecessor-successor requirements.

CNOL Carrybacks

Section 1.1502-21T(b)(2)(B) of the temporary regulations provides

an offspring rule which generally permits the common parent of a group

to carryback a consolidated net operating loss (CNOL) attributable to a

member that did not exist in the year to which the loss is carried,

provided that the member has been a member of the group continuously

since its organization. In that section, there is also a reference to

the application of the predecessor and successor rule of Sec. 1.1502-

21T(f), which states that a reference to a member also includes

references to a predecessor of the member, as the context may require.

Commentators were concerned that the combination of the predecessor

and successor rule would deny any carryback in the case of a merger

under section 368(a)(1)(A) and (a)(2)(D). For example, assume that P,

the common parent of a consolidated group, forms Newco in Year 2 for

the sole purpose of acquiring T, in a merger with and into Newco. In

Year 3, there is a CNOL all of which is attributable to Newco. Newco

appears to be within the scope of the offspring rule, and therefore a

carryback to P's Year 1 consolidated return, a year before Newco's

existence, would be permitted. However, because the merger is a

transaction to which section 381(a) applies, Newco is also a successor

to T. Under this analysis, Newco would not be considered to have been a

member of the P group continuously since its organization, so a

carryback to the P group's consolidated return year would not be

permitted. Moreover, Newco would not be permitted to carryback the loss

to any year of T. Thus, no carryback of Newco's loss would be

permitted.

The Treasury and the IRS believe that the denial of any carryback

in this situation is inappropriate. In general, a newly-formed group

member should be permitted to carry back its contribution to the

consolidated net operating loss, whether or not it is a successor to a

corporation that was acquired by the group. Moreover, the Treasury and

the IRS believe that rules providing for a carryback within--rather

than outside--the group would be more administrable than rules

requiring taxpayers to trace the assets of a newly-formed member to

determine whether such corporation's contribution to the consolidated

net operating loss should be carried back to the pre-consolidation

years of an acquired corporation or back within the group. The Treasury

and the IRS also considered whether to provide that all consolidated

net operating losses should be carried back within the group, even if

attributable to a corporation that was itself acquired from outside the

group. Whether or not such a rule is appropriate, it was determined

that such a change should not be adopted in final regulations.

Accordingly, the final regulations provide that the offspring rule

applies regardless of whether the newly-formed member is a successor to

any other corporation.

Successor's Income

Section 1.1502-21T(f)(2) of the temporary regulations provides,

``Except as the Commissioner may otherwise determine, any increase in

the taxable income of a SRLY subgroup that is attributable to a

successor is disregarded unless the successor acquires substantially

all of the assets and liabilities of its predecessor and the

predecessor ceases to exist.'' The rule was intended to prevent the

subgroup from inappropriately affecting the determination of its

taxable income either by removing assets that would generate losses or

by bringing into the subgroup income generated by members outside the

subgroup.

Some commentators stated that they did not understand whether the

rule was intended to require the subgroup to disregard all income of

the successor, or only that income of the successor in excess of that

generated by the transferred assets. In the event that all the

successor's income is disregarded, commentators argued that the rule

produced unduly harsh results. A particularly sympathetic case is a

divisive section 351 transaction. For example, if T, a member of a SRLY

subgroup, formed T1, by contributing to it one of its businesses, and

T1 produced net operating losses, those losses would be included in

[[Page 36097]]

determining the taxable income of the subgroup. On the other hand, if

T1 produced taxable income, that income would not be included in the

subgroup's taxable income. If no transfer to T1 had occurred, and the

business had remained in T, all of its income or loss, as the case may

be, would be included in determining the subgroup's taxable income.

The Treasury and the IRS have determined that a broad rule

disregarding all income contributed by the successor is necessary to

avoid an unadministrable requirement that the successor's income be

traced to particular assets, but that the rule should only be applied

in more limited circumstances. Thus, the final regulations provide that

the net positive income attributable to the successor generally is

disregarded, but provide four exceptions to this rule: (A) The

successor acquires substantially all of the assets and liabilities of

its predecessor, and the predecessor ceases to exist; (B) the successor

became a member of the SRLY subgroup at the time the subgroup was

formed (e.g., the successor was organized before it and its affiliates

joined the current group and thus qualifies in its own right as a

subgroup member); (C) 100 percent of the stock of the successor is

owned directly by corporations that were members of the SRLY subgroup

when the subgroup was formed; or (D) the Commissioner determines

otherwise. The IRS might, for example, publish a revenue ruling or

other guidance expanding the list of exceptions if it is later

determined that other circumstances should be excluded from the general

rule. It is also anticipated that through the letter ruling process,

the IRS will evaluate individual cases upon request and determine

whether income attributable to a successor will be included in

determining the subgroup's taxable income. See also Sec. 1.1502-

21(c)(2)(iv) of the regulations (an anti-abuse rule denying SRLY

subgroup treatment in certain circumstances.)

Built-in Losses

Non-Corporate Transferors

Section 1.1502-15T(a) of the temporary regulations provides that

solely for the purpose of determining the amount of, and the extent to

which, a built-in loss is limited by the SRLY rules for the year in

which it is recognized, a built-in loss is treated as a hypothetical

net operating loss carryover or net capital loss arising in a SRLY,

instead of as a deduction or loss in the year recognized.

Some commentators thought the rule was anomalous as applied to

transfers of built-in loss assets by individuals. In their view,

because a SRLY is defined only with respect to corporations (see

Sec. 1.1502-1(f)), it would be inappropriate to view a corporate

transferee as a successor to a non-corporate transferor. Other

commentators asserted that because the built-in loss concept is a

subset of the SRLY limitations, the built-in loss rules should not

apply to transfers by an individual or other non-corporate transferor

to a member of a consolidated group in a section 351 transaction.

The temporary regulation does not base the determination of whether

a corporation has built-in losses on any application of the predecessor

and successor rule. If an asset enters the group with a built-in loss,

in general, the temporary regulation deems the built-in loss to have

arisen in a SRLY without regard to whether the asset was owned by a

corporation when the built-in loss arose. Moreover, Sec. 1.1502-

15T(b)(2)(i) provides that in the case of an asset acquisition by a

group, the assets and liabilities acquired directly from the same

transferor pursuant to the same plan are treated as the assets and

liabilities of a corporation that becomes a member of the group on the

date of the acquisition. That corporation would generally be subject to

the SRLY built-in loss rules when it becomes a member of the

consolidated group. The Treasury and the IRS continue to believe that a

separate tax attribute arising outside the consolidated group should

not be freely absorbed within the group, regardless of where that

separate attribute arose. Accordingly, these final regulations reaffirm

that a built-in loss asset transferred to a group by a non-corporate

transferor is subject to the SRLY rules. An example explains that for

purposes of applying the SRLY limitation to that built-in loss, all of

the items contributed by the acquiring member (and not just items

attributable to that asset) to consolidated taxable income are taken

into account.

Lonely Parent

Under Sec. 1.1502-15T of the temporary regulations, the SRLY

limitation on recognized built-in losses applies to a loss recognized

by the group on an asset the common parent held prior to the formation

of a group. In contrast, net operating loss carryovers of a corporation

that becomes the common parent of a consolidated group are not subject

to a SRLY limitation within the group under the so-called ``lonely

parent'' rule (see Sec. 1.1502-1(f)(2)(i)).

The final regulations conform the built-in loss rules to the net

operating loss rules as applied in conjunction with the lonely parent

rule. Therefore, a loss recognized by any member of the group on an

asset that was held by the corporation that becomes the common parent

when the group is formed is not subject to the SRLY rules. However, a

built-in loss asset acquired by the common parent after the formation

of the group remains subject to the SRLY limitation. An anti-abuse rule

is also provided to apply the SRLY limitation to built-in loss assets

transferred to a corporation prior to and in anticipation of the

corporation becoming the common parent of a group.

For example, in Year 1, P, a stand alone corporation holds Asset 1,

a built-in loss asset. In Year 3, P forms S but retains Asset 1. In

Year 4, P sells Asset 1, recognizing a loss. Section 1.1502-15(f) of

the final regulations provides that the loss is not subject to the SRLY

limitation. Similarly if P transferred Asset 1 with an unrealized

built-in loss to S, the SRLY limitation on built-in losses would not

apply if S sold Asset 1 and recognized the loss. However if, after the

formation of the P/S group, P acquired an asset with an unrealized

built-in loss and sold the asset, recognizing that loss during the

recognition period, a SRLY limitation would apply with respect to that

loss.

Split Election Rule

Section 1.1502-21T(b)(3)(i) of the temporary regulations permits a

consolidated group to waive the entire carryback period provided by

section 172. This irrevocable election is not available on a member by

member basis, but rather requires that the common parent waive the

carryback period for all members of the group.

Some commentators suggested that the election be permitted on a

member-by-member basis. The commentators expressed concern that

requiring the whole group to waive the carryback period makes it

difficult for sellers and purchasers to negotiate who gets the benefit

of a post-acquisition loss. Because section 172 generally requires a

carryback to the earliest year, absent the purchaser's waiver of the

carryback, a seller could be required to disclose confidential tax

information to the purchaser relating to the ability to use the loss

carryback. In situations where such disclosure is a concern, an

election to waive the loss carryback, available on a member by member

basis, could ensure the separation of a particular purchaser and seller

without requiring the group to waive the remaining

[[Page 36098]]

amount of the consolidated net operating loss carryback.

The final regulations permit taxpayers to waive, with respect to

all consolidated net operating losses attributable to a member, the

portion of the carryback period for which the corporation was a member

of another group. If an election is made for any member, all members

acquired from the same group, in the same transaction, are required to

make the election. The election must be made on the timely filed

original return for the year of the acquisition.

Absorption of Losses

Section 1.1502-21T(b)(1) provides general rules concerning the

absorption of losses within a consolidated group. Although the rules

refer to section 382(l)(2)(B), commentators stated that the absorption

rules were ambiguous with respect to establishing the priority of

absorption of multiple losses carried from the same taxable year if

only a portion of the losses were subject to limitation under section

382. The final regulations make clear that the rule of section

382(l)(2)(B) applies, and that losses limited by section 382 are

absorbed before losses from the same taxable year that are not subject

to a section 382 limitation, regardless of whether such losses are

attributable to the same member.

A comment was also received requesting guidance on how to determine

the amount of a subgroup member's net operating loss carryover that was

absorbed so that it can determine how much of the loss it retains when

it leaves the group. In response to this comment, the final regulations

provide that within a subgroup, losses are absorbed on a pro rata

basis. Thus, when a subgroup member leaves the group, its net operating

loss carryover is treated as having been absorbed on a pro rata basis,

determined by comparing its initial net operating loss carryover and

the subgroup's initial net operating loss carryover.

Dates of Applicability

The final regulations generally are applicable for taxable years

for which the due date (without extensions) of the consolidated return

is after June 25, 1999. However, there are several special effective

dates, including an effective date which addresses transitional issues

relating to the adoption of the rule eliminating SRLY in the event of

an overlap with section 382.

Generally, if a particular attribute would not have been subject to

a SRLY limitation as of June 25, 1999 if these final regulations had

always been in effect, and the overlap transaction occurred after the

effective date of section 382 as amended by the 1986 Tax Reform Act,

then the existing SRLY limitation will not apply in taxable years for

which the due date (without extensions) of the consolidated return is

after June 25, 1999 (but will not be eliminated retroactively with

respect to earlier taxable years).

If an existing SRLY limitation for which the cumulative register

began in a taxable year prior to a taxable year for which the due date

(without extensions) of the consolidated return is after June 25, 1999

would not be eliminated by the overlap rule, that SRLY limitation

continues to be applied without regard to the changes applicable to the

definition of SRLY subgroups (so that a member or SRLY subgroup is not

forced to alter the application of a SRLY limitation in midstream).

However, when corporations enter a group in a new SRLY event occurring

in a taxable year for which the due date (without extensions) of the

consolidated return is after June 25, 1999, the regulations apply (with

respect to any overlap transactions occurring after the effective date

of section 382 as amended by the 1986 Tax Reform Act) as if the final

regulations had always been in effect.

Thus, for example, and assuming that all corporations are on a

calendar taxable year, if a corporation S joins the P group in an

overlap transaction in 1996, and the first year for which this final

regulation is effective is 1999, then any losses carried by S into the

P group are subject to a SRLY limitation in 1996, 1997 and 1998.

However, the losses are no longer subject to a SRLY limitation within

the P group starting in 1999.

