Excess depreciation tied to built-in losses cannot reduce section 1374 gain

Plain-English summary

Chief Counsel advice addressed whether excess depreciation deductions attributable to built-in-loss assets could reduce net recognized built-in gain for purposes of section 1374 after a corporation converted to S corporation status. The taxpayer sought to use the definition of recognized built-in gain used for section 382(h), including the method described in Notice 2003-65, for section 1374. The advice states that this approach is inappropriate. Under the section 1374 tax accrual rule, depreciation, amortization, or depletion attributable to built-in-loss assets does not reduce built-in gain during the recognition period.

Ruling snapshot

• Question: May depreciation attributable to built-in-loss assets reduce recognized built-in gain under section 1374 by using the section 382(h) approach?
• Outcome: Advice given
• Key authorities: IRC §§ 382(h) and 1374; Notice 2003-65

Full text (IRS public release)

ID: CCA-721125-09 Number: 201003018
Release Date: 1/22/2010
Office: --------------
UILC: 382.00-00, 1374.00-00

From: ----------------
Sent: Monday 3/30/2009 3:47 PM
To: -----------------------
Cc: ----------------
Subject: RE: Depreciation Allowed As a Recognized Loss Under 1374

------ forwarded your issue to me and ----- regarding the treatment of excess depreciation deductions for purposes of computing net recognized built-in gain for purposes of section 1374. The taxpayer is attempting to reduce recognized built-in gain by depreciation attributable to the amount of built-in loss on assets at the time of the conversion to S corp status. The taxpayer is attempting to use the definition of RBIG that we use for purposes of section 382(h) for purposes of section 1374. It is my personal opinion that such a use is inappropriate. Notice 2003-65 describes the available methods for purposes of section 382 and even has a method called the 1374 method. The Notice, however, contains the following sentence.

The 1374 approach departs from the tax accrual rule and the regulations under section 1374 in its treatment of amounts allowable as depreciation, amortization, or depletion (collectively, “amortization”) deductions during the recognition period. In accordance with the second sentence of .section 382(h)(2)(B),except to the extent the loss corporation establishes that the amount is not attributable to the excess of an asset's adjusted basis over its fair market value on the change date, these amounts are treated as RBIL, regardless of whether they accrued for tax purposes before the change date.

In other words, the tax accrual rule in the regulations under section 1374 does not allow for the reduction of BIG with depreciation with respect to BIL assets. Feel free to call me if you would like to discuss the matter further.

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