Corporate Tax | Just Tax

Net Operating Losses (§ 172)

This checklist guides the complete analysis of net operating loss computations, carryback and carryforward rules, utilization limitations, and related elections under § 172 as amended by the TCJA, CARES Act, and subsequent legislation. Use it when a client has incurred a loss for tax purposes and seeks to optimize loss utilization across current, prior, and future tax years.

Step 1. Determining Whether an NOL Exists

"For purposes of this section, the term 'net operating loss' means the excess of the deductions allowed by this chapter over the gross income. Such excess shall be computed with the modifications specified in subsection (d)." (IRC § 172(c))

• The basic formula. An NOL exists when deductions allowed by chapter 1 exceed gross income, subject to the modifications in § 172(d). These modifications are critical and often change the result. A taxpayer with substantial negative taxable income on a return may have no NOL after applying the modifications, and conversely a taxpayer with positive taxable income may have an NOL if the modifications add back enough deductions.
• The NOL is computed before the NOL deduction. The current year's NOL is determined without regard to any NOL deduction from other years. § 172(d)(1) provides "No net operating loss deduction shall be allowed." Treas. Reg. § 1.172-3(a)(1)(ii) implements this by disallowing any § 172 deduction in the NOL computation. This prevents stacking NOLs from multiple years into the current year's computation. Add back any NOL carryover or carryback deduction claimed on the return before testing whether an NOL exists. (IRS Form 172, Part I, Line 23)
• Corporate vs. noncorporate differences. The § 172(d) modifications differ significantly between corporations and noncorporate taxpayers. Flag the taxpayer type at the outset because the computation path diverges. Noncorporate taxpayers face the capital loss limitation (§ 172(d)(2)), the personal exemption disallowance (§ 172(d)(3)), the nonbusiness deduction limitation (§ 172(d)(4)), and the disallowance of the § 199A deduction (§ 172(d)(8)). Corporations face fewer modifications but are subject to the § 250 disallowance (§ 172(d)(9)) and a special dividends received deduction rule (§ 172(d)(5)).
• Step 1A. Confirm the taxpayer is not a C corporation before applying individual modifications. Treas. Reg. § 1.172-2 addresses the corporate NOL computation and Treas. Reg. § 1.172-3 addresses the noncorporate computation. The two regulations are structurally different. If the taxpayer is a corporation, skip Steps 2B and 4 (noncorporate modifications) and proceed to Step 2C.
• Step 1B. For noncorporate taxpayers, confirm § 461(l) has been applied before computing the NOL. § 461(l)(1)(B) disallows any excess business loss for noncorporate taxpayers for tax years beginning after December 31, 2020. The statute provides that any loss disallowed under § 461(l) "shall be treated as a net operating loss for the taxable year for purposes of determining any net operating loss carryover under section 172(b) for subsequent taxable years." (§ 461(l)(2)). This means the EBL limitation operates before the NOL computation. A loss disallowed under § 461(l) becomes an NOL in the subsequent year and is then subject to the 80 percent taxable income limitation under § 172(a)(2)(B). Do not confuse the current-year business loss with the current-year NOL. The former is computed on Form 461. The latter is computed on Form 172 Part I and may be a different amount.
• CAUTION. The excess business loss limitation applies at the partner or shareholder level for partnerships and S corporations. (§ 461(l)(4)). The ordering of limitations for pass-through owners is (1) basis under § 704(d) or § 1366(d), (2) at-risk under § 465, (3) passive activity loss under § 469, and (4) excess business loss under § 461(l). (IRS Publication 925 (2025)). Only losses that survive all four limitations enter the NOL computation.
• The burden of proof. The taxpayer claiming an NOL deduction bears the burden of proving entitlement to that deduction. United States v. Olympic Radio & Television, Inc., 349 U.S. 232, 235, 75 S. Ct. 733 (1955) ("We deal here with a deduction which one obtains not as of right, but as of grace. The taxpayer has the burden to show that it is within the provision allowing the deduction.").

Step 2. Modifications to Taxable Income Under § 172(d)

"In the case of a taxpayer other than a corporation, the deductions allowable by this chapter which are not attributable to a taxpayer's trade or business shall be allowed only to the extent of the amount of the gross income not derived from such trade or business." (IRC § 172(d)(4))

• All NOL computations require applying § 172(d) modifications. There are nine modifications organized by the paragraphs of § 172(d). Some apply to all taxpayers. Others apply only to noncorporate taxpayers. Still others apply only to corporations. Apply them in a logical sequence because later modifications may depend on earlier ones.

Step 2A. Modifications Applicable to All Taxpayers

• No NOL deduction from other years. § 172(d)(1) provides "No net operating loss deduction shall be allowed." This is the first modification applied. Add back the entire amount of any NOL deduction for losses from other tax years claimed on the return. Form 172 Part I Line 23 implements this. Treas. Reg. § 1.172-3(a)(1)(ii) confirms "No deduction shall be allowed under § 172 for the net operating loss deduction." This modification prevents a taxpayer from using a prior year's loss to create or increase a current year NOL.
• No § 199A deduction. § 172(d)(8) provides "Any deduction under section 199A shall not be allowed." Add back the full amount of any qualified business income deduction claimed under § 199A(a) or any deduction for agricultural or horticultural cooperatives under § 199A(g). Form 172 Part I Line 5 requires this addback. This modification applies to all taxpayers that could claim the § 199A deduction, which for C corporations is none because § 199A does not apply to C corporations. The § 199A deduction expires after December 31, 2025 unless extended by Congress.
• No § 250 deduction. § 172(d)(9) provides "The deduction under section 250 shall not be allowed." Add back the full amount of any deduction for foreign-derived intangible income (FDII) or global intangible low-taxed income (GILTI) claimed under § 250. This applies primarily to domestic corporations. Individual taxpayers who make a § 962 election to be taxed as a domestic corporation on subpart F income or GILTI can also claim the § 250 deduction, and for those taxpayers the disallowance applies as well. The § 250 deduction rate is 37.5 percent of FDII plus 50 percent of GILTI for tax years beginning before January 1, 2026, and 21.875 percent of FDII plus 37.5 percent of GILTI for tax years beginning after December 31, 2025.

Step 2B. Modifications Applicable Only to Noncorporate Taxpayers

• Capital loss limitation. § 172(d)(2)(A) provides "The amount deductible on account of losses from sales or exchanges of capital assets shall not exceed the amount includible on account of gains from sales or exchanges of capital assets." Net capital losses cannot create or increase an NOL. Treas. Reg. § 1.172-3(a)(2)(i) limits business capital losses to the sum of business capital gains plus that portion of nonbusiness capital gains allocated under the three-tier priority system of Treas. Reg. § 1.172-3(c). Treas. Reg. § 1.172-3(a)(2)(ii) limits nonbusiness capital losses to nonbusiness capital gains.
• Three-tier priority system for nonbusiness capital gains. Treas. Reg. § 1.172-3(c) establishes a mandatory waterfall. (1) First priority. Nonbusiness capital gains offset nonbusiness capital losses. (2) Second priority. Any remaining nonbusiness capital gains offset the excess of nonbusiness deductions over nonbusiness gross income (other than capital gains). (3) Third priority. Any remaining nonbusiness capital gains offset business capital losses. Only after this three-tier allocation can the practitioner determine whether any capital losses remain disallowed.
• No § 1202 exclusion. § 172(d)(2)(B) provides "The exclusion provided by section 1202 shall not be allowed." Any gain excluded from gross income under § 1202 on the sale of qualified small business stock must be added back as includible gain for NOL purposes. For QSBS acquired after September 27, 2010, up to 100 percent of gain may be excluded from gross income under § 1202. For NOL computation, this excluded amount is treated as taxable gain. Form 172 Part I Lines 15 through 18 implement this addback.
• No personal exemption deduction. § 172(d)(3) provides "No deduction shall be allowed under section 151 (relating to personal exemptions). No deduction in lieu of any such deduction shall be allowed." Treas. Reg. § 1.172-3(a)(1)(i) confirms that no deduction in lieu of personal exemptions is allowed. Personal exemptions are reduced to zero for tax years 2018 through 2025 under TCJA § 11041, so this modification has limited practical effect for current years. Personal exemptions are scheduled to return in 2026 unless extended.
• Nonbusiness deduction limitation. § 172(d)(4) provides "In the case of a taxpayer other than a corporation, the deductions allowable by this chapter which are not attributable to a taxpayer's trade or business shall be allowed only to the extent of the amount of the gross income not derived from such trade or business." This is the single most important modification for noncorporate taxpayers. The standard deduction, itemized deductions, and other personal deductions do not create or increase an NOL unless matched by nonbusiness income. Treas. Reg. § 1.172-3(a)(3)(i) confirms that ordinary nonbusiness deductions are allowed in full only to the extent of the sum of ordinary nonbusiness gross income plus the excess of nonbusiness capital gains over nonbusiness capital losses.
• What counts as business income and deductions. Treas. Reg. § 1.172-3(a)(3)(i) provides that wages and salary constitute income attributable to the taxpayer's trade or business for NOL purposes. Business income also includes self-employment income, rental income, gain on sale of business property, unemployment compensation, and the taxpayer's share of business income from partnerships and S corporations. Nonbusiness income includes interest on investments, dividends, annuity income, pension benefits, taxable IRA distributions, Social Security benefits, and the taxpayer's share of nonbusiness income from pass-through entities.
• Special rules within § 172(d)(4). § 172(d)(4)(A)(i) treats gain or loss on the sale of depreciable business property as business income or loss. § 172(d)(4)(A)(ii) does the same for gain or loss on the sale of real property used in a trade or business. § 172(d)(4)(C) treats casualty and theft losses under § 165(c)(2) or (3) as business losses even if the property is not connected with a trade or business. This is a taxpayer-favorable rule. § 172(d)(4)(D) treats deductions under § 404 for contributions to retirement plans on behalf of self-employed individuals as nonbusiness deductions, not business deductions.
• Classification as business or nonbusiness follows the origin of the claim. Courts apply a facts-and-circumstances test. In Estate of Kincaid v. Commissioner, T.C. Memo. 1986-543, the court directed the inquiry to the determination of the "kind of transaction" from which the litigation arose, considering the issues involved, the nature and objectives of the litigation, the defenses asserted, the purpose for which the claimed deductions were expended, the background of the litigation, and all facts pertinent to the controversy. In Sadatnejad and Marconet, 2024-OTA-625P (precedential) (California Office of Tax Appeals, January 2025), a settlement payment of over $5 million arising from embezzlement of client funds was classified as nonbusiness, meaning no NOL could be carried to other years. The court used the taxpayer's own litigation memorandum as evidence that the loss was nonbusiness.
• TRAP. Many taxpayers with significant business losses do not have an NOL because their nonbusiness deductions exceed their nonbusiness income, and the excess is disallowed by § 172(d)(4). Do not assume that a large Schedule C loss automatically produces an NOL. Compute the nonbusiness deduction limitation carefully. The standard deduction alone can eliminate a substantial portion of what would otherwise be an NOL.
• EXAMPLE. A sole proprietor has a $50,000 Schedule C loss, $10,000 of interest income, and takes the $15,000 standard deduction. The $5,000 excess of standard deduction over nonbusiness income ($15,000 minus $10,000) is disallowed in computing the NOL. The NOL is $45,000 ($50,000 loss minus $5,000 disallowed excess), not $50,000. The $10,000 of interest income is nonbusiness income that absorbs $10,000 of the standard deduction, leaving only $5,000 of the standard deduction that must be disallowed.
• EXAMPLE. A taxpayer in the retail record business is single and has the following for 2023. Wages from part-time job of $1,225. Interest on savings of $425. Net long-term capital gain on sale of real estate used in business of $2,000. Net loss from business of $5,000. Net short-term capital loss on sale of stock of $1,000. Standard deduction of $13,850. Total deductions exceed total income by $16,200. However, the nonbusiness net short-term capital loss of $1,000 is disallowed under § 172(d)(2)(A). The excess of nonbusiness deductions ($13,850 standard deduction) over nonbusiness income ($425 interest) of $13,425 is disallowed under § 172(d)(4). Total adjustments are $14,425. The NOL is $1,775. (IRS Publication 536 (2023), Example)

Step 2C. Modifications Applicable Only to Corporations

• Dividends received deduction computed without § 246(b) limitation. § 172(d)(5) provides "The deductions allowed by sections 243 (relating to dividends received by corporations) and 245 (relating to dividends received from certain foreign corporations) shall be computed without regard to section 246(b) (relating to limitation on aggregate amount of deductions)." This is a favorable rule that can increase a corporation's NOL. § 246(b) normally caps the aggregate dividends received deduction at 65 percent (for 20-percent-owned corporations) or 50 percent (for other corporations) of taxable income. For NOL computation, this limitation is disregarded, allowing the full DRD to contribute to an NOL even if the corporation has insufficient taxable income to absorb it. Treas. Reg. § 1.172-2(a)(2) confirms this rule.
• REIT taxable income modification. § 172(d)(6)(A) provides that a REIT's NOL is computed using the adjustments in § 857(b)(2) (excluding the dividends paid deduction) rather than regular taxable income. § 172(d)(6)(B) provides that for carryback or carryover years that are REIT years, "taxable income" means REIT taxable income under § 857(b)(2). § 172(d)(6)(C) provides that the 80 percent limitation in § 172(a)(2)(B)(ii)(I) uses REIT taxable income (as defined in § 857(b)(2) but without regard to the dividends paid deduction) instead of regular taxable income. The IRS Instructions for Form 1120-REIT confirm that "The NOL for the current year is computed using the REIT's taxable income before it is reduced by the dividends paid deduction." Without this modification, the dividends paid deduction would eliminate any REIT taxable income and no REIT could ever have an NOL.
• Summary of modifications by taxpayer type. For a noncorporate taxpayer, apply § 172(d)(1) (no NOL deduction), § 172(d)(2)(A) (capital loss limitation), § 172(d)(2)(B) (no § 1202 exclusion), § 172(d)(3) (no personal exemptions), § 172(d)(4) (nonbusiness deduction limitation), § 172(d)(8) (no § 199A deduction), and § 172(d)(9) (no § 250 deduction). For a C corporation, apply § 172(d)(1) (no NOL deduction), § 172(d)(5) (DRD without § 246(b) limitation), and § 172(d)(9) (no § 250 deduction). A REIT also applies § 172(d)(6) (REIT taxable income). Non-life insurance companies under § 172(f) are subject to the same modifications as other corporations but are exempt from the 80 percent limitation in § 172(a)(2).

Step 3. The Two-Tier NOL Deduction Framework (§ 172(a))

"There shall be allowed as a deduction for the taxable year an amount equal to...in the case of a taxable year beginning after December 31, 2020, the sum of (A) the aggregate amount of net operating losses arising in taxable years beginning before January 1, 2018, carried to such taxable year, plus (B) the lesser of (i) the aggregate amount of net operating losses arising in taxable years beginning after December 31, 2017, carried to such taxable year, or (ii) 80 percent of the excess (if any) of (I) taxable income computed without regard to the deductions under this section and sections 199A and 250, over (II) the amount determined under subparagraph (A)." (IRC § 172(a)(2))

• The pre-2018 NOL pool (tier one). NOLs arising in tax years beginning before January 1, 2018 are fully deductible without any percentage limitation. (§ 172(a)(2)(A)) These losses retain their 20-year carryforward period. (§ 172(b)(1)(A)(ii)(I)) This pool is applied first in the waterfall computation and reduces the taxable income base available for post-2017 NOLs.
• The post-2017 NOL pool (tier two). NOLs arising in tax years beginning after December 31, 2017 are subject to the 80 percent limitation. (§ 172(a)(2)(B)) These losses carry forward indefinitely. (§ 172(b)(1)(A)(ii)(II)) The limitation is computed as the lesser of (i) the aggregate post-2017 NOLs carried to the year, or (ii) 80 percent of the remaining taxable income after pre-2018 NOLs are applied.
• The taxable income base for the 80 percent computation. Taxable income is computed without regard to (1) the NOL deduction itself, (2) the § 199A qualified business income deduction, and (3) the § 250 foreign-derived intangible income and global intangible low-taxed income deduction. (§ 172(a)(2)(B)(ii)(I)) This produces a higher taxable income base, allowing more NOL to be absorbed. A corporation with significant FDII deductions under § 250 can still use a robust taxable income base for the 80 percent computation because those deductions are added back. The § 199A deduction (up to 20 percent of qualified business income for pass-through entities) and the § 250 deduction (up to 37.5 percent of FDII before 2026) are both disregarded. (§ 172(a)(2)(B)(ii)(I))
• The waterfall computation. First, pre-2018 NOLs fully offset taxable income. Then, post-2017 NOLs can offset up to 80 percent of the remaining taxable income after the pre-2018 NOLs.
  1. Compute taxable income without regard to the NOL deduction, the § 199A deduction, and the § 250 deduction. (§ 172(a)(2)(B)(ii)(I))
  2. Deduct all available pre-2018 NOLs from this base. (§ 172(a)(2)(A))
  3. Multiply the remaining taxable income by 80 percent. (§ 172(a)(2)(B)(ii))
  4. The post-2017 NOL deduction equals the lesser of (i) the aggregate post-2017 NOLs carried to the year, or (ii) the 80 percent amount computed in step three. (§ 172(a)(2)(B))
  5. Total NOL deduction equals pre-2018 NOLs plus the limited post-2017 NOL amount. (§ 172(a)(2))
• EXAMPLE. Corporation has $100 of taxable income before NOLs, $30 of pre-2018 NOLs, and $80 of post-2017 NOLs. Step One. Deduct $30 of pre-2018 NOLs, leaving $70 of taxable income. Step Two. Compute 80% of $70 equals $56. The post-2017 NOL deduction is limited to $56 (the lesser of $80 available and $56 limit). Total NOL deduction equals $30 plus $56 equals $86. Taxable income after NOL equals $14. The remaining $24 of post-2017 NOL carries forward indefinitely.
• Treas. Reg. § 1.172-1 confirms the three-step computation. The regulation provides that the NOL deduction is the aggregate of the net operating loss carryovers and net operating loss carrybacks to such taxable year. (Treas. Reg. § 1.172-1(a)) It further requires that computations involving any other taxable year be made under the law applicable to such other taxable year, known as the year-by-year rule. (Treas. Reg. § 1.172-1(e))
• CAUTION. Do not apply the 80 percent limitation to pre-2018 NOLs. The limitation in § 172(a)(2)(B)(ii) applies ONLY to post-2017 NOLs under subparagraph (B). Pre-2018 NOLs under subparagraph (A) face no percentage cap. (§ 172(a)(2)(A))
• TRAP. The taxable income base is computed BEFORE the § 199A and § 250 deductions. This add-back benefits the taxpayer by inflating the base, but practitioners sometimes mistakenly subtract these deductions before computing the 80 percent limitation. The correct approach is to start with taxable income computed without regard to §§ 172, 199A, and 250. (§ 172(a)(2)(B)(ii)(I))