If, in the above example, the M group had acquired both P and S on

January 1, 1998 in a non-overlap transaction, and S carried into the M

group its losses arising before it joined the P group, then, in 1998,

under the temporary regulations as then in effect, those S losses would

have been subject to a SRLY limitation computed with reference only to

S's cumulative register. Under the special transition rule, the new

regulations would not operate in 1999 or thereafter to cause S and P to

constitute a SRLY subgroup in the M group with respect to those S

losses, even though P and S would otherwise qualify as a SRLY subgroup

with respect to those losses under the new rules. However, if the X

group acquires both P and S from M in or after 1999, P and S would

constitute a SRLY subgroup with respect to those S loss carryovers.

Need for Immediate Guidance

Because the temporary regulations are not applicable for taxable

years ending after June 26, 1999, it is necessary to implement these

final regulations without delay to ensure continuity of treatment of

certain attributes and to ensure that there is no period within which

the treatment of such attributes is inconsistent with the temporary

regulations and these final regulations. See section 7805(e)(2).

Accordingly, it is impracticable and contrary to the public interest to

issue this Treasury decision subject to the effective date limitation

of section 553(d) of title 5 of the United States Code (if applicable).

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. It is hereby

certified that these regulations will not have a significant economic

impact on a substantial number of small entities. This certification is

based on the fact that these regulations principally affect

corporations filing consolidated federal income tax returns that have

carryover or carryback of certain losses from separate return

limitation years. Available data indicates that many consolidated

return filers are large companies (not small businesses). In addition,

the data indicates that an insubstantial number of consolidated return

filers that are smaller companies have loss carryovers or carrybacks

that are subject to the separate return limitation year rules.

Therefore, a Regulatory Flexibility Analysis under the Regulatory

Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to

section 7805(f) of the Code, the notice of proposed rulemaking

preceding these regulations was sent to the Small Business

Administration for comment on its impact on small businesses.

Drafting Information. The principal author of these regulations is

Jeffrey L. Vogel of the Office of Assistant Chief Counsel (Corporate),

IRS. Other personnel from the Treasury and the IRS participated in

their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

[[Page 36099]]

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by

removing the entries for sections 1.1502-15T, 1.1502-21T, 1.1502-22T,

and 1.1502-23T and adding entries in numerical order to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1502-12 also issued under 26 U.S.C. 1502. * * *

Section 1.1502-15 also issued under 26 U.S.C. 1502. * * *

Section 1.1502-22 also issued under 26 U.S.C. 1502.

Section 1.1502-23 also issued under 26 U.S.C. 1502. * * *

Par. 2. In the list below, for each section indicated in the left

column, remove the wording indicated in the middle column, and add the

wording indicated in the right column.

------------------------------------------------------------------------

Affected section Remove Add

------------------------------------------------------------------------

1.469-1(h)(2)............... 1.1502-21T (net 1.1502-21 (net

operating losses operating losses),

(temporary)), and and 1.1502-22

1.1502-22T (consolidated net

(consolidated net capital gain and

capital gain and loss).

loss (temporary)).

1.597-2(c)(5), first 1.1502-15T, 1.1502- 1.1502-15, 1.1502-

sentence. 21T, and 1.1502-22T. 21, and 1.1502-22

1.597-2(c)(5), second 1.1502-15T, 1.1502- 1.1502-15, 1.1502-21

sentence. 21T or 1.1502-22T. or 1.1502-22.

1.597-4(g)(3), fifth 1.1502-15T, 1.1502- 1.1502-15, 1.1502-21

sentence. 21T and 1.1502-22T. and 1.1502-22.

1.597-4(g)(3), sixth 1.1502-15T, 1.1502- 1.1502-15, 1.1502-

sentence. 21T, or 1.1502-22T. 21, or 1.1502-22.

1.904(f)-3(a), first (or Sec. 1.1502- (or Sec. 1.1502-

sentence. 21T(b). 21(b).

1.904(f)-3(b), first (or Sec. 1.1502- (or Sec. 1.1502-

sentence. 22T(b). 22(b).

1.1502-2(h)................. 1.1502-22T) (or, for 1.1502-22) (or, for

consolidated return consolidated return

years to which Sec. years to which Sec.

1.1502-22T. 1.1502-22.

1.1502-3T(c)(2)(iii), first 1.1502-21T(c)(2).... 1.1502-21(c)(2).

sentence.

1.1502-3T(c)(2)(iii), second 1.1502-21T(f)....... 1.1502-21(f).

sentence.

1.1502-9(a), seventh Sec. 1.1502-21T(b)( 1.1502-21(b)(2).

sentence. 2).

1.1502-9(a), eighth sentence 1.1502-21T(b)(1).... 1.1502-21(b)(1).

1.1502-11(a)(2)............. Sec. 1.1502-21T.... 1.1502-21.

1.1502-11(a)(3)............. Sec. 1.1502-22T.... 1.1502-22.

1.1502-11(a)(4)............. Sec. 1.1502-23T.... 1.1502-23.

1.1502-11(b)(2)(iii) Example 1.1502-21T.......... 1.1502-21.

1(c), last sentence.

1.1502-11(b)(2)(iii) Example 1.1502-21T and 1.1502-21 and 1.1502-

2(d), last sentence. 1.1502-22T. 22.

1.1502-12(b)................ 1.1502-15T.......... 1.1502-15.

1.1502-13(c)(7)(ii) Example S's net operating P's acquisition of S

10(d), first and second loss carryovers are is not subject to

sentences. subject to the the overlap rule of

separate return Sec. 1.1502-21(g),

limitation year and S's net

(SRLY) rules. See operating loss

Sec. 1.1502-21T(c). carryovers are

subject to the

separate return

limitation year

(SRLY) rules. See

Sec. 1.1502-21(c).

1.1502-13(g)(5) Example 1.1502-15T (or Sec. 1.1502-15 (as

4(b), fourth sentence. 1.1502-15A, as appropriate).

appropriate)

(limitations on the

absorption of built-

in losses).

1.1502-13(h)(2) Example 1.1502-21T(c)....... 1.1502-21(c).

1(a), second sentence.

1.1502-13(h)(2) Example 1.1502-21T(c)....... 1.1502-21(c).

1(b), first sentence.

1.1502-13(h)(2) Example 1.1502-15T.......... 1.1502-15.

2(a), last sentence.

1.1502-13(h)(2) Example 1.1502-22T.......... 1.1502-22.

2(b), second sentence.

1.1502-20(c)(4) Example 1.1502-21T.......... 1.1502-21.

7(iii), first sentence.

1.1502-20(g)(3) Example 1.1502-21T.......... 1.1502-21.

1(i), second sentence.

1.1502-20(g)(3) Example Sec. 1.1502-21A or 1.1502-21A or 1.1502-

2(i), fourth sentence. 1.1502-21T. 21.

1.1502-23A(a), third 1.1502-21T(c) and (1.1502-21T(c) in

sentence. 1.1502-22T(c), as effect prior to

provided in Sec. June 25, 1999, as

1.1502-15T(a). contained in 26 CFR

part 1 revised

April 1, 1999 and

1.1502-22T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

provided in 1.1502-

15T(a) in effect

prior to June 25,

1999, as contained

in 26 CFR part 1

revised April 1,

1999) or (1.1502-

21(c) and 1.1502-

22(c), as provided

in 1.1502-15(a), as

applicable)).

1.1502-23A(b), first 1.1502-21T(g)....... 1.1502-21(h) or

sentence. 1.1502-21T(g) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-23A(b), second 1.1502-21T(g) for 1.1502-21(h) or

sentence. effective dates of 1.1502-21T(g) in

that section. effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable for

effective dates of

these sections.

1.1502-26(a)(1) concluding 1.1502-21T(e)....... 1.1502-21(e).

text.

1.1502-32(b)(5)(ii) Example 1.1502-21T(b)....... 1.1502-21(b).

2 (b), third sentence.

1.1502-41A(c), first 1.1502-21T(g)....... 1.1502-21(h) or

sentence. 1.1502-21T(g) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable

[[Page 36100]]

1.1502-41A(c), second 1.1502-21T(g) for 1.1502-21(h) or

sentence. effective dates of 1.1502-21T(g) in

that section. effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable for

effective dates of

these sections.

1.1502-42(f)(4)(i)(A)....... 1.1502-21T(b)....... 1.1502-21(b).

1.1502-43(b)(2)(iv)......... 1.1502-21T(a)....... 1.1502-21(a).

1.1502-43(b)(2)(v).......... 1.1502-22T(a)....... 1.1502-22(a).

1.1502-43(b)(2)(vi)(A)...... 1.1502-22T(a)....... 1.1502-22(a).

1.1502-43(b)(2)(vii)........ 1.1502-22T(b)....... 1.1502-22(b).

1.1502-43(b)(2)(viii)....... 1.1502-15T) and 1.1502-15) and

1.1502-15T (SRLY 1.1502-15.

limitation on built-

in losses

(temporary)).

1.1502-44(b)(2)............. Sec. 1.1502-21T.... 1.1502-21.

1.1502-44(b)(3)............. Sec. 1.1502-22T.... 1.1502-22.

1.1502-47(h)(2)(i).......... 1.1502-21T.......... 1.1502-21.

1.1502-47(h)(2)(ii)......... 1.1502-21T(e)....... 1.1502-21(e).

1.1502-47(h)(2)(iii),first 1.1502-21T.......... 1.1502-21.

sentence.

1.1502-47(h)(2)(iv), first 1.1502-21T.......... 1.1502-21

sentence.

1.1502-47(h)(3)(iii)........ 1.1502-21T(c)....... 1.1502-21(c).

1.1502-47(h)(4)(i), first 1.1502-22T.......... 1.1502-22.

sentence.

1.1502-47(h)(4)(i), second 1.1502-22T.......... 1.1502-22.

sentence.

1.1502-47(h)(4)(ii), first 1.1502-22T.......... 1.1502-22.

sentence.

1.1502-47(h)(4)(ii), first 1.1502-21T.......... 1.1502-21.

sentence.

1.1502-47(h)(4)(iii)........ 1.1502-22T(b)....... 1.1502-22(b).

1.1502-47(k)(5) introductory 1.1502-22T.......... 1.1502-22.

text.

1.1502-47(l)(3)(i), second 1.1502-21T.......... 1.1502-21.

sentence.

1.1502-47(m)(2)(ii), first 1.1502-21T.......... 1.1502-21.

sentence.

1.1502-47(m)(2)(ii), first 1.1502-22T.......... 1.1502-22.

sentence.

1.1502-47(m)(3)(i), first 1.1502-21T and 1.1502-21 and 1.1502-

sentence. 1.1502-22T. 22.

1.1502-47(m)(3)(vi)(A), 1.1502-21T(b) or 1.1502-21(b)).

second sentence. 1.1502-79A(a)(3)(as

appropriate).

1.1502-47(m)(3)(vi)(A), Sec. 1.1502-21T(b) 1.1502-21(b).

second sentence. or 1.1502-

79A(a)(3)(as

appropriate).

1.1502-47(m)(3)(vii)(A)..... 1.1502-21A(b)(3)(ii) 1.1502-21A(b)(3)(ii)

or 1.1502-21(b).

1.1502-47(m)(3)(ix), last 1.1502-15T.......... 1.1502-15.

sentence.

1.1502-47(q), last sentence. 1.1502-21T.......... 1.1502-21.

1.1502-55T(h)(4)(iii) 1.1502-21T(c)(2).... 1.1502-21(c)(2).

(B)(4), first sentence.

1.1502-55T(h)(4)(iii) 1.1502-21T(f)....... 1.1502-21(f).

(B)(4), second sentence.

1.1502-78(a), first sentence 1.1502-21T(b), 1.1502-21(b), 1.1502-

1.1502-22T(b). 22(b).

1.1502-79(a), second 1.1502-21T(b)....... 1.1502-21(b).

sentence.

1.1502-79(b), second 1.1502-22T(b)....... 1.1502-22(b).

sentence.

1.1502-79(c)(1)............. 1.1502-21T(b)....... 1.1502-21(b).

1.1502-79(d)(1)............. 1.1502-21T(b)....... 1.1502-21(b).

1.1502-79(e)(1)............. 1.1502-21T(b)....... 1.1502-21(b).

