§ 1.1502-19. Excess loss accounts.

(a) Facts. M has a $150 basis in S's stock, and S has a $100 basis in T's stock. For Year 1, M has $500 of ordinary income, S has no income or loss, and T has a $200 ordinary loss. S sells T's stock to a nonmember for $60 at the close of Year 1.

(b) Analysis. Under paragraph (c) of this section, the sale is a disposition of T's stock at the close of Year 1 (the day of the sale). Under § 1.1502-32(b), T's loss results in S having a $100 excess loss account in T's stock immediately before the sale. Under paragraph (b)(1) of this section, S takes into account the $100 excess loss account as an additional $100 of gain from the sale. Consequently, S takes into account a $160 gain from the sale in determining the group's consolidated taxable income. Under § 1.1502-32(b), T's $200 loss and S's $160 gain result in a net $40 decrease in M's basis in S's stock as of the close of Year 1, from $150 to $110.

(c) Intercompany sale followed by sale to nonmember. The facts are the same as in paragraph (a) of this Example 1, except that S sells T's stock to M for $60 at the close of Year 1, and M sells T's stock to a nonmember at a gain at the beginning of Year 5. Under paragraph (c) of this section, S's sale is treated as a disposition of T's stock at the close of Year 1 (the day of the sale). Under § 1.1502-13 and paragraph (b)(2) of this section, S's $160 gain from the sale is deferred and taken into account in Year 5 as a result of M's sale of the T stock. Under § 1.1502-32(b), the absorption of T's $200 loss in Year 1 results in M having a $50 excess loss account in S's stock at the close of Year 1. In Year 5, S's $160 gain taken into account eliminates M's excess loss account in S's stock and increases M's basis in the stock to $110.

(d) Intercompany distribution followed by sale to a nonmember. The facts are the same as in paragraph (a) of this Example 1, except that the value of the T stock is $60 and S declares and distributes a dividend of all of the T stock to M at the close of Year 1, and M sells the T stock to a nonmember at a gain at the beginning of Year 5. Under paragraph (c) of this section, S's distribution is treated as a disposition of T's stock at the close of Year 1 (the day of the distribution). S's $100 excess loss account in T's stock is treated as additional gain under section 311(b) from the distribution. Under section 301(d), M's basis in the T stock is $60. Under § 1.1502-13, and paragraph (b)(2) of this section, S's $160 gain from the distribution is deferred and taken into account in Year 5 as a result of M's sale of the T stock. Under § 1.1502-32(b), T's $200 loss and S's $60 distribution result in M having a $110 excess loss account in S's stock at the close of Year 1. In Year 5, S's $160 gain taken into account eliminates M's excess loss account in S's stock and increases M's basis in the stock to $50.

(i) Facts. M owns all of the sole class of stock of each of S and T. M has 150 shares of S stock that it acquired on Date 1. Each S share has a $1 basis and a fair market value of $1. M has 100 shares of T stock that it acquired on Date 2. Each T share has a $1.20 excess loss account and a fair market value of $1. M transfers S's stock to T without receiving additional T stock. The transfer is an exchange described in both section 351 and section 354.

(ii) Analysis. Under sections 351 and 354, M does not recognize gain in connection with the transfer. Under § 1.358-2(a)(2)(iii), M is deemed to receive 150 shares of T stock of the same class. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1 basis in each such share. However, because the basis of the additional shares of T stock will be determined when M has an excess loss account in its original shares of T stock, under paragraph (d)(1) of this section, the basis that M would otherwise have in such additional shares will eliminate the excess loss account in M's original shares of T stock such that each original share of T stock will have a basis of $0 and each share of T stock deemed received will have a basis of $0.20. Then, under § 1.358-2(a)(2)(iii), the T stock is deemed to be recapitalized in a reorganization under section 368(a)(1)(E) in which M receives 100 shares of T stock (those shares M actually owns immediately after the transfer) in exchange for those 100 shares of T stock that M held immediately prior to the transfer and those 150 shares of T stock M is deemed to receive in the transfer. Under § 1.358-2(a)(2)(i), immediately after the transfer, M holds 100 shares of T stock, 60 of which take a basis of $0.50 each and 40 of which take a basis of $0 each. In addition, T takes a $1 basis in each share of S stock under section 362. (If M had actually received an additional 150 shares of T stock of the same class, paragraph (d)(1) of this section would apply to shift basis from such additional T shares to M's original T shares because the basis of the additional T stock would be determined when M had an excess loss account in its original T shares. M would have a basis of $0 in each of the original T shares and a basis of $0.20 in each of the additional T shares.)