Step 4. The 80 Percent Limitation in Detail

Step 4A. Mechanics of the Limitation

• The statutory formula. The post-2017 NOL deduction equals the lesser of (i) the aggregate post-2017 NOLs carried to the year, or (ii) 80 percent of taxable income computed without the NOL deduction, the § 199A deduction, and the § 250 deduction. (§ 172(a)(2)(B)) The IRS Form 172 Instructions confirm this computation and require taxpayers to attach a statement showing how the 80 percent limitation was figured, if applicable. (IRS Instructions for Form 172 (Rev. Dec. 2024), p. 4)
• Interaction with pre-2018 NOLs. Pre-2018 NOLs reduce the taxable income base for the 80 percent computation. The 80 percent is applied to taxable income remaining AFTER pre-2018 NOLs are deducted. (§ 172(a)(2)(B)(ii)(II)) This means pre-2018 NOLs are not merely deducted first for administrative convenience. They actually shrink the pool of income against which the 80 percent cap is measured. Every dollar of pre-2018 NOL absorbed reduces the post-2017 NOL absorption capacity by 80 cents.
• No final ordering rule between § 172, § 163(j), and § 250. Proposed regulations (REG-107213-18) would have established a five-step ordering rule. (1) Calculate tentative § 250 deduction without regard to § 163(j), § 172, or § 250(a)(2). (2) Calculate § 163(j) interest limitation with tentative § 250 but without § 172. (3) Calculate § 172 NOL deduction with § 163(j) but without § 250(a). (4) Calculate FDII by allocating deductions after §§ 163(j) and 172. (5) Determine final § 250 deduction. However, the final regulations (T.D. 9901, 85 Fed. Reg. 43,042 (July 15, 2020)) declined to adopt this approach. Treasury stated that it is considering a separate guidance project to address the interaction of sections 163(j), 172, 250(a)(2), and other Code sections that refer to taxable income, and that this guidance may include an option to use simultaneous equations in lieu of an ordering rule. As of 2025, no final ordering rule exists.
• CAUTION. The interaction between § 172 and § 163(j) can significantly affect the NOL deduction. If interest expense is limited under § 163(j), taxable income may be higher, which in turn increases the 80 percent base and allows more NOL absorption. But the precise computational sequence remains unresolved. Treasury has not issued final guidance. Practitioners should document their chosen methodology and be prepared to defend it on examination.
• REIT taxable income modification. For REIT years, § 172(a)(2)(B)(ii)(I) is applied by substituting "real estate investment trust taxable income (as defined in section 857(b)(2) but without regard to the deduction for dividends paid (as defined in section 561))" for "taxable income." (§ 172(d)(6)(C)) This means the 80 percent limitation for REITs is computed against REIT taxable income without the dividends paid deduction, not regular taxable income. Without this adjustment, the 80 percent limitation would apply to a near-zero base because REITs generally distribute most of their taxable income as dividends.

Step 4B. Exceptions to the 80 Percent Limitation

• Non-life insurance companies. § 172(f) exempts non-life insurance companies from the 80 percent limitation. These companies may offset 100 percent of taxable income with NOLs. The statute provides that in the case of an insurance company (as defined in § 816(a)) other than a life insurance company, the amount of the deduction allowed under § 172(a) shall be the aggregate of the net operating loss carryovers to such year plus the net operating loss carrybacks to such year, and subparagraph (C) of § 172(b)(2) shall not apply. (§ 172(f)(1) and (2)) Treas. Reg. § 1.1502-21(a)(2)(iii) confirms this exemption in the final regulations. (T.D. 9927, 85 Fed. Reg. 65,800 (Oct. 16, 2020)) For consolidated groups containing both non-life insurance companies and other members, the 80 percent limitation is applied using income pools. (Treas. Reg. § 1.1502-21(a)(2)(iii)(C)) The residual income pool (non-insurance members) is subject to the 80 percent limit while the property and casualty member income pool is subject to a 100 percent limit. See Step 7 for full analysis of non-life insurance company rules.
• Tax years beginning before January 1, 2021. The CARES Act temporarily suspended the 80 percent limitation for tax years beginning before 2021. (CARES Act, Pub. L. 116-136, § 2303(a), 134 Stat. 281 (Mar. 27, 2020)) For these years, the NOL deduction equaled the aggregate of all carryovers and carrybacks without any percentage cap. (§ 172(a)(1)) This provision has expired but remains relevant for amended returns and for carryforwards from 2018, 2019, and 2020 into post-2020 years. Any unabsorbed NOLs from 2018 through 2020 that carry forward into tax years beginning after December 31, 2020 are treated as post-2017 NOLs and are subject to the 80 percent limitation in those later years. (§ 172(a)(2)(B))
• The 80 percent limitation applies broadly to all taxpayers except non-life insurance companies. Corporations, individuals, estates, and trusts are all subject to the same 80 percent cap mechanism. (§ 172(a)(2)) The differences between corporate and non-corporate taxpayers arise in computing the NOL itself (for example, capital loss limitations for non-corporations under § 172(d)(2) and nonbusiness deduction limitations under § 172(d)(4)), not in the limitation mechanism.

Step 5. Carryback and Carryforward Periods Under § 172(b)(1)

"Except as provided in subparagraphs (B), (C), and (D), a net operating loss for any taxable year shall be a net operating loss carryover to each taxable year following the taxable year of the loss." (IRC § 172(b)(1)(A))

• General rule for losses arising in tax years beginning after December 31, 2020. No carryback. Indefinite carryforward. (§ 172(b)(1)(A)) This is the default rule for all taxpayers except those covered by specific exceptions. The general carryback provision defers to subparagraphs (B) (farming losses), (C)(i) (non-life insurance companies), and (D) (CARES Act 5-year carryback for 2018-2020 losses only). Since the CARES Act 5-year carryback in subparagraph (D) applies only to 2018 through 2020 loss years, and since farming and non-life insurance are the only remaining carryback exceptions, most taxpayers with losses arising in years beginning after December 31, 2020 have no carryback and only an indefinite carryforward.
• Pre-2018 losses. NOLs arising in tax years beginning before January 1, 2018 carry forward 20 years. (§ 172(b)(1)(A)(ii)(I)) These losses may have been carried back 2 years under the pre-TCJA rules if the taxpayer did not elect to waive the carryback under § 172(b)(3). (pre-TCJA § 172(b)(1)(A), as amended by TCJA, Pub. L. 115-97, § 13302) The TCJA fundamentally restructured the NOL rules effective for losses arising in tax years beginning after December 31, 2017 by eliminating carrybacks, adding the 80 percent limitation, and making carryforwards indefinite. (Pub. L. 115-97, § 13302, 131 Stat. 2054 (2017))
• Post-2017, pre-2021 losses (CARES Act 5-year carryback). NOLs arising in tax years beginning after December 31, 2017 and before January 1, 2021 could be carried back 5 years under CARES Act § 2303(b). (CARES Act, Pub. L. 116-136, § 2303(b), 134 Stat. 281 (Mar. 27, 2020)) This provision overrode the TCJA elimination of carrybacks for those three years and also temporarily suspended the 80 percent limitation for tax years beginning before January 1, 2021. (§ 172(a)(1)) The CARES Act further provided that subparagraphs (B) (farming losses) and (C)(i) (insurance companies) did not apply to these losses, meaning even farming and insurance company NOLs from 2018 through 2020 received the 5-year carryback. (§ 172(b)(1)(D)(i)(II)) This provision has expired. Taxpayers with unused losses from these years carry them forward indefinitely, subject to the 80 percent limitation when carried to tax years beginning after December 31, 2020. (§ 172(a)(2)(B))
• REIT carryback prohibition. A REIT-year NOL cannot be carried back to any preceding taxable year. (§ 172(b)(1)(D)(ii)(I)) Additionally, a non-REIT-year NOL cannot be carried back to any preceding taxable year that is a REIT year. (§ 172(b)(1)(D)(ii)(II)) For the CARES Act period, this meant REITs could not carry back NOLs at all even though other taxpayers received the 5-year carryback. For post-2020 losses, the general no-carryback rule renders the first prohibition largely redundant, but the second prohibition (preventing carrybacks to REIT years) still operates as a safeguard.
• Ordering rule. § 172(b)(2) requires the entire NOL to be carried to the earliest taxable year first. If an NOL exceeds the taxable income of the earliest year, the excess carries to the next earliest year. NOLs are applied in the order incurred (FIFO). The statute provides that "the entire amount of the net operating loss for any taxable year (hereinafter in this section referred to as the 'loss year') shall be carried to the earliest of the taxable years to which (by reason of paragraph (1)) such loss may be carried." (§ 172(b)(2)) The portion carried to each subsequent year is the excess of the loss over the sum of taxable income for each prior year to which the loss may be carried. The IRS Instructions for Form 172 confirm this rule and state that if the NOL deduction includes more than one NOL, the NOLs are applied against modified taxable income in the order incurred, starting with the earliest. (IRS Instructions for Form 172 (Rev. Dec. 2024), p. 7)
• EXAMPLE. A calendar-year corporation has a $500 NOL in 2024. It had $200 taxable income in 2023, $150 in 2022, and $100 in 2021. The NOL carries forward because no carryback is permitted for post-2020 losses. First, $200 absorbs in 2023. Then $150 absorbs in 2022. Then $100 absorbs in 2021. The remaining $50 carries to 2025. If the corporation also had a $300 NOL from 2023, that earlier NOL would absorb first in each year before the 2024 NOL is applied.
• Modified taxable income for absorption purposes. Under § 172(b)(2)(A), taxable income for each carryover year is computed with the modifications in § 172(d) other than paragraphs (1), (4), and (5), and without regard to the loss year NOL or any later NOL. § 172(b)(2)(B) provides that this modified taxable income shall not be considered to be less than zero. (§ 172(b)(2)(B)) This means an NOL cannot create negative taxable income in a carryover year. Any excess loss simply carries to the next available year. For taxable years beginning after December 31, 2020, § 172(b)(2)(C) further requires that modified taxable income be reduced by 20 percent of the excess described in § 172(a)(2)(B)(ii). (§ 172(b)(2)(C)) This is the statutory mechanism that implements the 80 percent limitation in the carryforward context.
• The farming loss as a separate NOL. § 172(b)(1)(B)(iii) treats a farming loss as a separate NOL that is applied after the remaining (non-farming) portion of the NOL for the same taxable year. (§ 172(b)(1)(B)(iii)) Under the ordering rule of § 172(b)(2), this means the non-farming portion absorbs first in each carryover year, and only after it is fully absorbed does the farming loss portion begin to absorb. A farming loss is defined as the lesser of (I) the NOL computed using only farming business income and deductions, or (II) the total NOL for the year. (§ 172(b)(1)(B)(ii)) A farming business is defined in § 263A(e)(4) as a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. (§ 263A(e)(4))
• Taxpayers may elect to waive the carryback. § 172(b)(3) allows any taxpayer entitled to a carryback period to elect not to have the carryback apply. The election must be made by the due date (including extensions) for filing the return for the taxable year of the NOL, and the election is irrevocable. (§ 172(b)(3)) For consolidated groups, the common parent makes this election through a separate statement. (Treas. Reg. § 1.1502-21(b)(3)(i)) The Tax Court in Apache Corporation held that where § 172(b)(1) creates multiple carryback periods for different portions of an NOL, a taxpayer may waive them individually. (Apache Corp. & Subs. v. Comm'r, 165 T.C. No. 11 (2025) (reviewed decision, 17 judges in majority), holding that a § 172(b)(3) election waived only the general carryback, not a separate 10-year specified liability loss carryback) This principle remains relevant for farming losses, which have a separate 2-year carryback under current law.
• CAUTION. Do not miss the election deadline. The § 172(b)(3) carryback waiver election must be made by the due date (including extensions) for the loss year return. Once made, it is irrevocable. (§ 172(b)(3)) Missing the deadline locks the taxpayer into the carryback, which may be disadvantageous if the taxpayer would prefer to carry the loss forward to offset income at a higher marginal rate.
• TRAP. Unabsorbed 2018-2020 NOLs become post-2017 NOLs in post-2020 years. Any remaining NOL from 2018, 2019, or 2020 that was not fully absorbed during the CARES Act period (whether in carryback years or in 2018-2020 carryforward years) carries forward indefinitely but is subject to the 80 percent limitation when carried to tax years beginning after December 31, 2020. (§ 172(a)(2)(B)) Practitioners must track these losses separately from pre-2018 NOLs and ensure the 80 percent cap is applied correctly in the absorption year.

Step 6. The Farming Loss Carryback Exception

"In the case of any portion of a net operating loss for the taxable year which is a farming loss with respect to the taxpayer, such loss shall be a net operating loss carryback to each of the 2 taxable years preceding the taxable year of such loss." (IRC § 172(b)(1)(B)(i))

• Applicable taxpayers. The farming loss carryback applies to any taxpayer, individual or corporate, that operates a farming business and incurs a farming loss. This includes sole proprietors, partnerships, S corporations, and C corporations. (§ 172(b)(1)(B)(i))
• The farming loss defined. A farming loss is the lesser of (I) the NOL that would result if only income and deductions attributable to farming businesses are taken into account, or (II) the total NOL for the taxable year. (§ 172(b)(1)(B)(ii)) It is a sub-component of the total NOL and can never exceed the total NOL. If the taxpayer has both farming and non-farming activities, compute the farming loss in isolation first.
• Compute the hypothetical farming-only NOL by including only farming business gross income and farming business deductions.
• Compute the total NOL for the taxable year under the general rule of § 172(c).
• The farming loss is the lesser of the amounts from steps 1 and 2.
• Farming business defined. A farming business is a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. (§ 263A(e)(4)) This specifically includes the trade or business of operating a nursery or sod farm, the raising or harvesting of trees bearing fruit, nuts, or other crops, the raising of ornamental trees (other than evergreen trees more than 6 years old at severance), and the raising, shearing, feeding, caring for, training, and management of animals. Contract harvesting of crops grown by someone else and a business that merely buys or sells plants or animals grown entirely by someone else are excluded from the farming business definition. (§ 263A(e)(4))
• Separate NOL treatment. The farming loss portion is treated as a separate NOL that is applied after the non-farming portion of the same loss year. (§ 172(b)(1)(B)(iii)) Under § 172(b)(2), the entire NOL must be carried to the earliest available taxable year. The non-farming portion is absorbed first. The farming portion (as a separate NOL) follows in the sequencing. This means the non-farming portion reduces available taxable income before the farming portion begins its absorption.
• Election to waive the farming loss carryback. Taxpayers entitled to a 2-year farming loss carryback may elect irrevocably under § 172(b)(1)(B)(iv) not to have the carryback apply. The election is made by attaching a statement to the return for the loss year (or within 6 months of the unextended due date under § 301.9100-2). The election, once made for any taxable year, is irrevocable. (§ 172(b)(1)(B)(iv))
• Consolidated group election procedure. For consolidated groups, the election to waive the farming loss carryback is made by the common parent. (Treas. Reg. § 1.1502-21(b)(3)(i)) The election may not be made separately for any individual member. The statement must be filed with the consolidated return for the loss year or by the extended due date.
• Principle of separate carryback periods from Apache Corp. In Apache Corporation v. Commissioner, 165 T.C. No. 11 (2025) (reviewed decision, 17 judges in majority), the Tax Court held that a taxpayer's election under § 172(b)(3) to waive the general carryback period did not relinquish a separate special carryback period for specified liability losses. The Court reasoned that § 172(b)(3) refers to "a carryback period" in the singular, and where the statute creates multiple carryback periods (as it does for farming losses under § 172(b)(1)(B)), taxpayers may waive them individually. This principle supports the ability to waive only the general carryback while preserving the farming loss carryback, or vice versa.
• TRAP. Do not confuse the farming loss waiver with the general carryback waiver. The § 172(b)(1)(B)(iv) election waives only the 2-year farming loss carryback. The § 172(b)(3) election waives the general carryback period. These are distinct elections under different Code paragraphs. A taxpayer wanting to preserve the farming carryback while waiving the general carryback should make only the § 172(b)(3) election. A taxpayer wanting to waive both must make both elections.