1.1502-91T(a)(2), last 1.1502-21T(a)....... 1.1502-21(a) or

sentence. 1.1502-21T(a) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-91T(c)(3) Example 1.1502-21T(c)....... 1.1502-21(c) or

(b), first sentence. 1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-91T(d)(1)(iii)....... 1.1502-21T(c)....... 1.1502-21(c) or

1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-91T(d)(6) Example 1.1502-21T(b)....... 1.1502-21(b) or

1(a), fourth sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-91T(d)(6) Example 1.1502-21T(b)....... 1.1502-21(b) or

2(a), fourth sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-91T(f)(2) Example 1.1502-21T(b)....... 1.1502-21(b) or

(a), last sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-92T(b)(2) Example 1.1502-21T(b)....... 1.1502-21(b) or

3(a), fourth sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-93T(e)............... 1.1502-21T(c)....... 1.1502-21(c) or

1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-94T(a)(1)(i)......... 1.1502-21T(c)....... 1.1502-21(c) or

1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-94T(b)(4) Example 1.1502-21T(c)....... 1.1502-21(c) or

1(c), last sentence. 1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

[[Page 36101]]

1.1502-95T(b)(1)(i)......... 1.1502-21T(b)....... 1.1502-21(b) or

1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-95T(b)(4) Example 1 1.1502-21T(b)....... 1.1502-21(b) or

(a), sixth sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-95T(c)(7) Example 1 1.1502-21T(b)....... 1.1502-21(b) or

(a), fifth sentence. 1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-96T(a)(1) 1.1502-21T(c)....... 1.1502-21(c) or

introductory text. 1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-96T(a)(2), first 1.1502-21T(c)....... 1.1502-21(c) or

sentence. 1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-96T(a)(5), first 1.1502-15T and 1.1502-15 and 1.1502-

sentence. 1.1502-21T. 21 (or Sec. 1.1502-

15T in effect prior

to June 25, 1999,

as contained in 26

CFR part 1 revised

April 1, 1999 and

1.1502-21T in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable).

1.1502-96T(b)(2)(ii)(A)..... 1.1502-21T(b)....... 1.1502-21(b) or

1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-96T(b)(2)(ii)(B)..... 1.1502-21T(c)....... 1.1502-21(c) or

1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-99T(c)(2)(i), fourth 1.1502-21T(c)....... 1.1502-21(c) or

sentence. 1.1502-21T(c) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-99T(c)(2)(ii)........ 1.1502-21T(b)....... 1.1502-21(b) or

1.1502-21T(b) in

effect prior to

June 25, 1999, as

contained in 26 CFR

part 1 revised

April 1, 1999, as

applicable.

1.1502-100(c)(2)............ Secs. 1.1502-21A or Sec. 1.1502-21A or

1.1502-21T. 1.1502-21.

1.1503-2(d)(2)(i), last Sec. 1.1502-21A(c) 1.1502-21A(c) or

sentence. or 1.1502-21T(c). 1.1502-21(c).

1.1503-2(d)(2)(ii), last Sec. 1.1502-21A(c) 1.1502-21A(c) or

sentence. or 1.1502-21T(c). 1.1502-21(c).

1.1503-2(d)(4) Example 1 1.1502-22T(c)....... 1.1502-22(c).

(iv), last sentence.

1.1503-2(g)(2)(vii)(B)(1), Sec. 1.1502-21A(c) 1.1502-21A(c) or

second sentence. or 1.1502-21T(c). 1.1502-21(c).

1.1503-2(g)(2)(vii)(B)(2), Sec. 1.1502-21A(c) 1.1502-21A(c) or

first sentence. or 1.1502-21T(c). 1.1502-21(c).

1.1503-2(g)(2)(vii)(G) Sec. 1.1502-21A(c) 1.1502-21A(c) or

Example 1, ninth sentence. or 1.1502-21T(c). 1.1502-21(c).

1.1503-2(g)(2)(vii)(G) Secs. 1.1502-21A(c) Sec. 1.1502-21A(c)

Example 2, last sentence. or 1.1502-21T(c). or 1.1502-21(c).

1.1503-2(h)(3), second Secs. 1.1502-21A(c) Sec. 1.1502-21A(c)

sentence. or 1.1502-21T(c)). or 1.1502-21(c).

1.1503-2A(f)(1)(i) 1.1502-21T(b)....... 1.1502-79A(a)(3).

introductory text.

1.1503-2A(f)(1)(i)(C)....... 1.1502-22T(b)....... 1.1502-22.

1.1503-2A(f)(2)(i), fourth 1.1502-21T(c)....... 1.1502-21(c).

sentence.

1.1503-2A(f)(2)(ii), last 1.1502-21T(c)....... 1.1502-21(c).

sentence.

301.6402-7(g)(2)(iii), first Sec. 1.1502-21T(b). 1.1502-21(b).

sentence.

301.6402-7(g)(3) Example 2, 1.1502-21T.......... 1.1502-21.

second sentence.

301.6402-7(g)(3) Example 2, 1.1502-21T(c)....... 1.1502-21(c).

third sentence.

301.6402-7(h)(1)(ii) Example 1.1502-21T(b) and 1.1502-21(b) and

(b), first sentence. 1.1502-22T(b). 1.1502-22(b).

------------------------------------------------------------------------

Par. 3. Section 1.1502-1 is amended by revising paragraph (f)(4) to

read as follows:

Sec. 1.1502-1 Definitions.

* * * * *

(f) * * *

(4) Predecessor and successors. The term predecessor means a

transferor or distributor of assets to a member (the successor) in a

transaction--

(i) To which section 381(a) applies; or

(ii) That occurs on or after January 1, 1997, in which the

successor's basis for the assets is determined, directly or indirectly,

in whole or in part, by reference to the basis of the assets of the

transferor or distributor, but in the case of a transaction that occurs

before June 25, 1999, only if the amount by which basis differs from

value, in the aggregate, is material. For a transaction that occurs

before June 25, 1999, only one member may be considered a predecessor

to or a successor of one other member.

* * * * *

Par. 4. Section 1.1502-15 is added to read as follows:

Sec. 1.1502-15 SRLY limitation on built-in losses.

(a) SRLY limitation. Except as provided in paragraph (f) of this

section (relating to built-in losses of the common parent) and

paragraph (g) of this section (relating to an overlap with section

382), built-in losses are subject to the SRLY limitation under

Secs. 1.1502-21(c) and 1.1502-22(c) (including applicable subgroup

principles). Built-in losses are treated as deductions or losses in the

year recognized, except for the purpose of determining the amount of,

and the extent to which the built-in loss is limited by, the SRLY

limitation for the year in which it is recognized. Solely for such

purpose, a built-in loss is treated as a hypothetical net operating

loss carryover or net capital loss carryover arising in a SRLY, instead

of as a deduction or loss in the year recognized. To the extent that a

built-in loss is allowed as a deduction under

[[Page 36102]]

this section in the year it is recognized, it offsets any consolidated

taxable income for the year before any loss carryovers or carrybacks

are allowed as a deduction. To the extent not so allowed, it is treated

as a separate net operating loss or net capital loss carryover or

carryback arising in the year of recognition and, under Sec. 1.1502-

21(c) or 1.1502-22(c), the year of recognition is treated as a SRLY.

(b) Built-in losses--(1) Defined. If a corporation has a net

unrealized built-in loss under section 382(h)(3) (as modified by this

section) on the day it becomes a member of the group (whether or not

the group is a consolidated group), its deductions and losses are

built-in losses under this section to the extent they are treated as

recognized built-in losses under section 382(h)(2)(B) (as modified by

this section). This paragraph (b) generally applies separately with

respect to each member, but see paragraph (c) of this section for

circumstances in which it is applied on a subgroup basis.

(2) Operating rules. Solely for purposes of applying paragraph

(b)(1) of this section, the principles of Sec. 1.1502-94(c) apply with

appropriate adjustments, including the following:

(i) Stock acquisition. A corporation is treated as having an

ownership change under section 382(g) on the day the corporation

becomes a member of a group, and no other events (e.g., a subsequent

ownership change under section 382(g) while it is a member) are treated

as causing an ownership change.

(ii) Asset acquisition. In the case of an asset acquisition by a

group, the assets and liabilities acquired directly from the same

transferor (whether corporate or non-corporate, foreign or domestic)

pursuant to the same plan are treated as the assets and liabilities of

a corporation that becomes a member of the group (and has an ownership

change) on the date of the acquisition.

(iii) Recognized built-in gain or loss. A loss that is included in

the determination of net unrealized built-in gain or loss and that is

recognized but disallowed or deferred (e.g., under Sec. 1.1502-20 or

section 267) is not treated as a built-in loss unless and until the

loss would be allowed during the recognition period without regard to

the application of this section. Section 382(h)(1)(B)(ii) does not

apply to the extent it limits the amount of recognized built-in loss

that may be treated as a pre-change loss to the amount of the net

unrealized built-in loss.

(c) Built-in losses of subgroups--(1) In general. In the case of a

subgroup, the principles of paragraph (b) of this section apply to the

subgroup, and not separately to its members. Thus, the net unrealized

built-in loss and recognized built-in loss for purposes of paragraph

(b) of this section are based on the aggregate amounts for each member

of the subgroup.

(2) Members of subgroups. A subgroup is composed of those members

that have been continuously affiliated with each other for the 60

consecutive month period ending immediately before they become members

of the group in which the loss is recognized. A member remains a member

of the subgroup until it ceases to be affiliated with the loss member.

For this purpose, the principles of Sec. 1.1502-21(c)(2)(iv) through

(vi) apply with appropriate adjustments.

(3) Coordination of 60 month affiliation requirement with the

overlap rule. If one or more corporations become members of a group and

are included in the determination of a net unrealized built-in loss

that is subject to the overlap rule described in paragraph (g)(1) of

this section, then for purposes of paragraph (c)(2) of this section,

such corporations that become members of the group are treated as

having been affiliated for 60 consecutive months with the common parent

of the group and are also treated as having been affiliated with any

other members who have been affiliated or are treated as having been

affiliated with the common parent at such time. The corporations are

treated as having been affiliated with such other members for the same

period of time that those members have been affiliated or are treated

as having been affiliated with the common parent. If two or more

corporations become members of the group at the same time, but this

paragraph (c)(3) does not apply to every such corporation, then

immediately after the corporations become members of the group, and

solely for purposes of paragraph (c)(2) of this section, the

corporations to which this paragraph (c)(3) applies are treated as

having not been previously affiliated with the corporations to which

this paragraph (c)(3) does not apply. If the common parent has become

the common parent of an existing group within the previous five year

period in a transaction described in Sec. 1.1502-75(d)(2)(ii) or (3),

the principles of Secs. 1.1502-91(g)(6) and 1.1502-96(a)(2)(iii) shall

apply.

(4) Built-in amounts. Solely for purposes of determining whether

the subgroup has a net unrealized built-in loss or whether it has a

recognized built-in loss, the principles of Sec. 1.1502-91(g) and (h)

apply with appropriate adjustments.

(d) Examples. For purposes of the examples in this section, unless

otherwise stated, all groups file consolidated returns, all

corporations have calendar taxable years, the facts set forth the only

corporate activity, value means fair market value and the adjusted

basis of each asset equals its value, all transactions are with

unrelated persons, and the application of any limitation or threshold

under section 382 is disregarded. The principles of this section are

illustrated by the following examples:

Example 1. Determination of recognized built-in loss. (i)

Individual A owns all of the stock of P and T. T has two depreciable

assets. Asset 1 has an unrealized loss of $55 (basis $75, value

$20), and asset 2 has an unrealized gain of $20 (basis $30, value

$50). P acquires all the stock of T from Individual A during Year 1,

and T becomes a member of the P group. P's acquisition of T is not

an ownership change as defined by section 382(g). Paragraph (g) of

this section does not apply because there is not an overlap of the

application of the rules contained in paragraph (a) of this section

and section 382.

(ii) Under paragraph (b)(2)(i) of this section, and solely for

purposes of applying paragraph (b)(1) of this section, T is treated

as having an ownership change under section 382(g) on becoming a

member of the P group. Under paragraph (b)(1) of this section, none

of T's $55 of unrealized loss is treated as a built-in loss unless T

has a net unrealized built-in loss under section 382(h)(3) on

becoming a member of the P group.

(iii) Under section 382(h)(3)(A), T has a $35 net unrealized

built-in loss on becoming a member of the P group (($55)+$20=($35)).