(iii) Transfer of shares with an excess loss account. The facts are the same as in paragraph (i) of this Example 2, except that M transfers T's stock to S without receiving additional S stock. The transfer is an exchange described in both section 351 and section 354. Under paragraph (c) of this section, M's transfer is treated as a disposition of T's stock. Under sections 351 and 354 and paragraph (b)(2) of this section, M does not recognize gain from the disposition. Under § 1.358-2(a)(2)(iii), M is deemed to have received 100 shares of S stock of the same class. Without regard to the application of paragraph (d) of this section, M would have a $1.20 excess loss account in each such share. However, because M will have an excess loss account in such shares and M owns other shares of S stock of the same class, under paragraph (d)(2) of this section, the excess loss account that M would otherwise have in such shares will decrease M's basis in its original shares of S's stock such that each such original share will have a basis of $0.20 and each share deemed received will have a basis of $0. Then, under § 1.358-2(a)(2)(iii), the S stock is deemed to be recapitalized in a reorganization under section 368(a)(1)(E) in which M receives 150 shares of S stock (those shares M actually owns immediately after the transfer) in exchange for those 150 shares of S stock that M held immediately prior to the transfer and those 100 shares of S stock that M is deemed to receive in connection with the transfer. Under § 1.358-2(a)(2)(i), immediately after the transfer, M holds 150 shares of S stock, 90 of which take a basis of $0.33 each and 60 of which take a basis of $0 each. In addition, S takes an excess loss account of $1.20 in each share of T stock under section 362. (If M had actually received 100 additional shares of S stock of the same class, paragraph (d)(2) of this section would apply to shift basis from M's original S stock because M would have otherwise had an excess loss account in such additional shares and M owned other shares of S stock of the same class. The excess loss account that M would have otherwise had in such additional shares would have decreased M's basis in its original shares of S's stock. M would have had a basis of $0.20 in each of the original shares and a basis of $0 in each of the additional shares.)

(iv) Intercompany merger—shares with excess loss account retained. The facts are the same as in paragraph (i) of this Example 2, except that S merges into T in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)), and M receives 150 additional shares of T stock of the same class in the reorganization. Under section 354, M does not recognize gain. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1 basis in each such share. However, because the basis of the additional shares of T stock will be determined when M has an excess loss account in its original shares of T stock, under paragraph (d)(1) of this section, the basis that M would otherwise have in such additional shares eliminates the excess loss account in M's original shares of T stock such that each original share of T stock has a basis of $0 and each additional share of T stock has a basis of $0.20.

(v) Intercompany merger—shares with excess loss account surrendered. The facts are the same as in paragraph (i) of this Example 2, except that T merges into S in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)), and M receives 100 additional shares of S stock of the same class in the reorganization. Under section 354 and paragraph (b)(2) of this section, M does not recognize gain from the disposition. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1.20 excess loss account in each additional share of S stock received. However, because M would have an excess loss account in such shares and M owns other shares of S stock of the same class, under paragraph (d)(2) of this section, the excess loss account that M would otherwise have in such shares decreases M's basis in its original shares of S's stock such that each original share of S stock has a basis of $0.20 and each additional share of S stock has a basis of $0.

(a) Facts. M has a $30 excess loss account in S's stock, and S has a $90 excess loss account in T's stock. S distributes the T stock to M in a transaction to which section 355 applies, and neither M nor S recognizes any gain or loss. At the time of the distribution, the T stock represents 33% of the value of the S stock. Following the distribution, M's basis in the S stock is allocated under § 1.358-2 in proportion to the fair market values of the S stock and the T stock.

(b) Analysis. Under paragraph (c) of this section, S's distribution of the T stock is treated as a disposition. Under section 355(c) and paragraph (b)(2) of this section, S does not recognize any gain from the distribution. Under section 358, S's excess loss account in the T stock is eliminated, and M's $30 excess loss account in the S stock is treated as basis allocated between the S stock and the T stock based on their relative values. Consequently, M has a $20 excess loss account in the S stock and a $10 excess loss account in the T stock. (If M had a $30 basis rather than a $30 excess loss account in the S stock, S would not recognize gain, its excess loss account in the T stock would be eliminated, and M's basis in the stock of S and T would be $20 and $10, respectively.)

(c) Section 355 distribution to nonmember. The facts are the same as in paragraph (a) of this Example 3, except that M also distributes the T stock to its shareholders in a transaction to which section 355 applies. Under paragraph (c) of this section, M's distribution is treated as a disposition of T's stock. Under paragraph (b)(2) of this section, because M's disposition is described in paragraph (c)(1)(ii) of this section, M's $10 excess loss account in the T stock must be taken into account at the time of the distribution, notwithstanding the nonrecognition rules of section 355(c).

(a) Facts. M has a $50 excess loss account in S's stock, and S has a $100 excess loss account in T's stock. T issues additional stock to a nonmember and, as a consequence, T becomes a nonmember.