Step 6A. CARES Act Coordination for Farming Losses

• The farming loss election to disregard CARES Act amendments. § 2303(e) of the CARES Act, as added by the COVID-Related Tax Relief Act of 2020 (CTRA, Div. N of Pub. L. 116-260, § 281), allows taxpayers with farming loss NOLs arising in tax years beginning in 2018, 2019, or 2020 to elect to disregard the CARES Act amendments. (§ 172(b)(1)(D) as modified by CTRA § 281)
• Effect of the election. If elected, the farming loss NOL is subject to the 80% limitation (which the CARES Act otherwise suspended for 2018-2020 losses), and the taxpayer retains the 2-year farming loss carryback instead of the 5-year general carryback that the CARES Act provided. Without the election, farming losses arising in 2018-2020 would receive the 5-year general carryback and the 80% limitation would be suspended.
• Rev. Proc. 2021-14 procedures. Rev. Proc. 2021-14, 2021-27 I.R.B. 1 establishes three mechanisms. (Rev. Proc. 2021-14, 2021-27 I.R.B. 1)
• Affirmative Election. A taxpayer affirmatively elects to apply § 172(b)(1)(B) farming loss rules and disregard the CARES Act 5-year carryback.
• Deemed Election. A taxpayer who filed a return before December 27, 2020 that applied the TCJA farming loss rules (2-year carryback, 80% limitation) is treated as having made the election.
• Revocation of Prior Waiver. A taxpayer who previously made a § 172(b)(1)(B)(iv) or § 172(b)(3) election to waive the farming carryback may revoke that election and instead make the affirmative election under Rev. Proc. 2021-14.
• Timing. For a farming loss NOL arising in a taxable year beginning in 2018 or 2019, the election must be made by the due date (including extensions) for filing the taxpayer's return for the first taxable year ending after March 27, 2020. For a loss arising in a taxable year beginning in 2020, the election must be made by the due date (including extensions) for filing the return for the taxable year in which the NOL arises. (Rev. Proc. 2021-14, § 4)
• CAUTION. Evaluate both scenarios before electing. For 2018-2020 farming losses, the practitioner must model both scenarios. (1) No election means 5-year carryback, no 80% limitation, but farming losses mixed with general carryback rules. (2) Election means 2-year carryback, 80% limitation applies, but the taxpayer preserves the specific farming loss treatment. The optimal choice depends on the taxpayer's carryback year income profile, tax rates, and refund timing.

Step 7. The Non-Life Insurance Company Exception

"In the case of an insurance company (as defined in section 816(a)) other than a life insurance company, (1) the amount of the deduction allowed under subsection (a) shall be the aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year, and (2) subparagraph (C) of subsection (b)(2) shall not apply." (IRC § 172(f))

• Full exemption from the 80 percent limitation. § 172(f)(1) provides that for non-life insurance companies, the NOL deduction equals the aggregate of all carryovers plus all carrybacks to the taxable year. This completely overrides the 80 percent limitation in § 172(a)(2)(B). Non-life insurance companies may offset 100 percent of taxable income with NOLs. The final regulations confirm this result explicitly. (Treas. Reg. § 1.1502-21(a)(2)(iii)) (T.D. 9927, 85 Fed. Reg. 65,800 (Oct. 16, 2020)) The regulations state that "the 80-percent limitation does not apply to insurance companies other than life insurance companies (nonlife insurance companies). § 172(f). Therefore, the taxable income of nonlife insurance companies may be fully offset by NOL deductions." (T.D. 9927)
• Two-year carryback retained. Non-life insurance companies may carry back NOLs 2 years. (§ 172(b)(1)(C)(i)) This is a permanent exception to the general no-carryback rule that applies to losses arising in tax years beginning after December 31, 2020. The carryback applies to the full NOL of a non-life insurance company, not just a portion.
• Twenty-year carryforward. Unlike other post-2017 losses that carry forward indefinitely, non-life insurance company losses carry forward only 20 years. (§ 172(b)(1)(C)(ii)) This is a critical planning constraint. A non-life insurance company that generates a large NOL may have a shorter window for utilization than other corporate taxpayers.
• Insurance company defined. An insurance company is any company more than half of the business of which during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. (§ 816(a)) A "nonlife insurance company" is an insurance company other than a life insurance company. (Treas. Reg. § 1.1502-1(k)) Life insurance companies do NOT qualify for this exception and are subject to the general NOL rules (no carryback, indefinite carryforward, 80% limitation). (§ 172(b)(1)(C)) (§ 816(a))
• Determining the more-than-half test. The § 816(a) test looks to whether more than 50 percent of the company's business consists of issuing insurance or annuity contracts or reinsuring risks. This is generally measured by comparing insurance-related gross receipts to total gross receipts. Companies near the 50 percent threshold require careful analysis of their revenue streams. (§ 816(a))
• IRM confirmation of the exemption. The IRS Internal Revenue Manual confirms that "for insurance companies other than life insurance companies, the 80% taxable income limitation does not apply, but the carryforward period is limited to 20 years." (IRM 4.11.11, Net Operating Loss Cases (Apr. 17, 2023))

Step 7A. Consolidated Group Treatment for Mixed Insurance and Non-Insurance Members

• The two-pool approach. In mixed consolidated groups containing both non-life insurance companies and other members, the 80 percent limitation is applied using a two-pool methodology. (Treas. Reg. § 1.1502-21(a)(2)(iii)(C)) The group divides itself into two pools and computes a separate post-2017 CNOL deduction limit for each.
• Residual income pool. For members that are NOT non-life insurance companies, compute 80 percent of the excess of the taxable income of those members over pre-2018 NOLs allocable to them. This pool is subject to the full 80 percent limitation.
• Nonlife income pool. For members that ARE non-life insurance companies, compute 100 percent of the excess of the taxable income of those members over pre-2018 NOLs allocable to them. This pool is NOT subject to the 80 percent limitation.
• Post-2017 CNOL deduction limit. The group's total post-2017 CNOL deduction limit equals the lesser of the aggregate post-2017 CNOLs carried to the year, or the sum of the residual income pool and the nonlife income pool. (Treas. Reg. § 1.1502-21(a)(2)(iii)(C))
• Pre-2018 CNOL allocation between pools. Pre-2018 CNOLs are prorated between the two pools based on the relative positive income of each pool. Pre-2018 CNOLs are deducted without any percentage limitation in both pools. (Treas. Reg. § 1.1502-21(a)(2)(iii)(C))
• TRAP. Do not apply the 80 percent limitation to the entire group. The two-pool approach exists precisely because applying the 80 percent limitation to the entire group's income would incorrectly restrict non-life insurance companies (which are statutorily exempt under § 172(f)). Conversely, applying no limitation to the entire group would under-restrict regular corporate members. The regulation requires the bifurcated computation.
• TRAP. Life insurance companies in the group are treated as non-insurance members. The § 172(f) exception applies only to companies that are insurance companies under § 816(a) OTHER THAN life insurance companies. Life insurance companies are placed in the residual income pool and are subject to the 80 percent limitation on the same terms as regular corporations. (Treas. Reg. § 1.1502-21(a)(2)(iii)(C)) (§ 1503(c))

Step 8. REIT Net Operating Loss Rules

"A net operating loss for a REIT year shall not be a net operating loss carryback to any taxable year preceding the taxable year of such loss." (IRC § 172(b)(1)(D)(ii)(I))

"In the case of any taxable year for which part II of subchapter M applies to the taxpayer, subsection (a)(2)(B)(ii)(I) shall be applied by substituting 'real estate investment trust taxable income (as defined in section 857(b)(2) but without regard to the deduction for dividends paid (as defined in section 561))' for 'taxable income'." (IRC § 172(d)(6)(C))

• Double carryback prohibition. REITs face a dual prohibition on NOL carrybacks. (§ 172(b)(1)(D)(ii))
• A REIT-year NOL cannot be carried back to ANY preceding taxable year. (§ 172(b)(1)(D)(ii)(I))
• A non-REIT-year NOL cannot be carried back to a REIT year. (§ 172(b)(1)(D)(ii)(II))

A "REIT year" is any taxable year for which the provisions of part II of subchapter M apply to the taxpayer. (§ 172(b)(1)(D)(ii)(III)) For post-2020 losses, the general no-carryback rule in § 172(b)(1)(A) makes the first prohibition less significant because most taxpayers already have no carryback. But the second prohibition still matters. It prevents a corporation that has a non-REIT-year NOL from carrying that loss back to a year in which it was a REIT.

• Indefinite carryforward. REITs may carry NOLs forward indefinitely to tax years following the year of loss, subject to the 80 percent limitation. (§ 172(b)(1)(A)(ii)(II)) The carryforward period for REIT NOLs is the same as for other post-2017 corporate losses. There is no shortened carryforward period for REITs (unlike non-life insurance companies).
• Special taxable income base for the 80 percent limitation. § 172(d)(6)(C) provides that the 80 percent limitation for REITs is computed against REIT taxable income as defined in § 857(b)(2) but WITHOUT the deduction for dividends paid (as defined in § 561). This adjustment is critical because REITs generally distribute most of their taxable income as dividends. Without this adjustment, the 80 percent limitation would apply to a very small taxable income base (post-dividends taxable income) and would render the NOL deduction nearly useless. (§ 172(d)(6)(C)) (§ 857(b)(2))
• TRAP. The dividends paid deduction is removed only for the 80 percent limitation base, not for NOL computation. For computing the NOL itself, § 172(d)(6)(A) provides that the NOL is computed by taking into account the adjustments described in § 857(b)(2) OTHER THAN the deduction for dividends paid. So the NOL is computed on a base that already excludes the dividends paid deduction. The 80 percent limitation then applies against that same REIT taxable income base (without dividends paid deduction). The two computations use the same adjusted base, which produces a coherent and functional result. (§ 172(d)(6)(A) and (C))
• Prior year taxable income also uses REIT taxable income. Where a REIT year is a "prior taxable year" for purposes of the § 172(b)(2) absorption computation, the term "taxable income" means "real estate investment trust taxable income" as defined in § 857(b)(2). (§ 172(d)(6)(B)) This means the full REIT taxable income (including the dividends paid deduction in this context) governs how much of a carried loss is absorbed in a carryover year.
• NOL applied to taxable income reduced by dividends paid deduction. Although the current-year NOL is computed without regard to the dividends paid deduction, an NOL carryover from a prior year is applied to the current year using taxable income AFTER it is reduced by the dividends paid deduction and the § 857(b)(2)(E) deduction (tax on net income from foreclosure property, tax under § 856(c)(7)(C), and tax under § 856(g)(5)). (Instructions for Form 1120-REIT (2025), Line 22a instructions) If the resulting amount is less than zero, no NOL deduction can be taken for the tax year.
• TRAP. The NOL amounts carried forward by a REIT are NOT reduced by subsequent year dividends paid deductions. The Form 1120-REIT instructions explicitly state that "the NOL amounts carried forward by the REIT are not reduced by subsequent year dividends paid deductions." The dividends paid deduction reduces the taxable income available to absorb a carryover in a given year, but it does not reduce the amount of the carryover itself. (Instructions for Form 1120-REIT (2025), Line 22a, Carryover Rules)

Step 8A. Capital Gain Dividend Coordination

• Capital gain dividends reduce both current year NOL and prior year carryover. § 857(b)(3)(D) provides that if a REIT pays capital gain dividends during any taxable year, the amount of the net capital gain for such taxable year (to the extent of the capital gain dividends) is excluded in determining (i) the NOL for the taxable year, and (ii) the amount of the NOL of any prior taxable year that may be carried through such taxable year to a succeeding taxable year. (§ 857(b)(3)(D))
• The mechanism in practice. When a REIT pays capital gain dividends, net capital gain is excluded from the current year NOL computation to the extent of those dividends. Simultaneously, the amount of a prior year NOL that can be carried through the current year to a future year is also reduced by the same capital gain dividend amount. This dual exclusion prevents capital gain dividends from creating or enlarging an NOL while also preventing them from absorbing prior year carryovers. (§ 857(b)(3)(D)(i) and (ii))
• **EXAMPLE. A REIT has $100 of ordinary income, $50 of net capital gain, and $120 of deductions (other than dividends paid). It pays $50 of capital gain dividends. The $50 of net capital gain is excluded from the NOL computation because capital gain dividends of $50 were paid. The NOL for the year is $20 ($100 ordinary income minus $120 deductions). The $50 capital gain is not part of the NOL computation. If the REIT also has $30 of prior year NOL carryover, only $20 of that carryover can pass through this year. The $50 capital gain dividends reduce the pass-through capacity of the prior year NOL by $50." This example is illustrative of the statutory mechanics under § 857(b)(3)(D).
• TRAP. The capital gain dividend exclusion applies only to the extent capital gain dividends do not exceed net capital gain. If capital gain dividends exceed net capital gain, the excess does not trigger further exclusion. The statutory cap is "to the extent such gain does not exceed the amount of such capital gain dividends." (§ 857(b)(3)(D)) In other words, the exclusion is limited to the lesser of net capital gain and capital gain dividends.

Step 8B. Special Situations

• § 382 ownership changes. When an ownership change described in § 382(g) occurs with respect to a REIT, the amount of taxable income that may be offset by pre-change NOL carryovers is limited under § 382. A loss REIT must file an information statement with its return for each year in which certain ownership shifts occur. (Instructions for Form 1120-REIT (2025), Line 22a) See Step 9 of this checklist for the full § 382 analysis.
• § 384 limitation on built-in gains. When a REIT acquires control of another corporation (or acquires its assets in a reorganization), the amount of pre-acquisition losses that may offset recognized built-in gains is limited under § 384. (Instructions for Form 1120-REIT (2025), Line 22a) This prevents a REIT from acquiring a corporation with built-in gains and immediately using the target's pre-acquisition losses to offset those gains.
• § 965(n) election for transition tax years. A REIT may elect under § 965(n) to reduce both (i) the amount of its NOL for a tax year determined under § 172, and (ii) the amount of taxable income reduced by NOL carryovers to such year. The reduction amount equals the § 965(a) inclusion (net of the § 965(c) deduction) plus any § 78 gross-up with respect to foreign taxes deemed paid on the § 965(a) inclusion. If the NOL is reduced, the reduction amount is included in other income. If taxable income reduced by NOL carryovers is reduced, the NOL deduction is reduced by the reduction amount. (Instructions for Form 1120-REIT (2025), Line 22a) (§ 965(n))
• TRAP. REITs cannot carry back CARES Act 5-year carryback losses. During the CARES Act period (losses arising in 2018, 2019, or 2020), the general 5-year carryback was available to most taxpayers. But § 172(b)(1)(D)(ii)(I) specifically prohibits a REIT-year NOL from being carried back to ANY preceding year. This prohibition applied even during the CARES Act period. REITs with losses in 2018-2020 could only carry those losses forward. (§ 172(b)(1)(D)(ii)(I)) (§ 172(b)(1)(D)(i))

Step 9. The Excess Business Loss Limitation (§ 461(l))

"In the case of a taxpayer other than a corporation, for any taxable year beginning after December 31, 2020, and before January 1, 2029, any excess business loss of the taxpayer for the taxable year shall not be allowed." (IRC § 461(l)(1)(B), as amended by the One Big Beautiful Bill Act, Pub. L. No. 119-21, § 70601 (2025) to remove the January 1, 2029 sunset for taxable years beginning after December 31, 2026)

• Applicability to noncorporate taxpayers only. § 461(l) applies to individuals, estates, and trusts. C corporations are not subject to the excess business loss limitation. (§ 461(l)(1)(A) ("In the case of a taxpayer other than a corporation"))
• The OBBBA made the limitation permanent for taxable years beginning after December 31, 2026. The original TCJA provision, as extended by the American Rescue Plan Act and the Inflation Reduction Act, would have expired for taxable years beginning after December 31, 2028. The One Big Beautiful Bill Act, enacted July 4, 2025, removed the sunset date, making § 461(l) a permanent feature of the Code for tax years beginning after December 31, 2026. (Pub. L. No. 119-21, § 70601) (IRS Draft Instructions for Form 461 (2025))
• CAUTION. Do not confuse § 461(l) with § 163(j) (business interest limitation) or § 469 (passive activity loss limitation). Each applies independently in a prescribed sequence.

Step 9A. The Excess Business Loss Computation

"The term 'excess business loss' means the excess (if any) of--(i) the aggregate deductions of the taxpayer for the taxable year which are attributable to trades or businesses of such taxpayer (determined without regard to whether or not such deductions are disallowed for such taxable year under paragraph (1) and without regard to any deduction allowable under section 172 or 199A), over (ii) the sum of--(I) the aggregate gross income or gain of such taxpayer for the taxable year which is attributable to such trades or businesses, plus (II) $250,000 (200 percent of such amount in the case of a joint return)." (IRC § 461(l)(3)(A))

• The statutory base amount is $250,000 ($500,000 for joint returns), indexed for inflation. The $250,000 base is adjusted annually under § 1(f)(3) cost-of-living adjustments. (§ 461(l)(3)(C))
• The threshold amounts for 2024. For taxable years beginning in 2024, the excess business loss threshold is $305,000 for single filers and $610,000 for married filing jointly. (Rev. Proc. 2023-34, § 3.32)
• The threshold amounts for 2025. For taxable years beginning in 2025, the excess business loss threshold is $313,000 for single filers and $626,000 for married filing jointly. (Rev. Proc. 2024-40, § 3.32)
• The threshold amounts for 2026. For taxable years beginning in 2026, the threshold resets to $256,000 for single filers and $512,000 for married filing jointly. The OBBBA re-indexed the inflation adjustment base year from 2017 to 2024, resetting the computation and producing lower thresholds than in 2025. (Rev. Proc. 2025-32, § 4.31) (Pub. L. No. 119-21, § 70601)
• TRAP. The 2026 threshold drop means more taxpayers will be subject to the excess business loss limitation starting in 2026. A married taxpayer with $600,000 of net business loss faced no § 461(l) limitation in 2025 (below the $626,000 threshold) but will face a $88,000 disallowed loss in 2026 (above the $512,000 threshold).
• The core formula. Excess business loss equals aggregate business deductions minus the sum of aggregate business income/gain plus the threshold amount. If the result is zero or negative, there is no excess business loss. (§ 461(l)(3)(A))
  1. Compute aggregate deductions from all trades or businesses.
  2. Compute aggregate gross income or gain from all trades or businesses.
  3. Add the applicable threshold amount to the aggregate income/gain.
  4. Subtract the sum from Step 3 from the aggregate deductions.
  5. If the result is positive, that amount is the excess business loss and is disallowed.
• EXAMPLE. A single taxpayer filing in 2025 has $600,000 of aggregate business deductions and $200,000 of aggregate business income. The net business loss is $400,000. The 2025 single-filer threshold is $313,000. The excess business loss is $400,000 minus $313,000 equals $87,000. The taxpayer deducts $313,000 currently. The $87,000 is disallowed under § 461(l) and becomes an NOL carried forward to the next taxable year.
• § 172 and § 199A deductions are excluded from the computation. The excess business loss is computed without regard to any deduction allowable under § 172 (NOL deduction) or § 199A (qualified business income deduction). (§ 461(l)(3)(A)(i)) A taxpayer cannot use an NOL deduction to create or increase an excess business loss.
• Capital losses are excluded from business deductions. Deductions for losses from sales or exchanges of capital assets are not taken into account in computing aggregate business deductions. (§ 461(l)(3)(B)(i))
• Capital gains included in business income are capped. The amount of capital gains from sales or exchanges of capital assets taken into account as business income cannot exceed the lesser of (1) capital gain net income determined by taking into account only gains and losses attributable to a trade or business, or (2) total capital gain net income. (§ 461(l)(3)(B)(ii)) Personal investment capital gains (e.g., from publicly traded stock) do not count as business income for this purpose.
• W-2 wage income is not business income. The excess business loss is determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee. (§ 461(l)(3)(A)) A taxpayer with significant W-2 wages cannot use that income to absorb business losses for § 461(l) purposes.
• The trade or business determination is made at the entity level for partnerships and S corporations. If a taxpayer owns an interest in a partnership or S corporation, the determination of whether the entity's activities constitute a trade or business is made at the entity level. (Instructions for Form 461 (2024), "Definitions - Trade or business")
• § 461(l) applies before § 172 in the computational sequence. The excess business loss limitation is applied before computing the NOL deduction. (§ 461(l)(1)(B)) A loss disallowed as an excess business loss is treated as an NOL in the subsequent taxable year and then flows through the regular § 172 rules. (§ 461(l)(2))
• TRAP. Because a disallowed excess business loss becomes an NOL subject to the 80 percent taxable income limitation in the carryover year, the same economic loss may be deferred across multiple years. In Year 1, 100 percent of the excess business loss is deferred. In Year 2, the NOL can offset only 80 percent of taxable income. At minimum, 20 percent of the original loss remains deferred after Year 2. (KPMG, "Tax News Flash, § 461(l) Excess Business Loss Limitation" (June 26, 2019))