Assume that this amount exceeds the threshold requirement in section

382(h)(3)(B). Under section 382(h)(2)(B), the entire amount of T's

$55 unrealized loss is treated as a built-in loss to the extent it

is recognized during the 5-year recognition period described in

section 382(h)(7). Under paragraph (b)(2)(iii) of this section, the

restriction under section 382(h)(1)(B)(ii), which limits the amount

of recognized built-in loss that is treated as pre-change loss to

the amount of the net unrealized built-in loss, is inapplicable for

this purpose. Consequently, the entire $55 of unrealized loss (not

just the $35 net unrealized loss) is treated under paragraph (b)(1)

of this section as a built-in loss to the extent it is recognized

within 5 years of T's becoming a member of the P group. Under

paragraph (a) of this section, a built-in loss is subject to the

SRLY limitation under Sec. 1.1502-21(c)(1).

(iv) Under paragraph (b)(2)(ii) of this section, the built-in

loss would similarly be subject to a SRLY limitation under

Sec. 1.1502-21(c)(1) if T transferred all of its assets and

liabilities to a subsidiary of the P group in a single transaction

described in section 351. To the extent the built-in loss is

recognized within 5 years of T's transfer, all of the items

contributed by the acquiring subsidiary to consolidated taxable

income (and not just the items attributable to the assets and

liabilities transferred by T) are included for purposes

[[Page 36103]]

of determining the SRLY limitation under Sec. 1.1502-21(c)(1).

Example 2. Actual application of section 382 not relevant. (i)

Individual A owns all of the stock of P, and Individual B owns all

of the stock of T. T has two depreciable assets. Asset 1 has an

unrealized loss of $25 (basis $75, value $50), and asset 2 has an

unrealized gain of $20 (basis $30, value $50). P buys 55 percent of

the stock of T in January of Year 1, resulting in an ownership

change of T under section 382(g). During March of Year 2, P buys the

45 percent balance of the T stock, and T becomes a member of the P

group.

(ii) Although T has an ownership change for purposes of section

382 in Year 1 and not Year 2, T's joining the P group in Year 2 is

treated as an ownership change under section 382(g) solely for

purposes of this section. Consequently, for purposes of this

section, whether T has a net unrealized built-in loss under section

382(h)(3) is determined as if the day T joined the P group were a

change date.

Example 3. Determination of a recognized built-in loss of a

subgroup. (i) Individual A owns all of the stock of P, S, and M. P

and M are each common parents of a consolidated group. During Year

1, P acquires all of the stock of S from Individual A, and S becomes

a member of the P group. P's acquisition of S is not an ownership

change as defined by section 382(g). At the beginning of Year 7, M

acquires all of the stock of P from Individual A, and P and S become

members of the M group. M's acquisitions of P and S are also not

ownership changes as defined by section 382(g). At the time of M's

acquisition of the P stock, P has (disregarding the stock of S) a

$10 net unrealized built-in gain (two depreciable assets, asset 1

with a basis of $35 and a value of $55, and asset 2 with a basis of

$55 and a value of $45), and S has a $75 net unrealized built-in

loss (two depreciable assets, asset 3 with a basis of $95 and a

value of $10, and asset 4 with a basis of $10 and a value of $20).

(ii) Under paragraph (c) of this section, P and S compose a

subgroup on becoming members of the M group because P and S were

continuously affiliated for the 60 month period ending immediately

before they became members of the M group. Consequently, paragraph

(b) of this section does not apply to P and S separately. Instead,

their separately computed unrealized gains and losses are aggregated

for purposes of determining whether, and the extent to which, any

unrealized loss is treated as built-in loss under this section and

is subject to the SRLY limitation under Sec. 1.1502-21(c).

(iii) Under paragraph (c) of this section, the P subgroup has a

net unrealized built-in loss on the day P and S become members of

the M group, determined by treating the day they become members as a

change date. The net unrealized built-in loss is the aggregate of

P's net unrealized built-in gain of $10 and S's net unrealized

built-in loss of $75, or an aggregate net unrealized built-in loss

of $65. (The stock of S owned by P is disregarded for purposes of

determining the net unrealized built-in loss. However, any loss

allowed on the sale of the stock within the recognition period is

taken into account in determining recognized loss.) Assume that the

$65 net unrealized built-in loss exceeds the threshold requirement

under section 382(h)(3)(B).

(iv) Under paragraphs (b)(1), (b)(2)(iii), and (c) of this

section, a loss recognized during the 5-year recognition period on

an asset of P or S held on the day that P and S became members of

the M group is a built-in loss except to the extent the group

establishes that such loss exceeds the amount by which the adjusted

basis of such asset on the day the member became a member exceeded

the fair market value of such asset on that same day. If P sells

asset 2 for $45 in Year 7 and recognizes a $10 loss, the entire $10

loss is treated as a built-in loss under paragraphs (b)(2)(iii) and

(c) of this section. If S sells asset 3 for $10 in Year 7 and

recognizes an $85 loss, the entire $85 loss is treated as a built-in

loss under paragraphs (b)(2)(iii) and (c) of this section (not just

the $55 balance of the P subgroup's $65 net unrealized built-in

loss).

(v) The determination of whether P and S constitute a SRLY

subgroup for purposes of loss carryovers and carrybacks, and the

extent to which built-in losses are not allowed under the SRLY

limitation, is made under Sec. 1.1502-21(c).

Example 4. Computation of SRLY limitation. (i) Individual A owns

all of the stock of P, the common parent of a consolidated group.

During Year 1, Individual A forms T by contributing $300 and T

sustains a $100 net operating loss. During Year 2, T's assets

decline in value to $100. At the beginning of Year 3, P acquires all

the stock of T from Individual A, and T becomes a member of the P

group with a net unrealized built-in loss of $100. P's acquisition

of T is not an ownership change as defined by section 382(g). Assume

that $100 exceeds the threshold requirements of section

382(h)(3)(B). During Year 3, T recognizes its unrealized built-in

loss as a $100 ordinary loss. The members of the P group contribute

the following net income to the consolidated taxable income of the P

group (disregarding T's recognized built-in loss and any

consolidated net operating loss deduction under Sec. 1.1502-21) for

Years 3 and 4:

------------------------------------------------------------------------

Year 3 Year 4 Total

------------------------------------------------------------------------

P group (without T) $100 $100 $200

T............................................ 60 40 100

CTI.......................................... 160 140 300

------------------------------------------------------------------------

(ii) Under paragraph (b) of this section, T's $100 ordinary loss

in Year 3 (not taken into account in the consolidated taxable income

computations above) is a built-in loss. Under paragraph (a) of this

section, the built-in loss is treated as a net operating loss

carryover for purposes of determining the SRLY limitation under

Sec. 1.1502-21(c).

(iii) For Year 3, Sec. 1.1502-21(c) limits T's $100 built-in

loss and $100 net operating loss carryover from Year 1 to the

aggregate of the P group's consolidated taxable income through Year

3, determined by reference to only T's items. For this purpose,

consolidated taxable income is determined without regard to any

consolidated net operating loss deductions under Sec. 1.1502-21(a).

(iv) The P group's consolidated taxable income through Year 3 is

$60 when determined by reference to only T's items. Under

Sec. 1.1502-21(c), the SRLY limitation for Year 3 is therefore $60.

(v) Under paragraph (a) of this section, the $100 built-in loss

is treated as a current deduction for all purposes other than

determination of the SRLY limitation under Sec. 1.1502-21(c).

Consequently, a deduction for the built-in loss is allowed in Year 3

before T's loss carryover from Year 1 is allowed, but only to the

extent of the $60 SRLY limitation. None of T's Year 1 loss carryover

is allowed because the built-in loss ($100) exceeds the SRLY

limitation for Year 3.

(vi) The $40 balance of the built-in loss that is not allowed in

Year 3 because of the SRLY limitation is treated as a $40 net

operating loss arising in Year 3 that is carried to other years in

accordance with the rules of Sec. 1.1502-21(b). The $40 net

operating loss is treated under paragraph (a) of this section and

Sec. 1.1502-21(c)(1)(ii) as a loss carryover or carryback from Year

3 that arises in a SRLY, and is subject to the rules of Sec. 1.1502-

21 (including Sec. 1.1502-21(c)) rather than this section. See also

Sec. 1.1502-21(c)(1)(iii) Example 4.

(vii) The facts are the same as in paragraphs (i) through (vi)

of this Example 4, except that T has an additional built-in loss

when it joins the P group which is recognized in Year 4. For

purposes of determining the SRLY limitation for these additional

losses in Year 4 (or any subsequent year), the $60 of built-in loss

allowed as a deduction in Year 3 is treated under paragraph (a) of

this section as a deduction in Year 3 that reduces the P group's

consolidated taxable income when determined by reference to only T's

items.

Example 5. Built-in loss exceeding consolidated taxable income

in the year recognized. (i) Individual A owns all of the stock of P

and T. During Year 1, P acquires all the stock of T from Individual

A, and T becomes a member of the P group. P's acquisition of T was

not an ownership change as defined by section 382(g). At the time of

acquisition, T has a noncapital asset with an unrealized loss of $45

(basis $100, value $55), which exceeds the threshold requirements of

section 382(h)(3)(B). During Year 2, T sells its asset for $55 and

recognizes the unrealized built-in loss. The P group has $10 of

consolidated taxable income in Year 2, computed by disregarding T's

recognition of the $45 built-in loss and the consolidated net

operating loss deduction, while the consolidated taxable income

would be $25 if determined by reference to only T's items (other

than the $45 loss).

(ii) T's $45 loss is recognized in Year 2 and, under paragraph

(b) of this section, constitutes a built-in loss. Under paragraph

(a) of this section and Sec. 1.1502-21(c)(1)(ii), the loss is

treated as a net operating loss carryover to Year 2 for purposes of

applying the SRLY limitation under Sec. 1.1502-21(c).

(iii) For Year 2, T's SRLY limitation is the aggregate of the P

group's consolidated taxable income through Year 2 determined by

[[Page 36104]]

reference to only T's items. For this purpose, consolidated taxable

income is determined by disregarding any built-in loss that is

treated as a net operating loss carryover, and any consolidated net

operating loss deductions under Sec. 1.1502-21(a). Consolidated

taxable income so determined is $25.

(iv) Under Sec. 1.1502-21(c), $25 of the $45 built-in loss could

be deducted in Year 2. Because the P group has only $10 of

consolidated taxable income (determined without regard to the $45),

the $25 loss creates a consolidated net operating loss of $15. This

loss is carried back or forward under the rules of Sec. 1.1502-21(b)

and absorbed under the rules of Sec. 1.1502-21(a). This loss is not

treated as arising in a SRLY (see Sec. 1.1502-21(c)(1)(ii)) and

therefore is not subject to the SRLY limitation under Sec. 1.1502-

21(c) in any consolidated return year of the group to which it is

carried. The remaining $20 is treated as a loss carryover arising in

a SRLY and is subject to the limitation of Sec. 1.1502-21(c) in the

year to which it is carried.

(e) Predecessors and successors. For purposes of this section, any

reference to a corporation or member includes, as the context may

require, a reference to a successor or predecessor, as defined in

Sec. 1.1502-1(f)(4).

(f) Built-in losses recognized by common parent of group--(1)

General rule. Paragraph (a) of this section does not apply to any loss

recognized by the group on an asset held by the common parent on the

date the group is formed. Following an acquisition described in

Sec. 1.1502-75(d)(2) or (3), references to the common parent are to the

corporation that was the common parent immediately before the

acquisition.

(2) Anti-avoidance rule. If a corporation that becomes a common

parent of a group acquires assets with a net unrealized built-in loss

in excess of the threshold requirement of section 382(h)(3)(B) (and

thereby increases its net unrealized built-in loss or decreases its net

unrealized built-in gain) prior to, and in anticipation of, the

formation of the group, paragraph (f)(1) of this section does not

apply.

(g) Overlap with section 382--(1) General rule. The limitations

provided in Secs. 1.1502-21(c) and 1.1502-22(c) do not apply to

recognized built-in losses or to loss carryovers or carrybacks

attributable to recognized built-in losses when the application of

paragraph (a) of this section results in an overlap with the

application of section 382.

(2) Definitions--(i) Generally. For purposes of this paragraph (g),

the definitions and nomenclature contained in section 382, the

regulations thereunder, and Secs. 1.1502-90 through 1.1502-99 apply.

(ii) Overlap--(A) An overlap of the application of paragraph (a) of

this section and the application of section 382 with respect to built-

in losses occurs if a corporation becomes a member of a consolidated

group (the SRLY event) within six months of the change date of an

ownership change giving rise to a section 382(a) limitation that would

apply with respect to the corporation's recognized built-in losses (the

section 382 event). Except as provided in paragraph (g)(3) of this

section, application of the overlap rule does not require that the size

and composition of the corporation's net unrealized built-in loss is

the same on the date of the section 382 event and the SRLY event.