(b) Analysis. Under paragraph (c)(2) of this section, S is treated as disposing of each of its shares of T's stock immediately before T becomes a nonmember. Under paragraph (b)(1) of this section, S takes into account its $100 excess loss account as gain from the sale or exchange of T's stock. Under § 1.1502-32(b) of this section, S's $100 gain eliminates M's excess loss account in S's stock and increases M's basis in S's stock to $50.

(c) Deconsolidation of a higher-tier member. The facts are the same as in paragraph (a) of this Example 4, except that S (rather than T) issues the stock and, as a consequence, both S and T become nonmembers. Under paragraph (c)(2) of this section, M is treated as disposing of S's stock and S is treated as disposing of T's stock immediately before S and T become nonmembers. Under § 1.1502-32(b) and paragraph (b)(3) of this section, because S and T become nonmembers in the same transaction and T is the lower-tier member, S is first treated under paragraph (b)(1) of this section as taking into account its $100 excess loss account as gain from the sale or exchange of T's stock. Under § 1.1502-32(b), S's $100 gain eliminates M's excess loss account in S's stock and increases M's basis in S's stock to $50 immediately before S becomes a nonmember. Thus, only S's $100 gain is taken into account in the determination of the group's consolidated taxable income.

(d) Intercompany gain and deconsolidation. The facts are the same as in paragraph (c) of this Example 4, except that T has $30 of gain that is deferred under § 1.1502-13 and taken into account in determining consolidated taxable income immediately before T becomes a nonmember. Under § 1.1502-32(b), T's $30 gain decreases S's excess loss account in T's stock from $100 to $70 immediately before S is treated as disposing of T's stock. Under paragraph (b)(1) of this section, S is treated as taking into account its $70 excess loss account as gain from the disposition of T's stock. Under § 1.1502-32(b), S's $70 gain from the excess loss account and T's $30 deferred gain that is taken into account eliminate M's $50 excess loss account in S's stock and increase M's basis in S's stock to $50 immediately before S becomes a nonmember.

(a) Facts. M forms S with a $150 contribution, and S borrows $150. For Year 1, S has a $50 ordinary loss that is carried over as part of the group's consolidated net operating loss. For Year 2, M has $160 of ordinary income, and S has a $160 ordinary loss. Under § 1.1502-32(b), S's loss results in M having a $10 excess loss account in S's stock. During Year 3, the value of S's assets (without taking S's liabilities into account) continues to decline and S's stock becomes worthless within the meaning of section 165(g) (without taking into account § 1.1502-80(c)). For Year 4, S has $10 of ordinary income.

(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section, M is not treated as disposing of S's stock in Year 3 solely because S's stock becomes worthless within the meaning of section 165(g) (taking S's liabilities into account). In addition, because S's stock is not treated as worthless, section 382(g)(4)(D) does not prevent the Year 1 consolidated net operating loss carryover from offsetting S's $10 of income in Year 4.

(c) Discharge of indebtedness. The facts are the same as in paragraph (a) of this Example 5, except that, instead of S's stock becoming worthless within the meaning of section 165(g), S's creditor discharges $40 of S's indebtedness during Year 3, S is insolvent by more than $40 before the discharge, the discharge is excluded from the M group's gross income under section 108(a), and $40 of the $50 consolidated net operating loss carryover attributable to S is eliminated under section 108(b). Under § 1.1502- 32(b)(3)(ii)(C), S's $40 of discharge income is treated as tax-exempt income because there is a corresponding decrease under § 1.1502-32(b)(3)(iii) for elimination of the loss carryover. Under paragraph (c)(1)(iii)(B) of this section, M is treated as disposing of S's stock if the amount discharged is not included in gross income and is not treated as tax-exempt income under § 1.1502-32(b)(3)(ii)(C). Because the discharge is treated as tax-exempt income, M is not treated as disposing of S's stock by reason of the discharge.

(a) Facts. M forms S with a $100 contribution and S borrows $150. For Years 1 through 5, S has a $210 ordinary loss that is absorbed by the group. Under § 1.1502-32(b), S's loss results in M having a $110 excess loss account in S's stock. S defaults on the indebtedness, but the creditor does not discharge the debt (or initiate collection procedures). At the beginning of Year 6, S ceases any substantial operations with respect to the assets, but maintains their ownership with a principal purpose to avoid M's taking into account its excess loss account in S's stock.

(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section, M's excess loss account on each of its shares of S's stock ordinarily is taken into account at the time substantially all of S's assets are treated as disposed of, abandoned, or destroyed for Federal income tax purposes. Under paragraph (e) of this section, however, S's assets are not taken into account at the beginning of Year 6 for purposes of applying paragraph (c)(1)(iii)(A) of this section. Consequently, S is treated as worthless at the beginning of Year 6, and M's $110 excess loss account is taken into account.