Step 9B. The Ordering of Limitations for Noncorporate Taxpayers

• Four separate limitations apply in sequence before a business loss creates an NOL. For a loss to be fully deductible or to create an NOL, it must survive each limitation in the following order. (IRS Publication 925 (2025), "Loss limits for partners and S corporation shareholders") (§ 461(l)(6))
  1. Basis limitation under § 704(d) (partnerships) or § 1366(d) (S corporations). A partner or shareholder cannot deduct losses in excess of basis.
  2. At-risk limitation under § 465. Losses are limited to the amount the taxpayer has at risk in the activity. (Form 6198)
  3. Passive activity loss limitation under § 469. Passive losses can offset only passive income. (Form 8582)
  4. Excess business loss limitation under § 461(l). Only losses that survive the first three limitations are tested. (Form 461)
• § 461(l)(6) explicitly mandates the § 469 ordering. "This subsection shall be applied after the application of section 469." (§ 461(l)(6)) A loss must first clear the passive activity loss hurdle before being tested under § 461(l).
• EXAMPLE. A partner has a $1,000,000 distributive share of partnership loss. The partner's basis in the partnership interest is $400,000. The partner is at-risk for the full $400,000. The activity is nonpassive. The § 704(d) limitation reduces the deductible loss to $400,000. The at-risk and passive activity limitations do not further reduce the loss. Assuming this is the partner's only business activity and the partner files jointly in 2025, the § 461(l) threshold is $626,000. The excess business loss is zero because $400,000 of net business loss is below the threshold. The partner deducts $400,000 currently.
• Determined at the partner or shareholder level for pass-through entities. § 461(l)(4)(A) requires the excess business loss determination to be made at the partner or shareholder level. Each partner's or shareholder's allocable share of items of income, gain, deduction, or loss from the partnership or S corporation is taken into account by the partner or shareholder. (§ 461(l)(4)(B)) For S corporations, an allocable share is the shareholder's pro rata share of an item. (§ 461(l)(4), flush language)
• Aggregate business losses across multiple trades or businesses. All trade or business deductions and income are aggregated. A taxpayer with one profitable business producing $300,000 of income and one loss business producing $700,000 of losses has net business losses of $400,000 for § 461(l) purposes. The profitable business partially offsets the loss business. (§ 461(l)(3)(A)(i) and (ii)(I))
• TRAP. A loss that clears § 461(l) may still not produce an NOL if § 172(d)(4) limits nonbusiness deductions to nonbusiness income in computing the NOL. The § 461(l) threshold allows a cushion of business loss deduction, but any excess business loss is disallowed before the NOL computation even begins.

Step 9C. Carryover of Disallowed Excess Business Losses

"Any loss which is disallowed under paragraph (1) shall be treated as a net operating loss for the taxable year for purposes of determining any net operating loss carryover under section 172(b) for subsequent taxable years." (IRC § 461(l)(2))

• Disallowed excess business losses become NOLs. A loss disallowed under § 461(l) is treated as a net operating loss for the taxable year in which it arises, for purposes of determining NOL carryovers to subsequent taxable years under § 172(b). (§ 461(l)(2))
• The carried-over amount is subject to regular § 172 rules. Once a disallowed excess business loss is converted to an NOL, it is treated like any other NOL carryforward. For post-2017 losses carried to post-2020 taxable years, the NOL deduction is limited to 80 percent of taxable income. (§ 172(a)(2)(B))
• The carried-over loss is NOT retested under § 461(l) in the carryover year. The disallowed excess business loss is treated as an NOL deduction in the subsequent year, not as an excess business loss. It does not again test against the § 461(l) threshold in the year it is utilized. (Weaver analysis of OBBBA, "One Bill, Big Impact" (July 2025)) (KPMG Tax News Flash (May 2025)) The OBBBA conference committee rejected a Senate proposal that would have required EBL carryovers to be retested under § 461(l) in subsequent years.
• TRAP. Form 461 must be filed if either (1) net losses from all trades or businesses exceed the threshold amount, or (2) any single line item shows a loss exceeding one-half of the threshold. For 2025, the single-item threshold is $156,500. (Instructions for Form 461 (2025), "Who Must File")
• Farming losses receive special ordering treatment. If a taxpayer has both farming and nonfarming business losses that exceed the threshold amount, the threshold must be allocated first to farming losses to the extent the taxpayer has an NOL. (Instructions for Form 461 (2024), "Farming and nonfarming losses") This ordering ensures that farming losses are treated as excess business losses before nonfarming losses, preserving the taxpayer's ability to carry back farming NOLs two years.
• Losses from fire, storm, casualty, disease, or drought involving a farming business are disregarded. Such losses are not taken into account in the excess business loss computation. (§ 461(j)(2)(D)) This exclusion protects farmers with disaster-related losses from the limitation.

Step 10. Ownership Changes and the § 382 Limitation

"The amount of the taxable income of any new loss corporation for any post-change year which may be offset by pre-change losses shall not exceed the section 382 limitation for such year." (IRC § 382(a))

• § 382 prevents trafficking in NOLs. If an ownership change occurs with respect to a loss corporation, the amount of taxable income for any post-change year that may be offset by pre-change net operating losses is capped. (T.D. 8824, 1999-1 C.B. 765) The policy is to prevent acquisitions of loss corporations solely for their tax attributes. The § 382 limitation approximates the annual income the business capital of the old loss corporation would have generated. (Berry Petroleum Co. v. Commissioner, 104 T.C. 584, 642 (1995), aff'd, 142 F.3d 442 (9th Cir. 1998))
• § 382 applies only after an ownership change. No limitation arises unless a corporation first experiences an ownership change as defined in § 382(g). A corporation may have substantial NOLs and never face § 382 if its ownership remains stable. (§ 382(a)) (§ 382(g))

Step 10A. Defining an Ownership Change

"An ownership change occurs if immediately after any owner shift involving a 5-percent shareholder or any equity structure shift, the percentage of stock of the loss corporation owned by one or more 5-percent shareholders has increased by more than 50 percentage points over the lowest percentage of stock of such corporation owned by such shareholders at any time during the testing period." (IRC § 382(g)(1))

• The three-part mechanical test. An ownership change occurs when (1) one or more 5-percent shareholders, (2) over a 3-year testing period, (3) increase their aggregate ownership by more than 50 percentage points over their lowest ownership during that period. (§ 382(g)(1)) Each element must be present. The test is mechanical. Intent to acquire NOLs is irrelevant.
• 5-percent shareholder defined. A 5-percent shareholder is any person or public group holding 5 percent or more of the loss corporation's stock, measured by value. (Treas. Reg. § 1.382-2T(f)(1)) Stock described in § 1504(a)(4) (nonvoting preferred) is generally excluded from the ownership change determination unless it participates in corporate growth to a significant extent. (§ 382(g)(4)(C)) (Treas. Reg. § 1.382-2T(f)(2))
• The public group rule. All stock owned by shareholders who are not 5-percent shareholders is treated as stock owned by a single 5-percent shareholder. (§ 382(g)(4)(A)) This means widely dispersed public shareholders are aggregated into one group. Treas. Reg. § 1.382-2T(j) provides detailed segregation rules requiring separation of public groups in equity structure shifts, redemption transactions, stock issuances, and rights offerings. (Treas. Reg. § 1.382-2T(j)(2)(iii))
• Related persons treated as one shareholder. Persons related under § 267 or § 707(b)(1) are treated as a single shareholder for purposes of identifying 5-percent shareholders. (Treas. Reg. § 1.382-2T(f)(1)) This prevents a controlling group from splitting ownership among related parties to stay below the 5 percent threshold.
• The testing period. The testing period is the 3-year period ending on the testing date, which is any date the corporation chooses to determine whether an ownership change has occurred. (§ 382(i)) (Treas. Reg. § 1.382-2T(d)) The testing period begins no earlier than the first day the corporation is a loss corporation. If no ownership change has occurred as of any test date, the testing period rolls forward. A new testing period begins on the day after an ownership change.
• Owner shifts include any transaction affecting 5-percent shareholder ownership. An owner shift includes purchases, dispositions, issuances, redemptions, recapitalizations, and equity structure shifts. (Treas. Reg. § 1.382-2T(e)(1))
• An equity structure shift means any reorganization within the meaning of § 368. Such term excludes reorganizations described in § 368(a)(1)(D) or (G) unless the requirements of § 354(b)(1) are met, and reorganizations described in § 368(a)(1)(F). (§ 382(g)(3))
• Aggregation of stock by value. Multiple classes of stock are aggregated by value for purposes of determining ownership percentages. (Notice 2010-50, 2010-27 I.R.B. 1) Notice 2010-50 announced that the IRS will not challenge reasonable methods that ignore changes in ownership proportion attributable solely to fluctuations in relative fair market values of different stock classes.
• Convertible instruments and options, the deemed exercise rule. Options, warrants, and convertible debt are generally treated as exercised for purposes of determining whether an ownership change has occurred, if such treatment would cause or avoid an ownership change. (Treas. Reg. § 1.382-2T(h)(4)) (Treas. Reg. § 1.382-4) This anti-avoidance rule prevents taxpayers from issuing contingent equity instruments to circumvent § 382.
• The step-transaction doctrine. Courts apply step-transaction analysis to determine whether multiple related transactions should be treated as a single integrated transaction for § 382 purposes. If a series of related steps are part of a single plan, they are treated as occurring on the date of the last step. The regulations and case law treat formalistic separations as a single transaction when the steps are interdependent and pre-arranged. (Treas. Reg. § 1.382-2T(i)) (see also IRS Field Service Advisory analysis of step-transaction in ownership change contexts)
• The duty to inquire at the entity shareholder level. A loss corporation must make reasonable inquiry to determine the ownership of its 5-percent shareholders and entity shareholders. Owner shifts occurring at the entity shareholder level must be tracked and measured. (Treas. Reg. § 1.382-2T(k)(3)(i)) If a loss corporation has a partnership, corporation, or trust as a shareholder, it must look through that entity to its owners to identify 5-percent shareholders.
• TRAP. An ownership change can occur even when no single acquirer intends to buy control. Cumulative purchases by multiple unrelated 5-percent shareholders within the same 3-year testing period can combine to trigger the 50-percentage-point threshold. A loss corporation must continuously monitor its shareholder base.
• CAUTION. Multiple ownership changes create layered limitations. Each pre-change loss is subject to the most restrictive limitation applicable to it. A subsequent ownership change with a larger limitation does not free up pre-change losses from earlier ownership changes. (T.D. 8824, 1999-1 C.B. 765)

Step 10B. Identifying a Loss Corporation

• Loss corporation definition. A loss corporation is any corporation entitled to use a net operating loss carryover, a net capital loss carryover, or certain tax credit carryovers. (§ 382(k)(1)) The definition is broad. Any corporation with an NOL carryforward qualifies, regardless of whether the NOL is currently being utilized. A new corporation with a current-year NOL also qualifies as a loss corporation. (§ 382(k)(1)(A) and (B))
• A built-in loss corporation. A corporation is a "built-in loss corporation" if it has a net unrealized built-in loss (NUBIL) or net unrealized built-in gain (NUBIG) of the lesser of (1) $10,000,000 or (2) 15 percent of the fair market value of its assets immediately before the ownership change. (§ 382(h)(3)(B)) If neither threshold is met, the NUBIG/NUBIL is zero and the RBIG/RBIL rules do not apply.
• TRAP. A corporation can be a built-in loss corporation even if it has no NOLs. If a corporation's assets have an aggregate adjusted basis exceeding their aggregate fair market value by more than the de minimis threshold, built-in losses recognized during the 5-year recognition period after an ownership change are treated as pre-change losses subject to the § 382 limitation. (§ 382(h)(1)(B))

Step 10C. Computing the § 382 Limitation

"The section 382 limitation for any post-change year is an amount equal to--(A) the value of the old loss corporation, multiplied by (B) the long-term tax-exempt rate." (IRC § 382(b)(1))

• The base limitation formula. The § 382 limitation equals the value of the old loss corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate in effect for the month of the change (or either of the two preceding months). (§ 382(b)(1)) (§ 382(f)) The rate is the highest of the adjusted federal long-term rates for the current month and the two prior months, giving the taxpayer the benefit of the highest available rate. The IRS publishes the applicable rate monthly in Revenue Rulings.
• Value of the old loss corporation. The value is the fair market value of the stock of the loss corporation (including § 1504(a)(4) preferred stock) immediately before the ownership change. (§ 382(e)(1)) This is the equity value, not the enterprise value. Several adjustments may apply.
• Adjustments to value. The following adjustments may reduce the value of the old loss corporation for § 382(b) purposes.
  1. Redemptions and corporate contractions (§ 382(e)(2)). If the loss corporation redeems stock or engages in a corporate contraction in connection with the ownership change, the value is reduced by the amount of the redemption or contraction. (§ 382(e)(2)) In Berry Petroleum Co. v. Commissioner, 104 T.C. 584, 649-650 (1995), the court held that a distribution structured as a loan intended to be forgiven constitutes a corporate contraction requiring value reduction.
  2. Capital contributions (§ 382(l)(1)). Any capital contribution received as part of a plan a principal purpose of which is to avoid or increase the § 382 limitation is disregarded. Capital contributions made during the 2-year period ending on the change date are presumed to be part of such a plan. (§ 382(l)(1)(A) and (B)) Notice 2008-78, 2008-41 I.R.B. 1, turns off this presumption and provides a facts-and-circumstances test with four safe harbors. Safe Harbor 1 applies if the contribution is made by a non-controlling, non-related party, no more than 20 percent of stock is issued, there was no agreement regarding an ownership change at the time of contribution, and the ownership change occurs more than six months after the contribution. (Notice 2008-78, Section III.B.2(a))
  3. Nonbusiness assets (§ 382(l)(4)). If nonbusiness assets equal at least one-third of total asset value, the value of the old loss corporation is reduced by the value of those nonbusiness assets. (§ 382(l)(4)) Cash and marketable securities are generally nonbusiness assets unless held as an integral part of a trade or business. In Berry Petroleum Co. v. Commissioner, 104 T.C. at 649-650, the court held that legally required cash reserves are an integral part of the business, but cash held for future acquisitions and other general business needs is not so protected.
• Unused limitation carryforward. If the § 382 limitation for any post-change year exceeds the taxable income offset by pre-change losses, the excess is added to the next post-change year's limitation. (§ 382(b)(2)) This prevents waste of limitation amounts in low-income years.
• Mid-year ownership change, the ratable allocation rule. For a post-change year that includes the change date, the § 382 limitation does not apply to taxable income allocable to the period on or before the change date. (§ 382(b)(3)(A)) By default, taxable income is allocated ratably to each day in the year. A taxpayer may elect to use a closing of the books method under Treas. Reg. § 1.382-6(b) to allocate actual income and loss to the pre-change and post-change periods. This election can be advantageous when the pre-change period has taxable income that can be offset by pre-change losses without limitation. The election must be made on a timely filed return.
• Built-in gains increase the limitation. If a loss corporation has a NUBIG, recognized built-in gain (RBIG) during the 5-year recognition period increases the § 382 limitation dollar for dollar. (§ 382(h)(1)(A)) RBIG includes gain recognized on disposition of assets held on the change date, to the extent of built-in gain, plus certain income items properly taken into account during the recognition period but attributable to periods before the change date. (§ 382(h)(2)) (§ 382(h)(6)(A))
• Built-in losses are treated as pre-change losses. If a loss corporation has a NUBIL, recognized built-in loss (RBIL) during the 5-year recognition period is treated as a pre-change loss subject to the § 382 limitation. (§ 382(h)(1)(B)) RBIL includes loss recognized on disposition of assets held on the change date, to the extent of built-in loss, plus certain deduction items properly taken into account during the recognition period but attributable to periods before the change date. (§ 382(h)(2)) (§ 382(h)(6)(B))
• The recognition period. The recognition period is the 5-year period beginning on the change date. (§ 382(h)(7)(A)) RBIG and RBIL are only relevant if recognized during this 5-year window. After the recognition period expires, built-in gains and losses recognized are treated like any other post-change income or loss.
• Notice 2003-65 safe harbor methods for RBIG and RBIL. Taxpayers may use either the 1374 approach (based on accrual accounting principles) or the 338 approach (comparing actual items to hypothetical items under a deemed § 338 election) to determine RBIG and RBIL. (Notice 2003-65, 2003-2 C.B. 747) Under the 338 approach, RBIG from built-in gain assets is determined by comparing actual cost recovery deductions to hypothetical deductions under a deemed § 338 election. Notice 2018-30 modified both approaches to exclude § 168(k) bonus depreciation from hypothetical cost recovery deductions. (Notice 2018-30, 2018-17 I.R.B. 508)
• TRAP. State conformity to § 382 varies significantly. Some states apportion the § 382 limitation. Some states (e.g., California) apportion differently for the general § 382 limit and the NUBIG/NUBIL computation. Some states do not conform to § 382 at all. A comprehensive § 382 analysis must include state-level considerations. (Withum, "§ 382 Common Traps and Pitfalls" (2025))