(B) For special rules in the event that there is a SRLY subgroup

and/or a loss subgroup as defined in Sec. 1.1502-91(d)(2) with respect

to built-in losses, see paragraph (g)(4) of this section.

(3) Operating rules--(i) Section 382 event before SRLY event. If a

SRLY event occurs on the same date as a section 382 event or within the

six month period beginning on the date of the section 382 event,

paragraph (g)(1) of this section applies beginning with the tax year

that includes the SRLY event. Paragraph (g)(1) of this section does not

apply, however, if a corporation that would otherwise be subject to the

overlap rule acquires assets from a person other than a member of the

group with a net unrealized built-in loss in excess of the threshold

requirement of section 382(h)(3)(B) (and thereby increases its net

unrealized built-in loss) after the section 382 event, and before the

SRLY event.

(ii) SRLY event before section 382 event. If a section 382 event

occurs within the period beginning the day after the SRLY event and

ending six months after the SRLY event, paragraph (g)(1) of this

section applies starting with the first tax year that begins after the

section 382 event. However, paragraph (g)(1) of this section does not

apply at any time if a corporation that otherwise would be subject to

paragraph (g)(1) of this section transfers assets with an unrealized

built-in loss to another member of the group after the SRLY event, but

before the section 382 event, unless the corporation recognizes the

built-in loss upon the transfer.

(4) Subgroup rules. In general, in the case of built-in losses for

which there is a SRLY subgroup and the corporations joining the group

at the time of the SRLY event also constitute a loss subgroup (as

defined in Sec. 1.1502-91(d)(2)), the principles of this paragraph (g)

apply to the SRLY subgroup, and not separately to its members. However,

paragraph (g)(1) of this section applies with respect to built-in

losses only if--

(i) all members of the SRLY subgroup with respect to those built-in

losses are also included in a loss subgroup; and

(ii) all members of a loss subgroup are also members of a SRLY

subgroup with respect to those built-in losses.

(5) Asset acquisitions. Notwithstanding the application of this

paragraph (g), paragraph (a) of this section applies to asset

acquisitions by the corporation that occurs after the latter of the

SRLY event and the section 382 event. See, paragraph (b)(2)(ii) of this

section.

(6) Examples. The principles of this paragraph (g) are illustrated

by the following examples:

Example 1. Determination of subgroup. (i) Individual A owns all

of the stock of P, P1, and S. In Year 1, P acquires all of the stock

of P1, and they file a consolidated return. In Year 3, P acquires

all of the stock of S, and S joins the P group. Individual B,

unrelated to Individual A, owns all of the stock of M and K, each

the common parent of a consolidated group. Individual C, unrelated

to either Individual A or Individual B, owns all of the stock of T.

(ii) At the beginning of Year 7, M acquires all of the stock of

P from Individual A, and, as a result, P, P1, and S become members

of the M group. At the time of M's acquisition of the P stock, P has

a $15 net unrealized built-in loss (disregarding the stock of P1),

P1 has a net unrealized built-in gain of $10, and S has a net

unrealized built-in gain of $5.

(iii) During Year 8, M acquires all of the stock of T, and T

joins the M group. At the time of M's acquisition of the T stock, T

had an unrealized built-in loss of $15. At the beginning of Year 9,

K acquires all of the stock of M from Individual B, and the members

of the M consolidated group including P, P1, S, and T become members

of the K group. At the time of K's acquisition of the M stock, M has

(disregarding the stock of P and T) a $15 net unrealized built-in

loss, P has a $20 net unrealized built-in loss (disregarding the

stock of P1), P1 has a net unrealized built-in gain of $5, S has a

net unrealized built-in loss of $35, and T has a $15 net unrealized

built-in loss.

(iv) M's acquisition of P in Year 7 results in P, P1, and S

becoming members of the M group (the SRLY event). Under paragraph

(c) of this section, P and P1 compose a SRLY built-in loss subgroup

because they have been affiliated for the 60 consecutive month

period immediately preceding joining the M group. S is not a member

of the subgroup because on becoming a member of the M group it had

not been continuously affiliated with P and P1 for the 60 month

period ending immediately before it became a member of the M group.

Consequently, Sec. 1.1502-15 applies to S separately from the P and

P1 subgroup.

(v) Assuming that the $5 net unrealized built-in loss of the P/

P1 subgroup exceeds the threshold requirement under section

382(h)(3)(B), M's acquisition of P resulted in an ownership change

of P and P1 within the

[[Page 36105]]

meaning of section 382(g) that subjects P and P1 to a limitation

under section 382(a) (the section 382 event). Because, with respect

to P and P1, the SRLY event and the change date of the section 382

event occur on the same date and because the loss subgroup and SRLY

subgroup are coextensive, there is an overlap of the application of

the SRLY rules and the application of the section 382.

(vi) S was not a loss corporation because it did not have a net

operating loss carryover, or a net unrealized built-in loss, and

therefore, M's acquisition of P did not result in an ownership

change of S within the meaning of section 382(g). S, therefore is

not subject to the overlap rule of paragraph (g) of this section.

(vii) M's acquisition of T resulted in T becoming a member of

the M group (the SRLY event). Assuming that T's $15 net unrealized

built-in loss exceeds the threshold requirement under section

382(h)(3)(B), M's acquisition of T also resulted in an ownership

change of T within the meaning of section 382(g) that subjects T to

a limitation under section 382(a) (the section 382 event). Because,

with respect to T, the SRLY event and the change date of the section

382 event occur on the same date, there is an overlap of the

application of the SRLY rules and the application of section 382

within the meaning of paragraph (g) of this section.

(viii) K's acquisition of M results in the members of the M

consolidated group, including T, P, P1, and S, becoming members of

the K group (the SRLY event). Because T, P, and P1 were each

included in the determination of a net unrealized built-in loss that

was subject to the overlap rule described in paragraph (g)(1) of

this section when they each became members of the M group, they are

deemed under paragraph (c)(3) of this section to have been

continuously affiliated with M for the 60 month period ending

immediately before becoming a member of the M group, notwithstanding

their actual affiliation history. As a result, M, T, P, and P1

compose a SRLY built-in loss subgroup under paragraph (c)(2) of this

section. K's acquisition of M is not subject to paragraph (g) of

this section because it does not result in a section 382 event.

(ix) S, however, is not a member of the subgroup under paragraph

(c)(2) of this section. Because S was not included in the

determination of a net unrealized built-in loss that was subject to

the overlap rule described in paragraph (g)(1) of this section when

it joined the M group, S is treated as becoming an affiliate of M on

the date it joined the M group. Furthermore, under paragraph (c)(3)

of this section, S is deemed to have begun its affiliation with P

and P1 on the date it joined the M group. Consequently, Sec. 1.1502-

15 applies to S separately to the extent its built-in loss is

recognized with the recognition period.

Example 2. Post-overlap acquisition of assets. (i) Individual A

owns all of the stock of P, the common parent of a consolidated

group. B, an individual unrelated to Individual A, owns all of the

stock of T. T has two depreciable assets. Asset 1 has an unrealized

built-in loss of $25 (basis $75, value $50), and asset 2 has an

unrealized built-in gain of $20 (basis $30, value $50). During Year

3, P buys all of the stock of T from Individual B. On January 1,

Year 4, P contributes $80 cash and Individual A contributes asset 3,

a depreciable asset, with a net unrealized built-in loss of $45

(basis $65, value $20), in exchange for T stock in a transaction

that is described in section 351.

(ii) P's acquisition of T results in T becoming a member of the

P group (the SRLY event) and also results in an ownership change of

T, within the meaning of section 382(g), that gives rise to a

limitation under section 382(a) (the section 382 event).

(iii) Because the SRLY event and the change date of the section

382 event occur on the same date, there is an overlap of the

application of the SRLY rules and the application of section 382.

Consequently, under paragraph (g) of this section, the limitation

under paragraph (a) of this section does not apply to T's net

unrealized built-in loss when it joined the P group.

(iv) Individual A's Year 4 contribution of a depreciable asset

occurred after T was a member of the P group. Assuming that the

amount of the net unrealized built-in loss exceeds the threshold

requirement of section 382(h)(3)(B), the sale of asset 3 within the

recognition period is subject to the SRLY limitation of paragraphs

(a) and (b)(2)(ii) of this section.

Example 3. Overlap rule. (i) Individual A owns all of the stock

of P, the common parent of a consolidated group. B, an individual

unrelated to Individual A, owns all of the stock of T. T has two

depreciable assets. Asset 1 has an unrealized loss of $55 (basis

$75, value $20), and asset 2 has an unrealized gain of $30 (basis

$30, value $60). On February 28 of Year 2, P purchases 55% of T from

Individual B. On June 30, of Year 2, P purchases an additional 35%

of T from Individual B.

(ii) The February 28 purchase of 55% of T is a section 382 event

because it results in an ownership change of T that gives rise to a

section 382(a) limitation. The June 30 purchase of 35% of T results

in T becoming a member of the P group and is therefore a SRLY event.

(iii) Because the SRLY event occurred within six months of the

change date of the section 382 event, there is an overlap of the

application of the SRLY rules and the application of section 382,

and paragraph (a) of this section does not apply. Therefore, the

SRLY limitation does not apply to any of the $55 loss in asset 1

recognized by T after T joined the P group. See Sec. 1.1502-94 for

rules relating to the application of section 382 with respect to T's

$25 unrealized built-in loss.

Example 4. Overlap rule-Fluctuation in value. (i) The facts are

the same as in Example 3, except that by June 30, of Year 2, asset 1

had declined in value by a further $10. Thus asset 1 had an

unrealized loss of $65 (basis $75, value $10), and asset 2 had an

unrealized gain of $30 (basis $30, value $60).

(ii) Because paragraph (a) of this section does not apply, the

further decrease in asset 1's value is disregarded. Consequently,

the results are the same as in Example 3.

(h) Effective date--(1) In general. This section generally applies

to built-in losses recognized in taxable years for which the due date

(without extensions) of the consolidated return is after June 25, 1999.

However--

(i) In the event that paragraphs (f)(1) and (g)(1) of this section

do not apply to a particular built-in loss in the current group, then

solely for purposes of applying paragraph (a) of this section to

determine a limitation with respect to that built-in loss and with

respect to which the SRLY register (consolidated taxable income

determined by reference to only the member's (or subgroup's) items of

income, gain, deduction or loss) began in a taxable year for which the

due date of the return was on or before June 25, 1999, paragraph (c)(3)

of this section shall not apply; and

(ii) For purposes of paragraph (g) of this section, only an

ownership change to which section 382(a) as amended by the Tax Reform

Act of 1986 applies shall constitute a section 382 event.

(2) Prior periods. For certain taxable years ending on or before

June 25, 1999, see Sec. 1.1502-15T in effect prior to June 25, 1999, as

contained in 26 CFR part 1 revised April 1, 1999, as applicable.

Sec. 1.1502-15T [Removed]

Par. 5. Section 1.1502-15T is removed.

Par. 6. Section 1.1502-21 is added to read as follows:

Sec. 1.1502-21 Net operating losses.

(a) Consolidated net operating loss deduction. The consolidated net

operating loss deduction (or CNOL deduction) for any consolidated

return year is the aggregate of the net operating loss carryovers and

carrybacks to the year. The net operating loss carryovers and

carrybacks consist of--

(1) Any CNOLs (as defined in paragraph (e) of this section) of the

consolidated group; and

(2) Any net operating losses of the members arising in separate

return years.

(b) Net operating loss carryovers and carrybacks to consolidated

return and separate return years. Net operating losses of members

arising during a consolidated return year are taken into account in

determining the group's CNOL under paragraph (e) of this section for

that year. Losses taken into account in determining the CNOL may be

carried to other taxable years (whether consolidated or separate) only

under this paragraph (b).

(1) Carryovers and carrybacks generally. The net operating loss

carryovers and carrybacks to a taxable year are determined under the

[[Page 36106]]

principles of section 172 and this section. Thus, losses permitted to

be absorbed in a consolidated return year generally are absorbed in the

order of the taxable years in which they arose, and losses carried from

taxable years ending on the same date, and which are available to

offset consolidated taxable income for the year, generally are absorbed

on a pro rata basis. Additional rules provided under the Internal

Revenue Code or regulations also apply. See, e.g., section 382(l)(2)(B)

(if losses are carried from the same taxable year, losses subject to

limitation under section 382 are absorbed before losses that are not

subject to limitation under section 382). See Example 2 of paragraph

(c)(1)(iii) of this section for an illustration of pro rata absorption

of losses subject to a SRLY limitation.