Step 10D. Continuity of Business Enterprise and Special Rules

• The COBE requirement. If the new loss corporation does not continue the business enterprise of the old loss corporation at all times during the 2-year period beginning on the change date, the § 382 limitation for any post-change year is zero. (§ 382(c)(1)) COBE requires either continuing the historic business of the loss corporation or using a significant portion of the loss corporation's assets in a business. (Treas. Reg. § 1.368-1(d), incorporated by reference)
• Exception for RBIG increases even if COBE is violated. The limitation shall not be less than the sum of any increase for recognized built-in gains under § 382(h)(1)(A) and any unused limitation carryforward attributable to RBIG amounts. (§ 382(c)(2)) RBIG increases are preserved even if the historic business is discontinued.
• The § 382(l)(5) bankruptcy exception. § 382(a) does not apply to an ownership change if (1) the old loss corporation is under the jurisdiction of a court in a Title 11 or similar case immediately before the ownership change, and (2) the pre-change shareholders and qualified creditors own at least 50 percent of the total voting power and value of the new loss corporation's stock after the change. (§ 382(l)(5)(A)) The trade-off is that the corporation must reduce its NOL carryforwards by interest deductions paid or accrued on debt that was converted to stock in the reorganization during the current and three preceding tax years. (§ 382(l)(5)(B)) Qualified indebtedness includes debt held by the same beneficial owner for at least 18 months before the bankruptcy filing, or debt that arose in the ordinary course of business and has been owned at all times by the same beneficial owner. (§ 382(l)(5)(E))
• TRAP. If a second ownership change occurs within 2 years after a § 382(l)(5) ownership change, the § 382 limitation for the second change is zero and all pre-change losses are effectively eliminated. (§ 382(l)(5)(D)) (Treas. Reg. § 1.382-9(n)(1)) A loss corporation may elect irrevocably not to apply § 382(l)(5). (Treas. Reg. § 1.382-9(i))
• The § 382(l)(6) alternative bankruptcy rule. If § 382(l)(5) does not apply, § 382(l)(6) provides a special valuation rule for bankruptcy ownership changes. The value of the loss corporation is the lesser of (1) the value of its stock immediately after the ownership change (reflecting any increase in value from cancellation of creditors' claims), or (2) the value of the loss corporation's pre-change assets without regard to liabilities. (Treas. Reg. § 1.382-9(j)) Unlike § 382(l)(5), the COBE requirement does apply under § 382(l)(6). (Treas. Reg. § 1.382-9(m)(2))
• Disallowed business interest under § 163(j) is treated as a pre-change loss. Carryovers of disallowed business interest under § 163(j)(2) are treated as pre-change losses subject to the § 382 limitation. (§ 382(d)(3), added by TCJA § 13311) A loss corporation with significant § 163(j) carryforwards must track them alongside NOLs for § 382 purposes.
• CAUTION. Treas. Reg. § 1.1502-96(c) provides that a loss corporation subject to a § 382 limitation continues to be subject to the limitation regardless of whether it becomes a member or ceases to be a member of a consolidated group. The § 382 limitation travels with the losses and cannot be avoided through consolidated group membership changes.

Step 11. The § 382 Limitation Amount and Built-in Gains/Losses

"The section 382 limitation for any post-change year is an amount equal to (A) the value of the old loss corporation, multiplied by (B) the long-term tax-exempt rate." (IRC § 382(b)(1))

"If the section 382 limitation for any post-change year exceeds the taxable income of the new loss corporation for such year which was offset by pre-change losses, the section 382 limitation for the next post-change year shall be increased by the amount of such excess." (IRC § 382(b)(2))

• The § 382 limitation formula. The annual limitation equals the value of the old loss corporation multiplied by the long-term tax-exempt rate. (§ 382(b)(1)(A) and (B)) Any unused limitation carries forward to the next post-change year and is added to that year's base limitation. (§ 382(b)(2)) This carryforward prevents waste of limitation amounts in years when the corporation has insufficient taxable income to absorb pre-change losses.

Step 11A. Computing the § 382 Limitation

• The value of the old loss corporation. Value means the fair market value of the stock of the old loss corporation immediately before the ownership change. (§ 382(e)(1)) The statute explicitly includes stock described in § 1504(a)(4), which covers certain nonvoting preferred stock that would otherwise be excluded from the affiliated group definition. (§ 382(e)(1)) Value includes all classes of stock, voting and nonvoting, common and preferred.
• Redemptions and extraordinary distributions adjustment. § 382(e)(2) reduces the value of the old loss corporation for redemptions and corporate contractions in the 2 years preceding the ownership change. If the corporation redeemed stock or made extraordinary distributions during this 2-year window, the value is reduced by the amount of value extracted. In Berry Petroleum Co. v. Commissioner, 104 T.C. 584 (1995), aff'd, 142 F.3d 442 (9th Cir. 1998) (table), the Tax Court held that a distribution structured as a loan intended to be forgiven constituted a corporate contraction requiring value reduction. The court reasoned that Congress intended to include "bootstrap" acquisitions in which the source of funds for acquiring the stock is the acquired corporation itself.
• Capital contribution anti-stuffing rule. § 382(l)(1)(A) disregards any capital contribution received as part of a plan a principal purpose of which is to avoid or increase any limitation under § 382. § 382(l)(1)(B) creates a rebuttable presumption that any capital contribution made during the 2-year period ending on the change date is part of such a plan. Notice 2008-78, 2008-41 I.R.B. 1 (Sept. 2, 2008), turned off this 2-year presumption and replaced it with a facts-and-circumstances test. The Notice provides four safe harbors. (1) Safe Harbor One. The contribution is made by a person who is neither a controlling shareholder nor a related party, no more than 20% of total outstanding stock value is issued, no agreement regarding an ownership change exists, and the ownership change occurs more than 6 months after the contribution. (2) Safe Harbor Two. The contribution is made by a related party holding 10% or less or by a non-related party, no agreement exists, and the ownership change occurs more than 1 year after the contribution. (3) Safe Harbor Three. Stock is issued for services or to a retirement plan. (4) Safe Harbor Four. The contribution is made at formation or before the corporation had losses. Taxpayers may rely on Notice 2008-78 for ownership changes in taxable years ending on or after September 26, 2008.
• TRAP. A capital contribution made as part of a plan to circumvent § 382 is disregarded. (§ 382(l)(1)(A), Notice 2008-78) The IRS scrutinizes pre-change capital infusions that appear designed to inflate the equity value and thus the annual limitation. Document the business purpose for any capital contribution within 2 years of an ownership change.
• The long-term tax-exempt rate. The IRS publishes this rate monthly under § 382(f). It is the highest of the adjusted federal long-term rates for the current month and the 2 prior months ending in the month of the ownership change. (§ 382(f)) The rate is intentionally set at the highest of the 3-month period to give loss corporations the benefit of the most favorable rate. The rate is published in monthly Revenue Rulings.
• EXAMPLE. Old Loss Corp has a pre-change value of $10 million. The long-term tax-exempt rate is 4%. The annual § 382 limitation is $400,000 ($10M multiplied by 4%). Only $400,000 of pre-change NOLs can offset post-change taxable income each year (subject to NUBIG adjustments and unused limitation carryforwards).
• Short taxable year proration. In the year of the ownership change and in any short post-change year, the § 382 limitation is prorated based on the number of days in the short period. (§ 382(b)(3), § 382(d)(1)(B)) § 382(b)(3)(A) further provides that the limitation does not apply to taxable income allocable to the period on or before the change date. Taxable income is allocated ratably to each day in the year by default, but the taxpayer may make a closing of the books election under Treas. Reg. § 1.382-6(b) to allocate actual income and loss to the pre-change and post-change periods. The closing of the books election can be advantageous when the pre-change period has taxable income that can be offset by pre-change losses without limitation. It must be made on a timely filed return.
• Income allocation in the change year. By default, taxable income is allocated ratably to each day of the year. (§ 382(b)(3)(A)) The § 382 limitation applies only to income allocable to the post-change period. If the ownership change occurs on day 180 of a 365-day year, approximately 50.7% of the year's taxable income is treated as pre-change income (not subject to the limitation) and 49.3% is post-change income (subject to the limitation).
• Nonbusiness assets reduction. § 382(l)(4) reduces the value of the old loss corporation if nonbusiness assets equal at least one-third of total asset value. "Nonbusiness assets" generally means assets held for investment, including cash not held as an integral part of a trade or business. (§ 382(l)(4)) In Berry Petroleum Co. v. Commissioner, 104 T.C. at 649-650, the court held that legally required cash reserves (for banks and insurance companies) are an integral part of the business and thus not nonbusiness assets, but cash held for future acquisitions and other business needs is not so protected. The test under § 382 is more stringent than the "reasonable needs of business" test of § 537.

Step 11B. Net Unrealized Built-in Gain and Loss

"The net unrealized built-in gain...is the amount (if any) by which the fair market value of the assets of the corporation immediately before the ownership change exceeds the aggregate adjusted basis of such assets at such time." (IRC § 382(h)(1)(A)(i))

"If a loss corporation has a net unrealized built-in gain, the section 382 limitation for any recognition period taxable year shall be increased by the recognized built-in gain for such taxable year." (IRC § 382(h)(1)(A))

"If a loss corporation has a net unrealized built-in loss, the section 382 limitation shall be subject to such rules as the Secretary may prescribe with respect to recognized built-in loss." (IRC § 382(h)(1)(B))

• The NUBIG/NUBIL computation. NUBIG equals aggregate FMV of assets minus aggregate adjusted basis immediately before the ownership change (if positive). NUBIL equals aggregate adjusted basis minus aggregate FMV (if positive). (§ 382(h)(3)(A)) The calculation requires a complete balance sheet appraisal at the change date. Every asset must be valued at FMV and compared to its adjusted basis.
• The de minimis threshold. NUBIG or NUBIL is treated as zero if it does not exceed the lesser of (i) $10 million or (ii) 15% of the FMV of the corporation's assets immediately before the ownership change. (§ 382(h)(3)(B)) If the threshold is not met, the built-in gain/loss rules do not apply at all. No RBIG or RBIL tracking is required.
• EXAMPLE. A loss corporation has assets with aggregate FMV of $50 million and aggregate adjusted basis of $42 million. NUBIG is $8 million. The threshold is the lesser of $10 million or $7.5 million (15% of $50M). Because $8 million exceeds $7.5 million, NUBIG is $8 million and the RBIG rules apply. If NUBIG had been $7 million, it would be treated as zero because $7 million is less than $7.5 million.
• Recognized built-in gain increases the limitation. If a loss corporation has a NUBIG, recognized built-in gains during the 5-year recognition period increase the § 382 limitation dollar-for-dollar. (§ 382(h)(1)(A)) RBIG includes gain recognized on the disposition of any asset held immediately before the ownership change, to the extent the gain does not exceed the asset's built-in gain at the change date. (§ 382(h)(2)) The burden is on the loss corporation to establish that gain qualifies as RBIG.
• RBIG includes certain income items attributable to pre-change periods. § 382(h)(6)(A) treats any item of income properly taken into account during the recognition period but attributable to periods before the change date as RBIG. This catch-all extends RBIG treatment beyond asset dispositions to items such as cash-basis accounts receivable collected after the change, completed contract method income recognized after the change, and certain cancellation of indebtedness income.
• Recognized built-in loss is treated as a pre-change loss. If a loss corporation has a NUBIL, recognized built-in losses during the recognition period are treated as pre-change losses subject to the § 382 limitation. (§ 382(h)(1)(B), § 382(h)(2)) RBIL includes losses recognized on disposition of assets held at the change date, to the extent the loss does not exceed the asset's built-in loss. The burden is on the loss corporation to establish that a loss does NOT qualify as RBIL.
• RBIL includes certain deduction items attributable to pre-change periods. § 382(h)(6)(B) treats any deduction allowable during the recognition period but attributable to periods before the change date as RBIL. This includes bad debt deductions for pre-change receivables, payments on contingent liabilities that existed at the change date, and similar items.
• The 5-year recognition period. RBIG and RBIL are tracked for the 5-year period beginning on the change date. (§ 382(h)(7)(A)) Gains and losses recognized after this period are treated as ordinary post-change items. The recognition period is fixed and does not extend for any reason.
• Notice 2003-65 safe harbor methods. Notice 2003-65, 2003-2 C.B. 747, as modified by Notice 2018-30, 2018-17 I.R.B. 508, provides two alternative safe harbor approaches for computing RBIG and RBIL.
  1. The 338 approach. RBIG from built-in gain assets is determined by comparing actual cost recovery deductions to hypothetical deductions under a deemed § 338 election. (Notice 2003-65, Section IV) An asset with built-in gain generates RBIG equal to the hypothetical cost recovery deduction that would have been allowed if a § 338 election had been made, minus the actual cost recovery deduction allowed. This approach can generate RBIG even without asset dispositions. Notice 2018-30 modified both approaches to exclude § 168(k) bonus depreciation from hypothetical cost recovery deductions for ownership changes after May 8, 2018.
  2. The 1374 approach (general principle approach). This approach allocates items between pre-change and post-change periods based on accrual accounting principles. It is generally more favorable to taxpayers in a NUBIL position. (Notice 2003-65, Section III)
• CAUTION. Proposed regulations under § 382(h) have not been finalized. Treasury issued proposed regulations (REG-112510-16, 84 Fed. Reg. 50753 (Sept. 26, 2019)) that would significantly modify the 1374 approach, include deductible contingent liabilities as RBIL, clarify that dividends on built-in gain stock are not RBIG, and address § 163(j) interactions. These proposed regulations have not been finalized. Taxpayers may continue to rely on Notice 2003-65 as modified by Notice 2018-30.

Step 11C. Continuity of Business Enterprise

"If the new loss corporation does not continue the business enterprise of the old loss corporation at all times during the 2-year period beginning on the change date, the section 382 limitation for any post-change year shall be zero." (IRC § 382(c)(1))

• COBE requirement. § 382(c)(1) requires the new loss corporation to continue the business enterprise of the old loss corporation throughout the 2-year period beginning on the change date. The COBE test adopts the framework from Treas. Reg. § 1.368-1(d) that applies to reorganizations. (ProQuest Academic Article on COBE under § 382 (2025)) Satisfaction requires either (A) continuing the historic business of the old loss corporation, or (B) using a significant portion of the old loss corporation's business assets in a business.
• Failure to meet COBE zeroes the limitation. If COBE is not satisfied at any time during the 2-year period, the § 382 limitation drops to zero for the year of failure and all subsequent years. (§ 382(c)(1)) This is a draconian result that can trap an entire pool of NOLs. A complete liquidation, sale of all operating assets, or conversion to a passive investment company during the 2-year window will trigger this result.
• What constitutes "significant portion". Generally, at least 33% of the gross FMV of the old loss corporation's assets must be used in the continued business. Treas. Reg. § 1.368-1(d)(3) provides guidance, though this regulation technically applies to reorganizations. The case law and administrative practice under § 368 inform the § 382(c) analysis.
• The RBIG exception to COBE zeroing. § 382(c)(2) provides a critical exception. Even if COBE is violated, the limitation shall not be less than the sum of (A) any RBIG increases under § 382(h)(1)(A), and (B) any unused limitation carryforwards attributable to RBIG amounts. (§ 382(c)(2)) This preserves the ability to use RBIG increases even if the historic business is discontinued. RBIG relates to appreciation in assets, not continuing operations, so this exception makes policy sense.
• Consolidated group COBE. Treas. Reg. § 1.1502-96(d) treats a consolidated group as a single entity for COBE purposes. A loss group is treated as a single entity for determining whether it satisfies the COBE requirement of § 382(c)(1). If some members discontinue their businesses but others continue, the group may still satisfy COBE.
• CAUTION. COBE applies under § 382(l)(6) but not under § 382(l)(5). If the corporation relies on the § 382(l)(5) bankruptcy exception, COBE does not apply. (Treas. Reg. § 1.382-9(m)(1)) But if the corporation makes the § 382(l)(6) election instead, COBE applies in full and a violation sets the limitation at zero. This is a key factor in the bankruptcy analysis. See Step 12 below.

Step 12. Bankruptcy Exceptions to § 382

"Subsection (a) shall not apply to any ownership change if the corporation was (directly or indirectly) under the jurisdiction of the court in a title 11 or similar case immediately before the ownership change, and the shareholders and creditors of the old loss corporation (determined immediately before the ownership change) own at least 50 percent of the fair market value and at least 50 percent of the voting power of the new loss corporation." (IRC § 382(l)(5)(A)(i) and (ii))

• The two bankruptcy rules. § 382 provides two distinct rules for ownership changes occurring in bankruptcy proceedings. § 382(l)(5) provides a full exception from the § 382(a) limitation but imposes an NOL reduction penalty. § 382(l)(6) provides an alternative valuation method with no NOL reduction but preserves the regular § 382 limitation. These rules are mutually exclusive for a given ownership change. The practitioner must model both scenarios to determine which produces a better outcome.

Step 12A. The § 382(l)(5) Bankruptcy Exception

• The two-pronged eligibility test. § 382(l)(5) applies only if both requirements are met. (§ 382(l)(5)(A)) First, the old loss corporation must be under the jurisdiction of a court in a Title 11 or similar case immediately before the ownership change. Second, the pre-change shareholders and qualified creditors must own at least 50% of the total voting power and at least 50% of the total value of the new loss corporation immediately after the ownership change. Both the value test and the voting power test must be satisfied. (§ 382(l)(5)(A)(ii))
• Qualified indebtedness requirement. Only indebtedness held by a beneficial owner for at least 18 months before the bankruptcy filing, or indebtedness that arose in the ordinary course of business and has been owned at all times by the same beneficial owner, counts toward the creditor ownership test. (§ 382(l)(5)(E)) This "old and cold" requirement prevents creditors who acquired debt shortly before bankruptcy from exploiting the exception.
• No § 382 limitation applies. If the § 382(l)(5) exception is met, the general § 382(a) limitation does not apply at all. The NOLs are fully available to offset post-change taxable income subject only to the 80% limitation under § 172(a)(2). This is the most favorable aspect of § 382(l)(5) and can be enormously valuable for a corporation with substantial NOLs and a low stock value.
• The NOL reduction penalty (the interest haircut). The trade-off is severe. The corporation must reduce its NOLs by the sum of (i) interest paid or accrued on indebtedness converted to stock in the reorganization during the taxable year of and the 3 taxable years preceding the ownership change, and (ii) 50% of the excess of the value of stock and interests distributed in the reorganization over the adjusted basis of those interests. (§ 382(l)(5)(B)) This reduction is applied to the NOL pool as of the ownership change date.
• TRAP. The NOL reduction can eliminate a substantial portion of the loss corporation's NOLs. A corporation that paid significant interest on debt that is ultimately converted to equity in the bankruptcy may see its NOLs drastically reduced. The practitioner must model both scenarios (the § 382 limitation under regular rules versus the NOL reduction under § 382(l)(5)) to determine which produces a better net present value. In many cases, the regular § 382 limitation preserves more value than the NOL reduction under § 382(l)(5).
• Second ownership change within 2 years. If a second ownership change occurs within the 2-year period beginning on the day after the § 382(l)(5) change, the exception is revoked retroactively. (§ 382(l)(5)(D)) The § 382 limitation for the period between the two changes is zero, and all pre-change losses are effectively eliminated. (Treas. Reg. § 1.382-9(n)(1)) This is a severe "one-bite" rule that makes § 382(l)(5) extremely risky for corporations that may undergo subsequent ownership changes.
• Election out of § 382(l)(5). A loss corporation may elect irrevocably not to have § 382(l)(5) apply. (Treas. Reg. § 1.382-9(i)) The election is made on the return for the year of the ownership change and is irrevocable once made. A corporation might elect out if (1) the NOL reduction would eliminate most NOLs, making the limitation under § 382(l)(6) more valuable, (2) the corporation expects a second ownership change within 2 years, or (3) the stock value under § 382(l)(6) produces a favorable limitation.
• COBE does not apply under § 382(l)(5). Unlike the regular § 382 rules and § 382(l)(6), the COBE requirement of § 382(c) does not apply when § 382(l)(5) is in effect. (Treas. Reg. § 1.382-9(m)(1)) However, § 269 may apply instead if the principal purpose of the reorganization is tax avoidance. This distinction matters for corporations that plan to significantly change their business model after emerging from bankruptcy.

Step 12B. The § 382(l)(6) Alternative Bankruptcy Rule

• When § 382(l)(6) applies. § 382(l)(6) applies to ownership changes in Title 11 or similar cases to which § 382(l)(5) does not apply. This includes cases where the corporation fails the creditor ownership test or elects out of § 382(l)(5). (§ 382(l)(6), Treas. Reg. § 1.382-9(j))
• Special asset-based valuation. Under § 382(l)(6), the value of the loss corporation for computing the § 382 limitation is the lesser of (1) the value of its stock immediately after the ownership change (reflecting the increase in value from cancellation of creditors' claims), or (2) the value of the loss corporation's pre-change assets without regard to liabilities. (Treas. Reg. § 1.382-9(j)) In bankruptcy, the stock value immediately before the ownership change is typically near zero because the corporation is insolvent. § 382(l)(6) allows the value to reflect post-reorganization equity value, which is typically much higher. The asset value test acts as a ceiling.
• Stock value test limitation. Under Treas. Reg. § 1.382-9(k)(7), the value of stock issued in connection with the ownership change cannot exceed the cash and value of any property (including indebtedness of the loss corporation) received by the loss corporation in consideration for the issuance of that stock. This prevents artificial inflation of the stock value.
• No NOL reduction. Unlike § 382(l)(5), the § 382(l)(6) election does not trigger any NOL reduction. The regular § 382 limitation applies using the special valuation method. Pre-change NOLs remain intact and are subject only to the annual limitation amount.
• COBE applies under § 382(l)(6). If § 382(l)(6) applies, the COBE requirement of § 382(c) applies in full. (Treas. Reg. § 1.382-9(m)(2)) A failure to continue the business enterprise during the 2-year period beginning on the change date zeros out the limitation. This is a critical distinction from § 382(l)(5).
• Second ownership change within 2 years. Unlike § 382(l)(5), a second ownership change within 2 years after a § 382(l)(6) change does not automatically produce a zero limitation. (Treas. Reg. § 1.382-9(n)(2)) The stock value for the second change is not reduced for value previously taken into account under § 382(l)(6). This is significantly more favorable than the § 382(l)(5) rule.
• When to make the § 382(l)(6) election. The election is made by not applying § 382(l)(5). If the § 382(l)(5) requirements are met, the corporation must elect out under Treas. Reg. § 1.382-9(i) to fall under § 382(l)(6). The election is made on the return for the year of the ownership change and is irrevocable.
• Comparison of approaches. The practitioner should model three scenarios. (1) No bankruptcy exception. Apply the regular § 382 limitation using the stock value immediately before the ownership change (which may be near zero in bankruptcy). (2) § 382(l)(5). No annual limitation, but the NOL is reduced by the interest haircut. A second ownership change within 2 years zeros everything. COBE does not apply. (3) § 382(l)(6). The regular § 382 limitation applies using the post-reorganization stock value or asset value. No NOL reduction. COBE applies. A second ownership change within 2 years does not zero the limitation. The optimal choice depends on the relative sizes of the NOL pool, the annual limitation under each approach, the NOL reduction amount under § 382(l)(5), the likelihood of a second ownership change, and whether the corporation can satisfy COBE.
• TRAP. Do not default to § 382(l)(5) simply because it eliminates the annual limitation. In many bankruptcy cases, the NOL reduction under § 382(l)(5)(B) eliminates so much of the NOL pool that the remaining losses plus the risk of a second ownership change make § 382(l)(6) or even the regular rules more favorable. Build a multi-year model projecting taxable income, NOL absorption, and the value of each approach before making the election. The election is irrevocable and must be made on the return for the change year.

Step 13. Credit Limitation Under § 383

"If an ownership change occurs with respect to a corporation, the amount of any excess credit for any taxable year which may be used in any post-change year shall be limited to an amount determined on the basis of the tax liability which is attributable to so much of the taxable income as does not exceed the section 382 limitation for such post-change year to the extent available after the application of section 382 and subsections (b) and (c) of this section." (IRC § 383(a)(1))

"The term 'excess credit' means (A) any unused general business credit of the corporation under section 39, and (B) any unused minimum tax credit of the corporation under section 53." (IRC § 383(a)(2))

• Two categories of excess credit subject to limitation. § 383(a)(2) defines "excess credit" to include only (A) unused general business credits under § 39 and (B) unused minimum tax credits under § 53. No other credits fall within the statutory definition.
• Foreign tax credits fall under a separate regulatory regime. § 383(c) authorizes regulations limiting excess foreign taxes carried forward under § 904(c) in a manner consistent with the purposes of §§ 382 and 383. Treas. Reg. § 1.383-1(c)(3)(i) implements this by defining pre-change credits to include excess foreign taxes carried forward to the change year or allocable to the pre-change period. The regulatory limitation applies in the same manner as the § 383(a) credit limitation. (Treas. Reg. § 1.383-1(c)(3)(i))
• The § 383 credit limitation equals the tax liability on taxable income sheltered by the remaining § 382 limitation. The credit limitation is computed as the excess of (A) the corporation's regular tax liability for the post-change year, over (B) its regular tax liability computed by allowing as an additional deduction an amount equal to the § 382 limitation remaining after the absorption ordering described below. (Treas. Reg. § 1.383-1(c)(6)(i)(A)-(B))
  1. Compute the § 382 limitation for the post-change year under the rules in Step 11.
  2. Apply the ordering rules of Treas. Reg. § 1.383-1(d)(2) to determine how much of the § 382 limitation is absorbed by pre-change capital losses, RBILs, and NOL carryforwards.
  3. The portion of the § 382 limitation that remains after steps (i) through (v) of the ordering represents the amount of taxable income that can still be sheltered.
  4. The credit limitation equals the tax liability attributable to that remaining taxable income. At the 21% corporate rate, each dollar of remaining § 382 limitation generates approximately 21 cents of credit limitation.
• EXAMPLE. L Corp has a $25,000 § 382 limitation for 2024, a $12,000 pre-change NOL carryover, and a $50,000 pre-change general business credit. L uses the $12,000 NOL first, leaving $13,000 of § 382 limitation. L's regular tax liability on $88,000 of taxable income (after the NOL) is $18,480. L's regular tax liability computed by allowing an additional $13,000 deduction (taxable income of $75,000) is $15,750. L's § 383 credit limitation is $2,730 ($18,480 minus $15,750). Of the $50,000 credit, only $2,730 can be used. (Treas. Reg. § 1.383-1(c)(6)(i), Example)
• Net capital loss carryforwards reduce the § 382 limitation itself. § 383(b) provides that any net capital loss used in a post-change year reduces the § 382 limitation applied to pre-change losses for that year. This is fundamentally different from the credit limitation mechanism. Credits generate a separate credit limitation. Capital losses directly consume the § 382 limitation dollar-for-dollar. (IRC § 383(b))
  1. When a pre-change net capital loss carryforward offsets post-change capital gain, the amount of the capital loss used reduces the § 382 limitation available for NOLs in that same year.
  2. Capital losses are first in the ordering hierarchy under Treas. Reg. § 1.383-1(d)(2), meaning they absorb the § 382 limitation before NOLs or credits.
  3. CAUTION. A practitioner who fails to account for capital loss usage against the § 382 limitation will overstate the NOL absorption capacity for the year.
• Ordering of pre-change attribute absorption. Treas. Reg. § 1.383-1(d)(2) prescribes the following mandatory sequence for each post-change year. (Treas. Reg. § 1.383-1(d)(2)(i)-(viii))
  1. Pre-change capital losses that are recognized built-in losses subject to the § 382 limitation.
  2. Pre-change capital loss carryforwards and current-year pre-change capital losses.
  3. Pre-change recognized built-in losses that are not capital losses.
  4. Pre-change losses including disallowed business interest carryforwards (for ownership changes on or after the effective date of T.D. 9905).
  5. Pre-change NOL carryforwards not described in paragraphs (i) through (iv).
  6. Pre-change excess foreign taxes.
  7. Pre-change general business credits.
  8. Pre-change minimum tax credits.
• The § 383 credit reduction amount. When pre-change credits are actually used, the amount of taxable income attributable to those credits (the "credit reduction amount") reduces the § 382 limitation carryforward to subsequent years. The regulation requires "grossing up" each dollar of credit by dividing by the effective marginal rate to determine the taxable income equivalent. (Treas. Reg. § 1.383-1(e)(2))
  1. Determine the portion of regular tax liability offset by pre-change credits.
  2. Divide each dollar of tax offset by the marginal rate at which that dollar was imposed.
  3. The sum of these grossed-up amounts is the credit reduction amount.
  4. Subtract the credit reduction amount from the § 382 limitation carryforward.
• Proration for the change year applies by reference to § 382. § 383(d) directs that rules similar to § 382(b)(3) (proration of the change year limitation) and § 382(d)(1)(B) (proration of the value and base period) apply. The same ratable allocation or closing-of-the-books methodology elected under § 1.382-6 must be used consistently for § 383 purposes. (IRC § 383(d))
• All § 382 definitions carry over with adjustments for credits and capital losses. § 383(e) provides that terms have the same meaning as in § 382, with appropriate adjustments to reflect that § 383 applies to credits and net capital losses rather than NOLs. (IRC § 383(e))
• The alternative minimum tax is also subject to §§ 382 and 383 limitations. Treas. Reg. § 1.383-1(h) cross-references § 1.383-2T for the application of §§ 382 and 383 limitations in computing the alternative minimum tax. Pre-change losses and credits cannot circumvent the limitations through the AMT system. (Treas. Reg. §§ 1.383-1(h), 1.383-2T)
• Pre-change credits must be converted to deduction equivalents for certain computational purposes. In applying § 1.382-2T(f)(18)(ii)(C), (f)(18)(iii)(C), and (h)(4)(ix), pre-change credits are converted to deduction equivalents by dividing the credit amount by the maximum effective rate of tax under § 11. (Treas. Reg. § 1.383-1(g))
• Planning the ordering of attribute utilization. Because credits and NOLs compete for the same § 382 limitation, the practitioner must optimize the ordering of utilization.
  1. Generally, NOLs should be used before credits because credits may have longer carryforward periods and different absorption rules.
  2. However, credits with shorter carryforward periods or expiration dates should be prioritized if the alternative is permanent loss of the credit.
  3. Consider the interaction with § 384(d), which extends similar rules to prevent preacquisition credits from offsetting RBIG. If § 384 also applies, the credit limitation under § 383 may be further constrained.
• Consolidated return coordination. Treas. Reg. § 1.1502-98 provides that the consolidated return rules in §§ 1.1502-91 through 1.1502-96 apply for purposes of § 383, with adjustments to reflect that § 383 applies to credits and net capital losses. The SRLY rules and § 383 operate concurrently. (Treas. Reg. § 1.1502-98)

Step 14. Gain Limitation Under § 384

"If (1)(A) a corporation acquires directly (or through 1 or more other corporations) control of another corporation, or (B) the assets of a corporation are acquired by another corporation in a reorganization described in subparagraph (A), (C), or (D) of section 368(a)(1), and (2) either of such corporations is a gain corporation, income for any recognition period taxable year (to the extent attributable to recognized built-in gains) shall not be offset by any preacquisition loss (other than a preacquisition loss of the gain corporation)." (IRC § 384(a))