(2) Carryovers and carrybacks of CNOLs to separate return years--

(i) In general. If any CNOL that is attributable to a member may be

carried to a separate return year of the member, the amount of the CNOL

that is attributable to the member is apportioned to the member

(apportioned loss) and carried to the separate return year. If carried

back to a separate return year, the apportioned loss may not be carried

back to an equivalent, or earlier, consolidated return year of the

group; if carried over to a separate return year, the apportioned loss

may not be carried over to an equivalent, or later, consolidated return

year of the group. For rules permitting the reattribution of losses of

a subsidiary to the common parent when loss is disallowed on the

disposition of subsidiary stock, see Sec. 1.1502-20(g).

(ii) Special rules--(A) Year of departure from group. If a

corporation ceases to be a member during a consolidated return year,

net operating loss carryovers attributable to the corporation are first

carried to the consolidated return year, and only the amount so

attributable that is not absorbed by the group in that year is carried

to the corporation's first separate return year. For rules concerning a

member departing a subgroup, see paragraph (c)(2)(vii) of this section.

(B) Offspring rule. In the case of a member that has been a member

continuously since its organization (determined without regard to

whether the member is a successor to any other corporation), the CNOL

attributable to the member is included in the carrybacks to

consolidated return years before the member's existence. If the group

did not file a consolidated return for a carryback year, the loss may

be carried back to a separate return year of the common parent under

paragraph (b)(2)(i) of this section, but only if the common parent was

not a member of a different consolidated group or of an affiliated

group filing separate returns for the year to which the loss is carried

or any subsequent year in the carryback period. Following an

acquisition described in Sec. 1.1502-75(d)(2) or (3), references to the

common parent are to the corporation that was the common parent

immediately before the acquisition.

(iii) Equivalent years. Taxable years are equivalent if they bear

the same numerical relationship to the consolidated return year in

which a CNOL arises, counting forward or backward from the year of the

loss. For example, in the case of a member's third taxable year (which

was a separate return year) that preceded the consolidated return year

in which the loss arose, the equivalent year is the third consolidated

return year preceding the consolidated return year in which the loss

arose. See paragraph (b)(3)(iii) of this section for certain short

taxable years that are disregarded in making this determination.

(iv) Amount of CNOL attributable to a member. The amount of a CNOL

that is attributable to a member is determined by a fraction the

numerator of which is the separate net operating loss of the member for

the year of the loss and the denominator of which is the sum of the

separate net operating losses for that year of all members having such

losses. For this purpose, the separate net operating loss of a member

is determined by computing the CNOL by reference to only the member's

items of income, gain, deduction, and loss, including the member's

losses and deductions actually absorbed by the group in the taxable

year (whether or not absorbed by the member).

(v) Examples. For purposes of the examples in this section, unless

otherwise stated, all groups file consolidated returns, all

corporations have calendar taxable years, the facts set forth the only

corporate activity, value means fair market value and the adjusted

basis of each asset equals its value, all transactions are with

unrelated persons, and the application of any limitation or threshold

under section 382 is disregarded. The principles of this paragraph

(b)(2) are illustrated by the following examples:

Example 1. Offspring rule. (i) During Year 1, Individual A forms

P and T, and they each file a separate return. P forms S on March 15

of Year 2, and P and S file a consolidated return. P acquires all

the stock of T from Individual A at the beginning of Year 3, and T

becomes a member of the P group. P's acquisition of T is not an

ownership change within the meaning of section 382. P, S, and T

sustain a $1,100 CNOL in Year 3 and, under paragraph (b)(2)(iv) of

this section, the loss is attributable $200 to P, $300 to S, and

$600 to T.

(ii) Of the $1,100 CNOL in Year 3, the $500 amount of the CNOL

that is attributable to P and S ($200 + $300) may be carried to P's

separate return in Year 1. Even though S was not in existence in

Year 1, the $300 amount of the CNOL attributable to S may be carried

back to P's separate return in Year 1 because S (unlike T) has been

a member of the P group since its organization and P is a qualified

parent under paragraph (b)(2)(ii)(B) of this section. To the extent

not absorbed in that year, the loss may then be carried to the P

group's return in Year 2. The $600 amount of the CNOL attributable

to T is a net operating loss carryback to T's separate return in

Year 1, and if not absorbed in Year 1, then to Year 2.

Example 2. Departing members. (i) The facts are the same as in

Example 1. In addition, on June 15 of Year 4, P sells all the stock

of T. The P group's consolidated return for Year 4 includes the

income of T through June 15. T files a separate return for the

period from June 16 through December 31.

(ii) $600 of the Year 3 CNOL attributable to T is apportioned to

T and is carried back to its separate return in Year 1. To the

extent the $600 is not absorbed in T's separate return in Year 1 or

Year 2, it is carried to the consolidated return in Year 4 before

being carried to T's separate return in Year 4. Any portion of the

loss not absorbed in T's Year 1 or Year 2 or in the P group's Year 4

is then carried to T's separate return in Year 4.

Example 3. Offspring rule following acquisition. (i) Individual

A owns all of the stock of P, the common parent of a consolidated

group. In Year 1, B, an individual unrelated to Individual A, forms

T. P acquires all of the stock of T at the beginning of Year 3, and

T becomes a member of the P group. The P group has $200 of

consolidated taxable income in Year 2, and $300 of consolidated

taxable income in Year 3 (computed without regard to the CNOL

deduction). At the beginning of Year 4, T forms a subsidiary, Y, in

a transaction described in section 351. The P group has a $300

consolidated net operating loss in Year 4, and under paragraph

(b)(2)(iv) of this section, the loss is attributable entirely to Y.

(ii) Even though Y was not in existence in Year 2, $300, the

amount of the consolidated net operating loss attributable to Y, may

be carried back to the P group's Year 2 consolidated return under

paragraph (b)(2)(ii)(B) of this section because Y has been a member

of the P group since its organization. To the extent not absorbed in

that year, the loss may then be carried to the P group's

consolidated return in Year 3.

(3) Special rules--(i) Election to relinquish carryback. A group

may make an irrevocable election under section 172(b)(3) to relinquish

the entire carryback period with respect to a CNOL for any consolidated

return year. Except as provided in paragraph (b)(3)(ii)(B) of this

section, the election may not be made separately for any

[[Page 36107]]

member (whether or not it remains a member), and must be made in a

separate statement entitled ``THIS IS AN ELECTION UNDER SECTION 1.1502-

21(b)(3)(i) TO WAIVE THE ENTIRE CARRYBACK PERIOD PURSUANT TO SECTION

172(b)(3) FOR THE [insert consolidated return year] CNOLs OF THE

CONSOLIDATED GROUP OF WHICH [insert name and employer identification

number of common parent] IS THE COMMON PARENT.'' The statement must be

signed by the common parent and filed with the group's income tax

return for the consolidated return year in which the loss arises.

(ii) Special elections--(A) Groups that include insolvent financial

institutions. For rules applicable to relinquishing the entire

carryback period with respect to losses attributable to insolvent

financial institutions, see Sec. 301.6402-7 of this chapter.

(B) Acquisition of member from another consolidated group. If one

or more members of a consolidated group becomes a member of another

consolidated group, the acquiring group may make an irrevocable

election to relinquish, with respect to all consolidated net operating

losses attributable to the member, the portion of the carryback period

for which the corporation was a member of another group, provided that

any other corporation joining the acquiring group that was affiliated

with the member immediately before it joined the acquiring group is

also included in the waiver. This election is not a yearly election and

applies to all losses that would otherwise be subject to a carryback to

a former group under section 172. The election must be made in a

separate statement entitled ``THIS IS AN ELECTION UNDER SECTION 1.1502-

21(b)(3)(ii)(B) TO WAIVE THE PRE-[insert first taxable year for which

the member (or members) was not a member of another group] CARRYBACK

PERIOD FOR THE CNOLs attributable to [insert names and employer

identification number of members].'' The statement must be filed with

the acquiring consolidated group's original income tax return for the

year the corporation (or corporations) became a member, and it must be

signed by the common parent and each of the members to which it

applies.

(iii) Short years in connection with transactions to which section

381(a) applies. If a member distributes or transfers assets to a

corporation that is a member immediately after the distribution or

transfer in a transaction to which section 381(a) applies, the

transaction does not cause the distributor or transferor to have a

short year within the consolidated return year of the group in which

the transaction occurred that is counted as a separate year for

purposes of determining the years to which a net operating loss may be

carried.

(iv) Special status losses. [Reserved]

(c) Limitations on net operating loss carryovers and carrybacks

from separate return limitation years--(1) SRLY limitation--(i) General

rule. Except as provided in paragraph (g) of this section (relating to

an overlap with section 382), the aggregate of the net operating loss

carryovers and carrybacks of a member arising (or treated as arising)

in SRLYs that are included in the CNOL deductions for all consolidated

return years of the group under paragraph (a) of this section may not

exceed the aggregate consolidated taxable income for all consolidated

return years of the group determined by reference to only the member's

items of income, gain, deduction, and loss. For this purpose--

(A) Consolidated taxable income is computed without regard to CNOL

deductions;

(B) Consolidated taxable income takes into account the member's

losses and deductions (including capital losses) actually absorbed by

the group in consolidated return years (whether or not absorbed by the

member);

(C) In computing consolidated taxable income, the consolidated

return years of the group include only those years, including the year

to which the loss is carried, that the member has been continuously

included in the group's consolidated return, but exclude--

(1) For carryovers, any years ending after the year to which the

loss is carried; and

(2) For carrybacks, any years ending after the year in which the

loss arose; and

(D) The treatment under Sec. 1.1502-15 of a built-in loss as a

hypothetical net operating loss carryover in the year recognized is

solely for purposes of determining the limitation under this paragraph

(c) with respect to the loss in that year and not for any other

purpose. Thus, for purposes of determining consolidated taxable income

for any other losses, a built-in loss allowed under this section in the

year it arises is taken into account.

(ii) Losses treated as arising in SRLYs. If a net operating loss

carryover or carryback did not arise in a SRLY but is attributable to a

built-in loss (as defined under Sec. 1.1502-15), the carryover or

carryback is treated for purposes of this paragraph (c) as arising in a

SRLY if the built-in loss was not allowed, after application of the

SRLY limitation, in the year it arose. For an illustration, see

Sec. 1.1502-15(d), Example 5. But see Sec. 1.1502-15(g)(1).

(iii) Examples. The principles of this paragraph (c)(1) are

illustrated by the following examples:

Example 1. Determination of SRLY limitation. (i) Individual A

owns P. In Year 1, Individual A forms T, and T sustains a $100 net

operating loss that is carried forward. P acquires all the stock of

T at the beginning of Year 2, and T becomes a member of the P group.

The P group has $300 of consolidated taxable income in Year 2

(computed without regard to the CNOL deduction). Such consolidated

taxable income would be $70 if determined by reference to only T's

items.

(ii) T's $100 net operating loss carryover from Year 1 arose in

a SRLY. See Sec. 1.1502-1(f)(2)(iii). P's acquisition of T was not

an ownership change as defined by section 382(g). Thus, the $100 net

operating loss carryover is subject to the SRLY limitation in

paragraph (c)(1) of this section. The SRLY limitation for Year 2 is

consolidated taxable income determined by reference to only T's

items, or $70. Thus, $70 of the loss is included under paragraph (a)

of this section in the P group's CNOL deduction for Year 2.

(iii) The facts are the same as in paragraph (i) of this Example

1, except that such consolidated taxable income (computed without

regard to the CNOL deduction and by reference to only T's items) for

Year 2 is a loss (a CNOL) of $370. Because the SRLY limitation may

not exceed the consolidated taxable income determined by reference

to only T's items, and such items aggregate to a CNOL, T's $ 100 net

operating loss carryover from Year 1 is not allowed under the SRLY

limitation in Year 2. Moreover, if consolidated taxable income

(computed without regard to the CNOL deduction and by reference to

only T's items) did not exceed $370 in Year 3, the carryover would

still be restricted under paragraph (c) of this section in Year 3,

because the aggregate consolidated taxable income for all

consolidated return years of the group computed by reference to only

T's items would not be a positive amount.