• § 384 is an anti-trafficking rule that prevents loss corporations from acquiring gain corporations to absorb NOLs against built-in gains. The provision stops the trafficking of gain corporations to soak up preacquisition losses. It operates independently from § 382 and both sections can apply simultaneously. (Staff, Joint Committee on Taxation, "Description of the Technical Corrections Act of 1988," at 421 (1988))
• Two triggering transactions activate § 384. (IRC § 384(a)(1))
  1. A corporation acquires directly or through one or more subsidiaries control of another corporation. Control means § 1504(a)(2) ownership, which requires 80% of both vote and value. (IRC § 384(c)(5))
  2. The assets of a corporation are acquired by another corporation in a reorganization described in § 368(a)(1)(A), (C), or (D).
• The gain corporation requirement. § 384(a)(2) requires that either of the corporations involved in the transaction be a "gain corporation." The TAMRA 1988 revision applies regardless of which corporation is the acquiror and which is the target. Either corporation may be the gain corporation. (Pub. L. 100-647, § 2004(m), Nov. 10, 1988)
• Gain corporation defined as any corporation with a net unrealized built-in gain. A gain corporation is any corporation with a NUBIG. NUBIG is determined using the same definition as § 382(h), with the "acquisition date" substituted for the "change date." The de minimis threshold applies. NUBIG does not exist if the lesser of (i) $10 million or (ii) 15% of the fair market value of the corporation's assets is greater than the aggregate built-in gains. (IRC §§ 384(c)(4), (c)(8))
• Preacquisition losses include three categories. (IRC § 384(c)(3))
  1. Any NOL carryforward to the taxable year in which the acquisition date occurs.
  2. Any NOL for the acquisition year to the extent allocable to the period on or before the acquisition date. Except as provided in regulations, this allocation is made ratably to each day in the year. (IRC § 384(c)(3)(A)(ii))
  3. Any recognized built-in loss in the case of a corporation with a NUBIL.
• Closing-of-the-books election for acquisition year loss allocation. The IRS has permitted taxpayers to allocate the acquisition year NOL using a closing-of-the-books method in lieu of the statutory ratable default. The practitioner may request this method through a PLR or cite existing PLRs as support. (PLR 201806005 (Feb. 9, 2018) (permitting closing-of-the-books method consistent with § 706(d) allocation). PLR 200238017 (June 11, 2002). PLR 9734028 (May 22, 1997))
• Recognized built-in gain defined. RBIG is any gain recognized during the 5-year recognition period on the disposition of any asset held at the acquisition date, subject to two rebuttal exceptions. (IRC § 384(c)(1)(A))
  1. The gain corporation can rebut the presumption by establishing that the asset was not held on the acquisition date.
  2. The gain corporation can rebut by establishing that the gain exceeds the excess of the asset's fair market value over its adjusted basis on the acquisition date (i.e., the gain exceeds the built-in gain at acquisition).
  3. Any item of income properly taken into account during the recognition period but attributable to periods before the acquisition date is treated as RBIG. This includes accrued income items such as accounts receivable of a cash-basis taxpayer, installment obligation deferred gain, and completed contract method deferred income. (IRC § 384(c)(1)(B))
• RBIG annual cap. Recognized built-in gains for any recognition period taxable year cannot exceed the NUBIG reduced by prior year RBIGs that would have been offset by preacquisition losses but for § 384. (IRC § 384(c)(1)(C))
  1. Compute total NUBIG at the acquisition date.
  2. Subtract RBIG from prior recognition period taxable years that would have been absorbed by preacquisition losses in the absence of § 384.
  3. The remainder is the RBIG cap for the current year.
• The gain corporation's own preacquisition losses may offset its own RBIG. The statutory carveout in § 384(a) permits a gain corporation to use its own preacquisition losses against its own RBIG. Only preacquisition losses of another corporation (the loss corporation) are barred. (IRC § 384(a) ("other than a preacquisition loss of the gain corporation"))
• EXAMPLE. Loss Corp has $50 million of NOL carryforwards. It acquires 100% of Gain Corp, which has a NUBIG of $20 million. During the 5-year recognition period, Gain Corp sells an asset and recognizes $5 million of built-in gain. Loss Corp cannot use any of its $50 million NOLs to offset this $5 million RBIG. Gain Corp must pay tax on the $5 million gain. However, if Gain Corp has its own $3 million NOL carryforward, that $3 million can offset the $5 million RBIG. Only $2 million of gain is taxed.
• Common control exception. § 384 does not apply if the loss corporation and the gain corporation were members of the same controlled group during the entire 5-year period ending on the acquisition date. (IRC § 384(b)(1))
  1. "Controlled group" means a controlled group as defined in § 1563(a), except that "more than 50 percent" is substituted for "at least 80 percent" each place it appears. (IRC § 384(b)(2)(A))
  2. The ownership requirements must be met with respect to both voting power and value. (IRC § 384(b)(2)(B))
  3. The determination is made without regard to § 1563(a)(4) (the insurance company exclusion). (IRC § 384(b)(2)(C))
  4. TRAP. The controlled group threshold is 50% (not 80%), and both vote and value are required. Do not confuse this test with the § 1504(a)(2) affiliated group test.
• Affiliated group aggregation. All corporations that are members of the same affiliated group immediately before the acquisition date are treated as one corporation for § 384 purposes. This means NUBIG and preacquisition losses are determined on an aggregated basis. (IRC § 384(c)(6))
• Predecessor and successor rule. Any reference to a corporation includes a reference to any predecessor or successor. If a gain corporation liquidates into its parent under § 332, the RBIG limitation continues to apply to the successor corporation during the remainder of the recognition period. (IRC § 384(c)(7))
• Extension to excess credits and net capital losses. § 384(d) applies rules similar to § 384(a) to excess credits as defined in § 383(a)(2) and to net capital losses. Preacquisition excess credits and net capital losses of one corporation cannot offset the tax attributable to RBIG of another corporation. (IRC § 384(d))
• Ordering rules for losses carried from the same taxable year. § 384(e) provides two coordination rules. (IRC § 384(e))
  1. Carryover rule. If a preacquisition loss is barred from offsetting RBIG, the RBIG does not reduce the amount of that loss available for carryover to other taxable years under § 172(b)(2). A similar rule applies to excess credits and net capital losses limited by § 384(d). (IRC § 384(e)(1))
  2. Same-year ordering rule. When a preacquisition loss from a taxable year is subject to § 384 limitation and another NOL from the same taxable year is not subject to § 384, taxable income is treated as having been offset first by the loss subject to the limitation. This preserves the unrestricted NOL for potential use against non-RBIG income. (IRC § 384(e)(2))
• § 384 operates independently from § 382 and the practitioner must apply the more restrictive limitation. The Joint Committee on Taxation has confirmed that § 384 applies independently of and in addition to § 382. Both can apply to the same transaction. (Staff, JCT, "Description of the Technical Corrections Act of 1988," at 421 (1988))
  1. § 382 limits pre-change NOLs against all post-change income based on the annual limitation amount.
  2. § 384 further limits preacquisition losses from offsetting RBIG of a gain corporation, even if the § 382 limitation would otherwise permit the offset.
  3. The practitioner must compute both limitations and apply the more restrictive one.
• CAUTION. No comprehensive Treasury regulations have been issued under § 384. The IRS opened a regulations project in 1989 (54 FR 17052, April 24, 1989) but discontinued it effective June 30, 1992 (Notice 92-12, 1992-16 I.R.B. 35). The absence of regulations creates uncertainty on key interpretive questions including (1) how to allocate taxable income between RBIG and non-RBIG items, (2) whether operating expenses reduce RBIG or non-RBIG income, and (3) the interaction between RBIG and recognized built-in losses. (Greg A. Fairbanks, "Issues in Allocating Income Under Sec. 384," Tax Adviser, Feb. 2023) (FSA 200447037 (Nov. 19, 2004))
• Anti-circumvention regulatory authority. § 384(f) grants the Secretary broad authority to issue regulations to ensure the purposes of § 384 are not circumvented through the use of any provision of law or regulations (including subchapter K) or through contributions of property to a corporation. Despite this broad grant, no regulations have been issued. (IRC § 384(f))
• Interaction with consolidated return SRLY rules. In consolidated return settings, the SRLY rules and § 384 overlap but apply differently. SRLY rules limit a subsidiary's pre-affiliation losses against consolidated taxable income. § 384 limits preacquisition losses from offsetting RBIG. SRLY rules extend to operating income, while § 384 applies only to recognized built-in gains. In a reverse acquisition, § 384 generally applies but SRLY rules may not. (Treas. Reg. § 1.1502-98)
• Planning considerations.
  1. Analyze whether the common control exception of § 384(b) applies before undertaking a detailed § 384 computation. If the acquiror and target were in the same 50%-controlled group for the prior 5 years, § 384 is inapplicable.
  2. If § 384 applies, identify the gain corporation's NUBIG and project RBIG recognition during the 5-year recognition period.
  3. Structure the transaction to ensure post-acquisition losses (which are not subject to § 384) can offset RBIG.
  4. Consider the interaction with § 382. If the acquisition also triggers an ownership change, both limitations apply and the practitioner must model both constraint sets.
  5. When allocating the acquisition year NOL between pre-acquisition and post-acquisition periods, consider requesting a closing-of-the-books method through PLR if ratable allocation is disadvantageous.

Step 15. Consolidated Group NOL Rules and the SRLY Limitation

"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 (SRLY member) arising (or treated as arising) in SRLYs (SRLY NOLs) that are included in the CNOL deductions for all consolidated return years of the group 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 (cumulative register)." (Treas. Reg. § 1.1502-21(c)(1)(i))

Step 15A. CNOL Computation and Deduction

• The CNOL defined. A consolidated net operating loss is any excess of deductions over gross income, as determined under § 1.1502-11(a) (the consolidated taxable income computation) without regard to the CNOL deduction itself. (Treas. Reg. § 1.1502-21(e)) The CNOL is a group-level concept. If one member has significant income and another has significant losses, they net at the group level. A group has a CNOL when aggregate deductions exceed aggregate gross income.
• The CNOL deduction. The CNOL deduction for any consolidated return year equals the aggregate of all NOL carryovers and carrybacks to the year. This aggregate consists of two components. First, CNOLs arising in consolidated return years of the group. Second, NOLs of members arising in separate return years. (Treas. Reg. § 1.1502-21(a)(1)) Subject to limitations under the Code, including the 80% limitation under § 172(a)(2) and the SRLY limitation.
• FIFO absorption of CNOLs. Losses are absorbed in the order of the taxable years in which they arose. Losses from taxable years ending on the same date are absorbed pro rata. (Treas. Reg. § 1.1502-21(b)(1)) This FIFO ordering applies the principles of § 172 at the consolidated level. Losses subject to a § 382 limitation are absorbed before losses not subject to a § 382 limitation.
• Apportionment of absorbed CNOLs. When a CNOL is absorbed by the group, it is apportioned among members based on the percentage of the CNOL attributable to each member. (Treas. Reg. § 1.1502-21(b)(2)(iv)) Attribution is determined by the member's separate NOL (or separate taxable income) relative to the group's total. If Member A contributed $40 of a $100 CNOL and Member B contributed $60, then 40% of any absorbed amount is treated as using Member A's loss and 60% as using Member B's loss.
• Recomputation of apportionment percentages. Apportionment percentages must be recomputed each year based on unabsorbed CNOLs. The percentage attributable to a member in Year 1 may differ from the percentage in Year 2 as losses are absorbed and new CNOLs arise.
• TRAP. Post-2017 CNOL 80% limitation. For consolidated return years beginning after December 31, 2020, the deductibility of post-2017 CNOLs is limited to 80% of taxable income. Pre-2018 CNOLs are deducted without limitation. (Treas. Reg. § 1.1502-21(a)(2)) For mixed groups with both nonlife insurance companies and other members, the IRS adopted a two-pool approach. The group computes a "residual income pool" (members that are not nonlife insurance companies, subject to the 80% limitation) and a "nonlife income pool" (nonlife insurance companies, not subject to the 80% limitation). (Treas. Reg. § 1.1502-21(a)(2)(iii)(C). See T.D. 9900, 85 FR 72746 (Nov. 16, 2020))

Step 15B. The SRLY Limitation

• The cumulative register concept. A Separate Return Limitation Year (SRLY) is generally a separate return year of a member. (Treas. Reg. § 1.1502-1(f)(1)) The core SRLY rule limits a member's pre-group NOLs to the member's cumulative contribution to consolidated taxable income. The cumulative register is the aggregate consolidated taxable income for all consolidated return years determined by reference to ONLY the SRLY member's items of income, gain, deduction, and loss. (Treas. Reg. § 1.1502-21(c)(1)(i)) The cumulative register operates on a lifetime basis across all consolidated years, not year-by-year. A member's unused positive contribution in one year can support SRLY loss absorption in a later year when the member itself has no current income. (IRS Field Attorney Advice 20251401F (Apr. 4, 2025))
• Cumulative register reduced by the full income amount. When the 80% limitation under § 172(a)(2) applies to a SRLY member's post-2017 NOLs, the cumulative register is reduced by the full amount of income needed to support the deduction, not merely the amount of NOL actually absorbed. (Treas. Reg. § 1.1502-21(c)(1)(i)(E). See T.D. 9957, 90 FR 6677 (Feb. 4, 2025)) If the group deducts $80 of SRLY NOL (the 80% limit), the register is reduced by $100. This rule prevents SRLY members from over-utilizing register capacity given that each dollar of absorbed post-2017 SRLY NOL consumes more than one dollar of register capacity.
• SRLY subgroups. Members that were part of the same former affiliated group and joined the new group together can form a SRLY subgroup. The SRLY limitation applies to the subgroup as a whole, not separately to each member. (Treas. Reg. § 1.1502-21(c)(2)) A subgroup includes the loss-carrying member and each other member that was part of the same former group and became a member of the new group at the same time. A member remains in the subgroup until it ceases to be affiliated with the loss-carrying member. This allows profitable members of the acquired group to support the loss member's NOLs by aggregating their income contributions to the cumulative register.
• Pro rata absorption within subgroups. Within a subgroup, losses are absorbed on a pro rata basis. When a subgroup member leaves the group, its NOL carryover is treated as having been absorbed on a pro rata basis, determined by comparing its initial NOL carryover to the subgroup's initial NOL carryover. (T.D. 8823, 64 FR 36092, 36095 (July 2, 1999))
• The § 382 overlap rule. When a member's SRLY limitation period overlaps with a § 382 ownership change, the SRLY limitation does not apply to losses subject to § 382. (Treas. Reg. § 1.1502-21(g)) An overlap occurs when 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 § 382(a) limitation (the § 382 event). When both limitations would apply, only § 382 limits the use of the loss. The more restrictive rule controls. This overlap rule was added in 1999 to eliminate the complexity of computing two separate limitations in the vast majority of acquisitions where both would apply. (T.D. 8823, 64 FR 36092 (July 2, 1999))
• Coextensive subgroup requirement. The overlap rule applies only if the SRLY subgroup and the § 382 loss subgroup are coextensive. All members of the SRLY subgroup must also be in the loss subgroup, and vice versa. (Treas. Reg. § 1.1502-21(g)(4)) If the subgroup structures differ, both limitations apply independently.
• Timing rules for overlap application. If the SRLY event occurs before the § 382 event, the overlap rule applies starting with the first tax year that begins after the § 382 event (not immediately). (Treas. Reg. § 1.1502-21(g)(3)(ii)) If the § 382 event occurs before the SRLY event, the overlap rule applies beginning with the tax year that includes the SRLY event. (Treas. Reg. § 1.1502-21(g)(3)(i))
• Interim losses during the overlap period. If the SRLY event occurs within six months after the § 382 event, an overlap is also treated as occurring with respect to NOLs that arise between the § 382 event and the SRLY event. (Treas. Reg. § 1.1502-21(g)(2)(ii)(B)) This interim loss rule prevents NOLs generated between the two events from falling into a gap where neither limitation applies.
• Successor income exclusion from SRLY subgroups. If a successor's items of income and gain exceed its items of deduction and loss (net positive income), the net positive income attributable to the successor is excluded from the computation of the consolidated taxable income of a SRLY subgroup, unless specified exceptions apply. (Treas. Reg. § 1.1502-21(f)(2)) Exceptions include (A) the successor acquires substantially all the assets and liabilities of its predecessor and the predecessor ceases to exist. (B) The successor was a member of the SRLY subgroup when the SRLY subgroup members became members of the group. (C) 100% of the stock of the successor is owned directly by corporations that were members of the SRLY subgroup when the SRLY subgroup members became members of the group. (D) The Commissioner so determines.
• CAUTION. Built-in losses subject to SRLY limitation. Built-in losses are subject to the SRLY limitation under § 1.1502-15. A built-in loss is treated as a hypothetical NOL carryover arising in a SRLY solely for purposes of determining the SRLY limitation. For all other purposes, it remains a deduction in the year recognized. To the extent a built-in loss exceeds the SRLY limitation in the year recognized, it is treated as a separate NOL arising in that year (which is itself a SRLY). (Treas. Reg. § 1.1502-15(a)) The definition of net unrealized built-in loss is modified from the § 382(h)(3) definition by (1) disregarding subsidiary stock for the NUBIL computation and (2) treating all unrealized losses (not just net losses) as built-in if recognized within the 5-year recognition period. (Treas. Reg. § 1.1502-15(b))

Step 15C. Departing Member Rules

• Apportionment of CNOL carryovers to departing members. When a member departs the group, any unabsorbed CNOL carryovers are apportioned to the departing member based on the percentage of the CNOL attributable to that member. (Treas. Reg. § 1.1502-21(b)(2)(iv)) The departing member takes its attributable portion to its separate return years.
• Anti-duplication rule. An apportioned loss carried to a separate return year may not also be carried to an equivalent consolidated return year. If carried over to a separate return year, the apportioned loss may not be carried over to an equivalent or later consolidated 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. (Treas. Reg. § 1.1502-21(b)(2)(i)) This prevents the same loss from offsetting income at both the separate and consolidated levels.
• Priority of utilization for departing members. Departing member losses are subject to a strict priority of utilization. First, the group absorbs the losses in the year of departure. Second, the losses are reduced under § 108 and § 1.1502-28 (discharge of indebtedness income excluded from gross income). Third, the losses are reduced under § 1.1502-36 (transfers of loss shares of subsidiary stock). Only the amount that survives all three reductions may be carried to the corporation's first separate return year. (Treas. Reg. § 1.1502-21(b)(2)(ii)(A))
• The offspring rule. A member that has been a member of the group continuously since its organization (determined without regard to whether the member is a successor to any other corporation) may carry back its attributable portion of a CNOL to consolidated return years that predate the member's existence. (Treas. Reg. § 1.1502-21(b)(2)(ii)(B)) This prevents the formation of a new subsidiary from creating a dead zone for loss carryback purposes.
• TRAP. Careful tracking required. Groups must maintain detailed records of each member's contribution to CNOLs and the cumulative register for each SRLY member. Without this tracking, the group cannot prove compliance upon IRS examination. SRLY registers, apportionment percentages, and overlap determinations should be documented contemporaneously, not reconstructed at audit. In Wolter Constr. Co. v. Commissioner, 634 F.2d 1029 (6th Cir. 1980), the Sixth Circuit affirmed the Tax Court and held that a subsidiary's pre-affiliation NOLs were deductible only against the subsidiary's own income in consolidated years. Because the subsidiary had no income, no portion of its pre-affiliation NOLs could reduce the parent's taxable income on the consolidated returns. This case established the foundational principle underlying the SRLY regime.