Example 2. Net operating loss carryovers. (i) In Year 1,

Individual A forms P, and P sustains a $40 net operating loss that

is carried forward. P has no income in Year 2. Individual A also

owns T which sustains a net operating loss of $50 in Year 2 that is

carried forward. P acquires the stock of T from Individual A during

Year 3, but T is not a member of the P group for each day of the

year. P and T file separate returns and sustain net operating losses

of $120 and $60, respectively, for Year 3. The P group files

consolidated returns beginning in Year 4. During Year 4, the P group

has $160 of consolidated taxable income (computed without regard to

the CNOL deduction). Such consolidated taxable income would be $70

if determined by reference to only T's items. These results are

summarized as follows:

[[Page 36108]]

----------------------------------------------------------------------------------------------------------------

Separate Separate Separate/ Consolidated

-------------------------------- affiliated ---------------

----------------

Year 1 Year 2 Year 3 Year 4

----------------------------------------------------------------------------------------------------------------

P............................................... $ (40) $0 $ (120) $90

T............................................... 0 (50) (60) 70

---------------

CTI............................................. .............. .............. .............. 160

----------------------------------------------------------------------------------------------------------------

(ii) P's Year 1, Year 2, and Year 3 are not SRLYs with respect

to the P group. See Sec. 1.1502-1(f)(2)(i). Thus, P's $40 net

operating loss arising in Year 1 and $120 net operating loss arising

in Year 3 are not subject to the SRLY limitation under paragraph (c)

of this section. Under the principles of section 172, paragraph (b)

of this section requires that the loss arising in Year 1 be the

first loss absorbed by the P group in Year 4. Absorption of this

loss leaves $120 of the group's consolidated taxable income

available for offset by other loss carryovers.

(iii) T's Year 2 and Year 3 are SRLYs with respect to the P

group. See Sec. 1.1502-1(f)(2)(ii). P's acquisition of T was not an

ownership change as defined by section 382(g). Thus, T's $50 net

operating loss arising in Year 2 and $60 net operating loss arising

in Year 3 are subject to the SRLY limitation. Under paragraph (c)(1)

of this section, the SRLY limitation for Year 4 is $70, and under

paragraph (b) of this section, T's $50 loss from Year 2 must be

included under paragraph (a) of this section in the P group's CNOL

deduction for Year 4. The absorption of this loss leaves $70 of the

group's consolidated taxable income available for offset by other

loss carryovers.

(iv) P and T each carry over net operating losses to Year 4 from

a taxable year ending on the same date (Year 3). The losses carried

over from Year 3 total $180. Under paragraph (b) of this section,

the losses carried over from Year 3 are absorbed on a pro rata

basis, even though one arises in a SRLY and the other does not.

However, the group cannot absorb more than $20 of T's $60 net

operating loss arising in Year 3 because its $70 SRLY limitation for

Year 4 is reduced by T's $50 Year 2 SRLY loss already included in

the CNOL deduction for Year 4. Thus, the absorption of Year 3 losses

is as follows:

Amount of P's Year 3 losses absorbed = $120/($120 + $20) x $70

= $60.

Amount of T's Year 3 losses absorbed = $20/($120 + $20) x $70

= $10.

(v) The absorption of $10 of T's Year 3 loss further reduces T's

SRLY limitation to $10 ($70 of initial SRLY limitation, reduced by

the $60 net operating loss already included in the CNOL deductions

for Year 4 under paragraph (a) of this section).

(vi) P carries its remaining $60 Year 3 net operating loss and T

carries its remaining $50 Year 3 net operating loss over to Year 5.

Assume that, in Year 5, the P group has $90 of consolidated taxable

income (computed without regard to the CNOL deduction). The group's

CTI determined by reference to only T's items is a CNOL of $4. For

Year 5, the CNOL deduction is $66, which includes $60 of P's Year 3

loss and $6 of T's Year 3 loss (the aggregate consolidated taxable

income for Years 4 and 5 determined by reference to T's items, or

$66, reduced by T's SRLY losses actually absorbed by the group in

Year 4, or $60).

Example 3. Net operating loss carrybacks. (i) P owns all of the

stock of S and T. The members of the P group contribute the

following to the consolidated taxable income of the P group for

Years 1, 2, and 3:

----------------------------------------------------------------------------------------------------------------

Year 1 Year 2 Year 3 Total

----------------------------------------------------------------------------------------------------------------

P............................................... $100 $60 $80 $240

S............................................... 20 20 30 70

T............................................... 30 10 (50) (10)

CTI............................................. 150 90 60 300

----------------------------------------------------------------------------------------------------------------

(ii) P sells all of the stock of T to Individual A at the

beginning of Year 4. For its Year 4 separate return year, T has a

net operating loss of $30.

(iii) T's Year 4 is a SRLY with respect to the P group. See

Sec. 1.1502-1(f)(1). T's $30 net operating loss carryback to the P

group from Year 4 is not allowed under paragraph (c) of this section

to be included in the CNOL deduction under paragraph (a) of this

section for Year 1, 2, or 3, because the P group's consolidated

taxable income would not be a positive amount if determined by

reference to only T's items for all consolidated return years

through Year 4 (without regard to the $30 net operating loss). The

$30 loss is carried forward to T's Year 5 and succeeding taxable

years as provided under the Internal Revenue Code.

Example 4. Computation of SRLY limitation for built-in losses

treated as net operating loss carryovers. (i) Individual A owns P.

In Year 1, Individual A forms T by contributing $300 and T sustains

a $100 net operating loss. During Year 2, T's assets decline in

value by $100. At the beginning of Year 3, P acquires all the stock

of T from Individual A, and T becomes a member of the P group in a

transaction that does not result in an ownership change under

section 382(g). At the time of the acquisition, T has a $100 net

unrealized built-in loss, which exceeds the threshold requirements

of section 382(h)(3)(B). During Year 3, T recognizes its unrealized

loss as a $100 ordinary loss. The members of the P group contribute

the following to the consolidated taxable income of the P group for

Years 3 and 4 (computed without regard to T's recognition of its

unrealized loss and any CNOL deduction under this section):

------------------------------------------------------------------------

Year 3 Year 4 Total

------------------------------------------------------------------------

P group (without T).......................... $100 $100 $200

T............................................ 60 40 100

CTI.......................................... 160 140 300

------------------------------------------------------------------------

(ii) Under Sec. 1.1502-15(a), T's $100 of ordinary loss in Year

3 constitutes a built-in loss that is subject to the SRLY limitation

under paragraph (c) of this section. The amount of the limitation is

determined by treating the deduction as a net operating loss

carryover from a SRLY. The built-in loss is therefore subject to a

$60 SRLY limitation for Year 3. The built-in loss is treated as a

net operating loss carryover solely for purposes of determining the

extent to which the loss is not allowed by reason of the SRLY

limitation, and for all other purposes the loss remains a loss

arising in Year 3. Consequently, under paragraph (b) of this

section, the $60 allowed under the SRLY limitation is absorbed by

the P group before T's $100 net operating loss carryover from Year 1

is allowed.

(iii) Under Sec. 1.1502-15(a), the $40 balance of the built-in

loss that is not allowed in Year 3 because of the SRLY limitation is

treated as a $40 net operating loss arising in Year 3 that is

subject to the SRLY limitation because, under paragraph (c)(1)(ii)

of this section, Year 3 is treated as a SRLY, and is carried to

other years in accordance with the rules of paragraph (b) of this

section. The SRLY limitation for Year 4 is the P group's

consolidated taxable income for Year 3 and Year 4 determined by

reference to only T's items and without regard to the group's CNOL

deductions ($60 + $40), reduced by T's loss actually absorbed by the

group in Year 3 ($60). The SRLY limitation for Year 4 is $40.

(iv) Under paragraph (c) of this section and the principles of

section 172(b), $40 of T's $100 net operating loss carryover from

Year 1 is included in the CNOL deduction under paragraph (a) of this

section in Year 4.

[[Page 36109]]

Example 5. Dual SRLY registers and accounting for SRLY losses

actually absorbed. (i) In Year 1, T sustains a $ 100 net operating

loss and a $50 net capital loss. At the beginning of Year 2, T

becomes a member of the P group in a transaction that does not

result in an ownership change under section 382(g). Both of T's

carryovers from Year 1 are subject to SRLY limits under this

paragraph (c) and Sec. 1.1502-22(c). The members of the P group

contribute the following to the consolidated taxable income for

Years 2 and 3 (computed without regard to T's CNOL deduction under

this section or net capital loss carryover under Sec. 1.1502-22):

------------------------------------------------------------------------

P T

------------------------------------------------------------------------

Year 1 (SRLY)

------------------------------------------------------------------------

Ordinary.............................................. ....... (100)

Capital............................................... ....... (50)

------------------------------------------------------------------------

Year 2

------------------------------------------------------------------------

Ordinary.............................................. 30 60

Capital............................................... 0 (20)

------------------------------------------------------------------------

Year 3

------------------------------------------------------------------------

Ordinary.............................................. 10 40

Capital............................................... 0 30

------------------------------------------------------------------------

(ii) For Year 2, the group computes separate SRLY limits for

each of T's SRLY carryovers from Year 1. The group determines its

ability to use its capital loss carryover before it determines its

ability to use its ordinary loss carryover. Under section 1212,

because the group has no Year 2 capital gain, it cannot absorb any

capital losses in Year 2. T's Year 1 net capital loss and the

group's Year 2 consolidated net capital loss (all of which is

attributable to T) are carried over to Year 3.

(iii) Under this section, the aggregate amount of T's $100 net

operating loss carryover from Year 1 that may be included in the

CNOL deduction of the group for Year 2 may not exceed $60--the

amount of the consolidated taxable income computed by reference only

to T's items, including losses and deductions to the extent actually

absorbed (i.e., $60 of T's ordinary income for Year 2). Thus, the

group may include $60 of T's ordinary loss carryover from Year 1 in

its Year 2 CNOL deduction. T carries over its remaining $40 of its

Year 1 loss to Year 3.

(iv) For Year 3, the group again computes separate SRLY limits

for each of T's SRLY carryovers from Year 1. The group has

consolidated net capital gain (without taking into account a net

capital loss carryover deduction) of $30. Under Sec. 1.1502-22(c),

the aggregate amount of T's $50 capital loss carryover from Year 1

that may be included in computing the group's consolidated net

capital gain for all years of the group (here Years 2 and 3) may not

exceed $30 (the aggregate consolidated net capital gain computed by

reference only to T's items, including losses and deductions

actually absorbed (i.e., $30 of capital gain in Year 3)). Thus, the

group may include $30 of T's Year 1 capital loss carryover in its

computation of consolidated net capital gain for Year 3, which

offsets the group's capital gains for Year 3. T carries over its

remaining $20 of its Year 1 loss to Year 4. The group carries over

the Year 2 consolidated net capital loss to Year 4.

(v) Under this section, the aggregate amount of T's net

operating loss carryover from Year 1 that may be included in the

CNOL deduction of the group for Years 2 and 3 may not exceed $100,

which is the amount of the aggregate consolidated taxable income for

Years 2 and 3 determined by reference only to T's items, including

losses and deductions actually absorbed (i.e., $60 of ordinary

income in Year 2 plus $40 of ordinary income, $30 of capital gain,

and $30 of SRLY capital losses actually absorbed in Year 3). The

group included $60 of T's ordinary loss carryover in its Year 2 CNOL

deduction. It may include the remaining $40 of the carryover in its

Year 3 CNOL deduction.

(2) SRLY subgroup limitation. In the case of a net operating loss

carryover or carryback for which there is a SRLY subgroup, the

principles of paragraph (c)(1) of this section apply to the SRLY

subgroup, and not separately to its members. Thus, the contribution to

consolidated taxable income and the net operating loss carryovers and

carrybacks arising (or treated as arising) in SRLYs that are included

in the CNOL deductions for all consolidated return years of the group

under paragraph (a) of this section are based on the aggregate amounts

of income, gain, deduction, and loss of the members of the SRLY

subgroup for the relevant consolidated return years (as provided in

paragraph (c)(1)(i)(C) of this section). For an illustration of

aggregate amounts during the relevant consolidated return years

following the year in which a member of a SRLY subgroup ceases to be a

member of the group, see paragraph (c)(2)(viii) Example 4 of this

section. A SRLY subgroup may exist only for a carryover or carryback

arising in a year that is not a SRLY (and is not treated as a SRLY

under paragraph (c)(1)(ii) of this section) with respect to another

group (the former group), or for a carryover that was subject to the

overlap rule described in paragraph (g) of this section or Sec. 1.1502-

15(g) with respect to another group (the former group). A separate SRLY

subgroup is determined for each such carryover or carryback. A

consolidated group may include more than one SRLY subgroup and a member

may be a member of more than one SRLY subgroup. Solely for purposes of

determining the members of a SRLY subgroup with respect to a loss:

(i) Carryovers. In the case of a carryover, the SRLY subgroup is

composed of the member carrying over the loss (the loss member) and

each other member that was a member of the former group that becomes a

member of the group at the same time as the loss member. A member

remains a member of the SRLY subgroup until it ceases to be affiliated

with the loss member. The aggregate determination described in

paragraph (c)(1) of this section and this paragraph (c)(2) includes the

amounts of income, gain, deduction, and loss of each member of the SRLY

subgroup for the consolidated return years during which it remains a

member of the SRLY subgroup. For an illustration of the aggregate

determination of a SRLY subgroup, see paragraph (c)(2)(viii) Example 2

of this section.

(ii) Carrybacks. In the case of a carryback, the SRLY subgroup is

composed of the member carrying back the loss (the loss member) and

each other member of the group from which the loss is carried back that

has been continuously affiliated with the loss member from the year to

which the loss is carried through the year in which the loss arises.

(iii) Built-in losses. In the case of a built-in loss, the SRLY

subgroup is composed of the member recognizing the loss (the loss

member) and each other member that was part of the subgroup with

respect to the loss determined under Sec. 1.1502-15(c)(2) immediately

before the members became members of the group. The principles of

paragraphs (c)(2) (i) and (ii) of this section apply to determine the

SRLY subgroup for the built-in loss that is, under paragraph (c)(1)(ii)

of this section, treated as arising in a SRLY with respect to the group

in which the loss is recognized. For this purpose and as the context

requires, a reference in paragraphs (c)(2) (i) and (ii) of this section

to a group or former group is a reference to the subgroup determined

under Sec. 1.1502-15(c)(2).

(iv) Principal purpose of avoiding or increasing a SRLY limitation.

The members composing a SRLY subgroup are not treated as a SRLY

subgroup if any of them is formed, acquired, or availed of with a

principal purpose of avoiding the application of, or increasing any

limitation under, this paragraph (c). Any member excluded from a SRLY

subgroup, if excluded with a principal purpose of so avoiding or

increasing any SRLY limitation, is treated as included in the SRLY

subgroup.

(v) Coordination with other limitations. This paragraph (c)(2) does

not allow a net operating loss to offset income to the extent

inconsistent with other limitations or restrictions on the use of

losses, such as a limitation based on the nature or activities of

members. For example, any dual consolidated loss

[[Page 36110]]

may not reduce the taxable income to an extent greater than that

allowed under section 1503(d) and Sec. 1.1503-2. See also Sec. 1.1502-

47(q) (relating to preemption of rules for life-nonlife groups).

(vi) Anti-duplication. If the same item of income or deduction

could be taken into account more than once in determining a limitation

under this paragraph (c), or in a manner inconsistent with any other

provision of the Internal Revenue Code or regulations incorporating

this paragraph (c), the item of income or deduction is taken into

account only once and in such manner that losses are absorbed in

accordance with the ordering rules in paragraph (b) of this section and

the underlying purposes of this section.

(vii) Corporations that leave a SRLY subgroup. If a loss member

ceases to be affiliated with a SRLY subgroup, the amount of the

member's remaining SRLY loss from a specific year is determined by

multiplying the aggregate of the unabsorbed net operating loss

carryovers of the SRLY subgroup from that year by a fraction, the

numerator of which is the net operating loss carryover for that year

that the member leaving the subgroup had when it became a member of the

group, and the denominator of which is the aggregate of the net

operating loss carryovers of the members of the SRLY subgroup for that

year when they joined the group. The unabsorbed net operating loss

carryovers of the SRLY subgroup are those carryovers that have not been

absorbed by the group as of the end of the taxable year in which the

loss member leaves the group.

(viii) Examples. The principles of this paragraph (c)(2) are

illustrated by the following examples:

Example 1. Members of SRLY subgroups. (i) Individual A owns all

of the stock of P, S, T and M. P and M are each common parents of a

consolidated group. During Year 1, P sustains a $50 net operating

loss. At the beginning of Year 2, P acquires all the stock of S at a

time when the aggregate basis of S's assets exceeds their aggregate

value by $70 and S becomes a member of the P group. At the beginning

of Year 3, P acquires all the stock of T, T has a $60 net operating

loss carryover at the time of the acquisition, and T becomes a

member of the P group. During Year 4, S forms S1 and T forms T1,

each by contributing assets with built-in gains which are, in the

aggregate, material. S1 and T1 become members of the P group. During

Year 7, M acquires all of the stock of P, and the members of the P

group become members of the M group for the balance of Year 7. The

$50 and $60 loss carryovers of P and T are carried to Year 7 of the

M group, and the value and basis of S's assets did not change after

it became a member of the former P group. None of the transactions

described above resulted in an ownership change under section

382(g).

(ii) Under paragraph (c)(2) of this section, a separate SRLY

subgroup is determined for each loss carryover and built-in loss. In

the P group, P's $50 loss carryover is not treated as arising in a

SRLY. See Sec. 1.1502-1(f). Consequently, the carryover is not

subject to limitation under paragraph (c) of this section in the P

group.

(iii) In the M group, P's $50 loss carryover is treated as

arising in a SRLY and is subject to the limitation under paragraph

(c) of this section. A SRLY subgroup with respect to that loss is

composed of members which were members of the P group, the group as

to which the loss was not a SRLY. The SRLY subgroup is composed of

P, the member carrying over the loss, and each other member of the P

group that became a member of the M group at the same time as P. A

member of the SRLY subgroup remains a member until it ceases to be

affiliated with P. For Year 7, the SRLY subgroup is composed of P,

S, T, S1, and T1.

(iv) In the P group, S's $70 unrealized loss, if recognized

within the 5-year recognition period after S becomes a member of the

P group, is subject to limitation under paragraph (c) of this

section. See Sec. 1.1502-15 and paragraph (c)(1)(ii) of this

section. Because S was not continuously affiliated with P, T, or T1

for 60 consecutive months prior to joining the P group, these

corporations cannot be included in a SRLY subgroup with respect to

S's unrealized loss in the P group. See paragraph (c)(2)(iii) of

this section. As a successor to S, S1 is included in a subgroup with

S in the P group, and because 100 percent of S1's stock is owned

directly by corporations that were members of the SRLY subgroup when

the members of the SRLY subgroup became members of the P group, its

net positive income is not excluded from the consolidated taxable

income of the P group that may be offset by the built-in loss. See

paragraph (f) of this section.

(v) In the M group, S's $70 unrealized loss, if recognized

within the 5-year recognition period after S becomes a member of the

M group, is subject to limitation under paragraph (c) of this

section. Prior to becoming a member of the M group, S had been

continuously affiliated with P (but not T or T1) for 60 consecutive

months and S1 is a successor that has remained continuously

affiliated with S. Those members had a net unrealized built-in loss

immediately before they became members of the group under

Sec. 1.1502-15(c). Consequently, in Year 7, S, S1, and P compose a

subgroup in the M group with respect to S's unrealized loss. Because

S1 was a member of the SRLY subgroup when it became a member of the

M group and also because 100 percent of S1's stock is owned directly

by corporations that were members of the SRLY subgroup when the

members of the SRLY subgroup became members of the M group its net

positive income is not excluded from the consolidated taxable income

of the M group that may be offset by the recognized built-in loss.

See paragraph (f) of this section.

(vi) In the P group, T's $60 loss carryover arose in a SRLY and

is subject to limitation under paragraph (c) of this section. P, S,

and S1 were not members of the group in which T's loss arose and T's

loss carryover was not subject to the overlap rule described in

paragraph (g) of this section with respect to the P group (the

former group). Thus, P, S, and S1 are not members of a SRLY subgroup

with respect to the T carryover in the P group. See paragraph

(c)(2)(i) of this section. As a successor to T, T1 is included in a

SRLY subgroup with T in the P group; and, because 100 percent of

T1's stock is owned directly by corporations that were members of

the SRLY subgroup when the members of the SRLY subgroup became

members of the P group, its net positive income is not excluded from

the consolidated taxable income of the P group that may be offset by

the carryover. See paragraph (f) of this section.

(vii) In the M group, T's $60 loss carryover arose in a SRLY and

is subject to limitation under paragraph (c) of this section. T and

T1 remain the only members of a SRLY subgroup with respect to the

carryover. Because T1 was a member of the SRLY subgroup when it

became a member of the M group and also because 100 percent of T1's

stock is owned directly by corporations that were members of the

SRLY subgroup when the members of the SRLY subgroup became members

of the M group, its net positive income is not excluded from the

consolidated taxable income of the M group that may be offset by the

carryover. See paragraph (f) of this section.

Example 2. Computation of SRLY subgroup limitation. (i)

Individual A owns all of the stock of S, T, P and M. P and M are

each common parents of a consolidated group. In Year 2, P acquires

all the stock of S and T from Individual A, and S and T become

members of the P group. For Year 3, the P group has a $45 CNOL,

which is attributable to P, and which P carries forward. M is the

common parent of another group. At the beginning of Year 4, M

acquires all of the stock of P and the former members of the P group

become members of the M group. None of the transactions described

above resulted in an ownership change under section 382(g).

(ii) P's year to which the loss is attributable, Year 3, is a

SRLY with respect to the M group. See Sec. 1.1502-1(f)(1). However,

P, S, and T compose a SRLY subgroup with respect to the Year 3 loss

under paragraph (c)(2)(i) of this section because Year 3 is not a

SRLY (and is not treated as a SRLY) with respect to the P group. P's

loss is carried over to the M group's Year 4 and is therefore

subject to the SRLY subgroup limitation in paragraph (c)(2) of this

section.

(iii) In Year 4, the M group has $10 of consolidated taxable

income (computed without regard to the CNOL deduction for Year 4).

Such consolidated taxable income would be $45 if determined by

reference to only the items of P, S, and T, the members included in

the SRLY subgroup with respect to P's loss carryover. Therefore, the

SRLY subgroup limitation under paragraph (c)(2) of this section for

P's net operating loss carryover from Year 3 is $45. Because the M

group has only $10 of consolidated taxable income in Year 4,

however, only $10 of P's

[[Page 36111]]

net operating loss carryover is included in the CNOL deduction under

paragraph (a) of this section in Year 4.

(iv) In Year 5, the M group has $100 of consolidated taxable

income (computed without regard to the CNOL deduction for Year 5).

Neither P, S, nor T has any items of income, gain, deduction, or

loss in Year 5. Although the members of the SRLY subgroup do not

contribute to the $100 of consolidated taxable income in Year 5, the

SRLY subgroup limitation for Year 5 is $35 (the sum of SRLY subgroup

consolidated taxable income of $45 in Year 4 and $0 in Year 5, less

the $10 net operating loss carryover actually absorbed by the M

group in Year 4). Therefore, $35 of P's net operating loss carryover

is included in the CNOL deduction under paragraph (a) of this

section in Year 5.

Example 3. Inclusion in more than one SRLY subgroup. (i)

Individual A owns all of the stock of S, T, P and M. S, P and M are

each common parents of a consolidated group. At the beginning of

Year 1, S acquires all the stock of T from Individual A, and T

becomes a member of the S group. For Year 1, the S group has a CNOL

of $10, all of which is attributable to S and is carried over to

Year 2. At the beginning of Year 2, P acquires all the stock of S,

and S and T become members of the P group. For Year 2, the P group

has a CNOL of $35, all of which is attributable to P and is carried

over to Year 3. At the beginning of Year 3, M acquires all of the

stock of P and the former members of the P group become members of

the M group. None of the transactions described above resulted in an

ownership change under section 382(g).

(ii) P's and S's net operating losses arising in SRLYs with

respect to the M group are subject to limitation under paragraph (c)

of this section. P, S, and T compose a SRLY subgroup for purposes of

determining the limitation for P's $35 net operating loss carryover

arising in Year 2 because, under paragraph (c)(2)(i) of this

section, Year 2 is not a SRLY with respect to the P group.

Similarly, S and T compose a SRLY subgroup for purposes of

determining the limitation for S's $10 net operating loss carryover

arising in Year 1 because Year 1 is not a SRLY with respect to the S

group.

(iii) S and T are members of both the SRLY subgroup with respect

to P's losses and the SRLY subgroup with respect to S's losses.

Under paragraph (c)(2) of this section, S's and T's items cannot be

included in the determination of the SRLY su

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