Step 16. Acquiring Corporation Attributes Under § 381

"Where a corporation acquires the assets of another corporation in a distribution in complete liquidation described in section 332, or in a transfer described in section 361 (relating to certain reorganizations), the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in subsection (c) of the transferor or distributor corporation." (IRC § 381(a))

• Transactions triggering § 381. § 381 applies in three categories of transactions. First, a complete liquidation of a subsidiary under § 332 (parent-subsidiary liquidation). (§ 381(a)(1)) Second, a reorganization described in § 368(a)(1)(A) (statutory merger), (C) (acquisition of assets for stock), (D) (nondivisive, satisfying § 354(b)(1) requirements), or (F) (mere change in identity, form, or place of organization). (§ 381(a)(2). See Treas. Reg. § 1.381(a)-1(b)(1)(i)-(iv)) Third, certain transfers under § 361. (§ 381(a)(2))
• Transactions that do NOT trigger § 381. B reorganizations (stock-for-stock exchanges) do NOT qualify for § 381 because there is no transfer of assets. The target remains in existence with its own attributes. (Treas. Reg. § 1.381(a)-1(b)(1)) Divisive D reorganizations (spin-offs under § 355) also do NOT qualify. Partial liquidations and G reorganizations that are not acquisitive do NOT qualify. (Treas. Reg. § 1.381(a)-1(b)(3))
• Only one acquiring corporation. Only a single corporation may be the acquiring corporation for purposes of § 381. It is the corporation that directly acquires the assets transferred by the transferor corporation, even if that corporation ultimately retains none of the assets so transferred. (Treas. Reg. § 1.381(a)-1(b)(2)(i) (T.D. 9700, 79 FR 66617 (Nov. 10, 2014))) The 2014 amendment fixed the acquiring corporation as the direct transferee to reduce electivity and administrative burden.
• NOL carryovers under § 381(c)(1)(A). The acquiring corporation succeeds to the transferor's NOL carryovers. The acquiring corporation is entitled to carry over NOLs to the first taxable year ending after the transaction date and to subsequent taxable years. (Treas. Reg. § 1.381(c)(1)-1(a)(1)) The carryover period continues to run from the year the loss was incurred by the transferor. No new 20-year (or indefinite) period begins.
• Acquisition-year limitation on NOL deduction. In the taxable year that includes the transaction date, the NOL deduction from the transferor's losses cannot exceed the taxable income of the acquiring corporation (computed without NOL deduction) multiplied by the fraction of the number of days after the transaction date divided by the total days in the taxable year. (§ 381(c)(1)(B)) This acquisition-year limitation is computed by daily proration. There is no closing-of-the-books option. The full amount of available carryovers is taken over, even if less than 100% of assets were acquired. (Treas. Reg. § 1.381(c)(1)-1(c)(2))
• Carryback restriction under § 381(b)(2). § 381(b)(2) prevents the acquiring corporation from carrying back its post-acquisition losses to the transferor's pre-transfer taxable years, except in an F reorganization. The transferor corporation may still carry back its own pre-transaction losses to its own prior years. In a D reorganization, the transferor's taxable year ends on the date of transfer, which further limits the items that can carry over. (§ 381(b)(2)-(3))
• § 381 does NOT override § 382. An NOL that carries over under § 381 remains subject to any § 382 limitation triggered by the acquisition. (§ 382(g). See Treas. Reg. § 1.381(a)-1(a)) The practitioner must analyze both provisions simultaneously. § 381 determines WHICH corporation holds the NOL. § 382 determines HOW MUCH can be used. Treas. Reg. § 1.381(a)-1(a) explicitly states that carryovers are subject to "the conditions and limitations specified in sections 381, 382(b), and 383." The § 382 limitation is computed separately and may be more restrictive than the § 381 limitation.
• FIFO ordering of NOL deductions. NOLs are deducted in the order of the taxable years in which the losses were sustained, beginning with the earliest taxable year. (Treas. Reg. § 1.381(c)(1)-1(e)) When both the acquiring corporation and the transferor have NOLs, each corporation's NOLs maintain their separate identity, and within each group the earliest-year losses are used first.
• Multiple acquisitions in the same taxable year. If the acquiring corporation acquires assets from two or more transferor corporations on the same date, the aggregate NOL carryovers from all transferors are available subject to the § 381(c)(1)(B) limitation based on the post-acquisition income for the entire period. (Treas. Reg. § 1.381(c)(1)-2(a)) If acquisitions occur on different dates during the same taxable year, separate post-acquisition periods must be computed and the NOL carryovers from each transferor are applied against the income of the respective post-acquisition period. (Treas. Reg. § 1.381(c)(1)-2(b)) This prevents an acquiring corporation from using NOLs from a later acquisition to offset income from an earlier acquisition period.
• Successive acquisitions and attribute chaining. § 381 carryover chains can extend through multiple acquisitions. An acquiring corporation that previously acquired attributes in a § 381(a) transaction can itself transfer those attributes (including any acquired from prior transferors) in a subsequent § 381(a) transaction. (Treas. Reg. § 1.381(c)(1)-1(g)) The successor gets not only the immediate transferor's attributes but also any attributes that transferor had previously acquired from earlier predecessors.
• Other § 381(c) carryover attributes. § 381(c) lists 29 categories of carryover items. Among the most significant for practitioners are § 381(c)(2) (earnings and profits, including deficits), § 381(c)(3) (capital loss carryovers, subject to the same acquisition-year fraction limitation as NOLs), § 381(c)(4) (methods of accounting, with a "principal method" rule when parties used different methods), § 381(c)(5) (inventory methods, including LIFO layers), § 381(c)(6) (depreciation and amortization methods under §§ 167 and 168), § 381(c)(20) (disallowed business interest carryforwards under § 163(j), added by the TCJA), § 381(c)(24) (business credits under § 38), and § 381(c)(25) (minimum tax credits under § 53). (§ 381(c)(1) through (c)(29))
• Ordering of attribute utilization. The acquiring corporation uses its own attributes first, then the transferor's attributes, subject to the applicable limitation rules (§ 382, SRLY, etc.). When multiple transferors' attributes are involved, the attributes of each transferor maintain their separate identity and ordering.
• Key case on § 381 integrity. In Commissioner v. Stern, 357 U.S. 39 (1958), the Supreme Court held that the tax benefit rule does not permit the IRS to recapture tax benefits from the transferor corporation when the acquiring corporation uses the transferred attributes. The Court confirmed the integrity of the § 381 carryover mechanism. The transferor's attributes pass cleanly to the acquirer and the IRS cannot reach back to recapture benefits from the transferor.
• Continuity of business enterprise principle. The principle that attribute carryovers require continuity of business enterprise traces to Libson Shops, Inc. v. Koehler, 353 U.S. 313 (1957), in which the Supreme Court held that NOL carryovers are permitted only when the taxpayer claiming the deduction is essentially the same business entity that sustained the losses. The Court required a tracing of the business operations that generated the losses to the business operations that generated the income against which the losses were sought to be offset. This principle is now codified in the COBE requirement of § 382(c).
• CAUTION. Attributes not listed in § 381(c). Attributes not listed in § 381(c) generally do not carry over under § 381 itself, though they may carry over under other theories. The Senate Report accompanying the 1954 Code states that the section is not intended to affect the carryover treatment of items not specified therein. (S. Rep. No. 1622, 83d Cong., 2d Sess. 277 (1954)) In CCA 201605018 (Jan. 29, 2016), the IRS ruled that TARP status, while not listed in § 381(c), could be treated as a carryover attribute because it was analogous to listed attributes. Treas. Reg. § 1.381(a)-1(b)(3) states that "no inference is to be drawn" when an attribute is not listed. But practitioners should be cautious about claiming carryovers for unlisted attributes without specific authority.
• TRAP. Confirm transaction characterization before claiming carryover. The practitioner must confirm that the transaction actually qualifies as a § 381(a) transaction before assuming attributes carry over. A transaction reported as a C reorganization that is later recharacterized as a B reorganization will not qualify for § 381 because a B reorganization involves no asset transfer. Similarly, a transaction reported under § 332 that is recharacterized as a § 338(h)(10) deemed asset sale will not trigger § 381. The characterization determination should be documented before attribute carryover is claimed. In Russell v. Commissioner, 832 F.2d 349 (6th Cir. 1987), the taxpayers attempted to structure a transaction as a reorganization to allow carryback of post-acquisition NOLs. The Tax Court and Sixth Circuit held the transaction was a § 332 liquidation to which § 334(b)(2) applied, not a reorganization. Under § 381(b)(2), the acquiring corporation could not carry back its NOLs to the transferor's taxable years because the transaction was not an F reorganization.

Step 17. Elections, Quick Refunds, and Procedural Requirements

Step 17A. The Carryback Waiver Election

"Any taxpayer entitled to a carryback period under paragraph (1) may elect to relinquish the entire carryback period with respect to a net operating loss for any taxable year. Such election shall be made in such manner as may be prescribed by the Secretary, and shall be made by the due date (including extensions of time) for filing the taxpayer's return for the taxable year of the net operating loss for which the election is to be in effect. Such election, once made for any taxable year, shall be irrevocable for such taxable year." (IRC § 172(b)(3))

• Election mechanics for individuals, estates, and trusts. Attach a statement to the original return filed by the due date (including extensions) for the NOL year. The statement must show that the taxpayer is choosing to waive the carryback period under section 172(b). (Instructions for Form 172 (Rev. December 2024))
• Late election relief under § 301.9100-2. If the original return was filed on time without the election, the taxpayer may make the election on an amended return filed within 6 months of the due date (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the statement. (Treas. Reg. § 301.9100-2)
• Corporate election procedure. Corporations may make the election by (1) checking the box on Form 1120, Schedule K, line 11 (or the comparable line of the corporation's income tax return), and (2) filing the return by its due date including extensions. In this case, do not attach the statement described in Temporary Regulations section 301.9100-12T. (Instructions for Form 1139 (Rev. December 2025))
• Late corporate election. If the corporation timely filed its return for the loss year without making the election, it can make the election on an amended return filed within 6 months of the due date of the loss year return (excluding extensions). Attach the election to the amended return and write "Filed pursuant to section 301.9100-2" on the election statement. (Instructions for Form 1139 (Rev. December 2025))
• Consolidated group additional requirement. Corporations filing a consolidated return that elect to waive the entire carryback period for the group must also attach the statement required by Regulations section 1.1502-21(b)(3) or the election will not be valid. (Instructions for Form 1139 (Rev. December 2025))
• Irrevocability of the election. The election is irrevocable once made for any taxable year. (§ 172(b)(3)) The election cannot be changed even if the taxpayer later discovers the carryback would have produced a larger refund than the carryforward.
• CAUTION. Model both carryback and carryforward scenarios before making the election. Once waived, the carryback period is permanently lost. The election applies to the entire carryback period unless the taxpayer has separate NOL components.
• Separate elections for separate NOL components. Under Apache Corp. v. Commissioner, 165 T.C. No. 11 (2025), different elections may be made for different components of an NOL. The Tax Court held that a taxpayer's election under § 172(b)(3) relinquished the carryback of only the portion of the NOL that exceeded the reported specified liability loss. The SLL component retained its separate 10-year carryback.
• Treas. Reg. § 1.172-13(c)(4) confirms this result. "If a taxpayer sustains during the taxable year both a net operating loss not attributable to product liability and a product liability loss, an election pursuant to section 172(b)(3) does not preclude the product liability loss from being carried back 10 years."
• Carryback waiver for SLL components under § 172(f)(6). A taxpayer entitled to a 10-year SLL carryback may separately elect under § 172(f)(6) to have the carryback period determined without regard to the 10-year SLL period. This election is also irrevocable. (§ 172(f)(6))
• Revocation exceptions (rare). The election is generally irrevocable. Exceptions arise only in specific statutory circumstances.
• When new legislation specifically allows revocation (e.g., ARRA 2009, § 1211 allowed revocation until April 17, 2009).
• A bankruptcy trustee may revoke a valid election.
• Rev. Proc. 2020-24, section 4.04 allowed taxpayers to revoke a prior election for NOLs sustained in a taxable year beginning before 2018 and ending after 2017 (fiscal year 2018 returns) if the revocation was filed no later than July 27, 2020.
• A taxpayer may revoke on a superseding return filed before the original due date. (IRM 21.5.9)

Step 17B. Quick Refund Claims

"The Commissioner shall act upon any application for a tentative carryback adjustment filed under section 6411(a) within a period of 90 days from whichever of the following two dates is the later (1) The date the application is filed; or (2) The last day of the month in which falls the last date prescribed by law (including any extension of time granted the taxpayer) for filing the return for the taxable year of the net operating loss." (Treas. Reg. § 1.6411-3(a))

• § 6411(a) tentative carryback adjustment as quick refund mechanism. Taxpayers may file for a quick refund using Form 1045 (individuals, estates, trusts) or Form 1139 (corporations). The IRS has 90 days to act on the application. (§ 6411(a)) (Treas. Reg. § 1.6411-3(a))
• Form 1045 for individuals, estates, and trusts. Form 1045 is used to apply for a quick tax refund resulting from the carryback of an NOL, the carryback of an unused general business credit, the carryback of a net section 1256 contracts loss, or an overpayment due to a claim of right adjustment under § 1341(b)(1). (Instructions for Form 1045 (2024))
• Form 1045 filing deadline. Form 1045 must be filed on or after the date the tax return for the NOL year is filed, but not later than 1 year after the end of the NOL year. (Instructions for Form 1045 (2024))
• Form 1139 for corporations. A corporation (other than an S corporation) files Form 1139 to apply for a quick refund from the carryback of an NOL, a net capital loss, an unused general business credit, or a claim of right adjustment under § 1341(b)(1). (Instructions for Form 1139 (Rev. December 2025))
• Form 1139 filing deadline. The corporation must file Form 1139 within 12 months of the end of the tax year in which the NOL arose. The corporation must file its income tax return for the tax year no later than the date it files Form 1139. (Instructions for Form 1139 (Rev. December 2025))
• A § 6411 application is NOT a claim for credit or refund. Per IRM 21.5.9.5.16.6, "An application for tentative refund filed on Form 1045 and Form 1139 is not treated as a claim for credit or refund. It may be rejected, in whole or in part, if there are any material omissions, math errors that cannot be corrected within the 90-day period. If the application is rejected in whole or in part, no suit challenging the rejection may be brought in any court."
• No appeal rights for rejected applications. The taxpayer does not have appeal rights under law for any rejected or unprocessed tentative refund application. (IRM 21.5.9)
• If rejected, file a formal claim for refund. If the taxpayer timely files a Form 1045 or Form 1139 and the application is rejected or not processed for any reason, the taxpayer must file a claim for credit or refund using Form 1040-X, Form 1041, or Form 1120-X on or before the period of limitations for credit or refund expires. (IRM 21.5.9)
• CAUTION. Filing a Form 1139 or Form 1045 does not extend the statute of limitations for the carryback year. If the application is rejected and the normal limitations period has expired, the formal refund claim will be barred. (§ 6411(b))
• Immediate assessment of excess refund. If the IRS refunds or credits an amount from Form 1045 or Form 1139 and later determines the refund or credit is too much, the IRS may assess and collect the excess immediately as if it were due to a math or clerical error on the return. (Instructions for Form 172) (Instructions for Form 1139 (Rev. December 2025))
• Form 1045 vs. Form 1040-X key differences.
• Speed. Form 1045 provides a faster refund (90-day statutory processing window) but is not a formal claim for refund. Form 1040-X takes longer but is a formal claim with full judicial review rights.
• Filing deadline. Form 1045 must be filed within 1 year after the end of the NOL year. Form 1040-X must be filed within 3 years after the due date (including extensions) of the return for the loss year under § 6511(d)(2)(A).
• Scope. Form 1045 can apply an NOL to all carryback years on one form. Form 1040-X requires a separate form for each carryback year.
• Suit rights. A disallowed Form 1045 requires a subsequent formal claim. A disallowed Form 1040-X supports direct suit for refund.
• When Form 1040-X is required instead of Form 1045. An individual must file Form 1040-X (not Form 1045) to carry back to any of the following. (Instructions for Form 1040-X (Rev. December 2025))
• Any items to a § 965 year.
• A prior year foreign tax credit released due to an NOL or net capital loss carryback.
• A prior year general business credit released because of the release of the foreign tax credit.
• Amended return procedures for estates and trusts. Estates and trusts that do not file Form 1045 must file an amended Form 1041 (instead of Form 1040-X) for each carryback year to which NOLs are applied. Use a copy of the appropriate year's Form 1041, check the Net operating loss carryback box, and follow the Form 1041 instructions for amended returns. (Instructions for Form 172 (Rev. December 2024))
• § 6511(d)(2)(A) extended limitations period for NOL carryback refund claims. If the claim for credit or refund relates to an overpayment attributable to an NOL carryback, the limitations period is 3 years after the time prescribed by law for filing the return (including extensions) for the taxable year of the NOL, or the period under § 6511(c) for the loss year, whichever expires later. This replaces the normal 3-year period from the filing of the carryback year return. (§ 6511(d)(2)(A))
• Assessment statute extension under § 6501(h). A deficiency in the carryback year attributable to an NOL carryback may be assessed at any time before the expiration of the assessment statute for the loss year. In effect, the assessment statute for the carryback year is extended to match the assessment statute expiration date of the loss year. (§ 6501(h)) (Treas. Reg. § 301.6501(h)-1)
• § 6501(h) applies only to deficiencies attributable to the NOL carryback. It does not extend the assessment statute for unrelated deficiencies in the carryback year. (PMTA 2010-054)
• § 6501(k) tentative carryback assessment extension. If an NOL carryback results in a tentative carryback allowance under § 6411, the assessment statute for the carryback year is extended to include the applicable period in § 6501(h). The amount that may be assessed is limited to the carryback amount tentatively allowed less any amount already assessed under § 6501(h). Under § 6501(k), the IRS can also assess deficiencies unrelated to the NOL carryback, but the total assessable amount cannot exceed the tentative carryback refund amount. (§ 6501(k)) (PMTA 2010-054)
• CARES Act special timing for 2018 and 2019 fiscal year taxpayers. For NOLs arising in a taxable year beginning during calendar year 2018 and ending on or before June 30, 2019, the IRS granted a six-month extension to file Form 1045 or Form 1139 under Notice 2020-26. The form had to include "Notice 2020-26, Extension of Time to File Application for Tentative Carryback Adjustment" on top.

Step 17C. The § 965 Year Exclusion Election

"If the 5-year carryback period under clause (i)(I) with respect to any net operating loss of a taxpayer includes 1 or more taxable years in which an amount is includible in gross income by reason of section 965(a), the taxpayer may, in lieu of the election otherwise available under paragraph (3), elect under such paragraph to exclude all such taxable years from such carryback period." (IRC § 172(b)(1)(D)(v)(I))

• Election to exclude § 965 years from the 5-year carryback. For NOLs arising in 2018, 2019, or 2020, taxpayers could elect under § 172(b)(1)(D)(v)(I) to exclude all taxable years in which a § 965(a) inclusion was recognized from the carryback period. The election applies to all § 965 years within the carryback period. It cannot exclude only some § 965 years. (Rev. Proc. 2020-24, § 4.01)
• How to make the election. A taxpayer makes the election by attaching an election statement to the earliest filed of (1) the federal income tax return for the taxable year in which the NOL arises, (2) a Form 1139 or Form 1045 applying the NOL to a carryback year, or (3) an amended federal income tax return applying the NOL to the earliest carryback year that is not a § 965 year. (Rev. Proc. 2020-24, § 4.01(2))
• Required election statement content. The election statement must state that the taxpayer is electing to apply § 172(b)(1)(D)(v)(I) under Rev. Proc. 2020-24, identify the taxable year in which the NOL arose, and list the § 965 years. Once made, the election is irrevocable. (Rev. Proc. 2020-24, § 4.01(2)(c))
• Timing for 2018 and 2019 losses. For NOLs arising in taxable years beginning in 2018 or 2019, the election was due by the due date (including extensions) for filing the federal income tax return for the first taxable year ending after March 27, 2020. (Rev. Proc. 2020-24, § 4.01) (IRS FAQs on Carrybacks of NOLs for Taxpayers with § 965 Inclusions)
• Timing for 2020 losses. For NOLs arising in taxable years beginning in 2020, the election was due by the due date (including extensions) for filing the federal income tax return for the taxable year in which the NOL arises. (Rev. Proc. 2020-24, § 4.01) (IRS FAQs)
• Deemed § 965(n) election if carryback proceeds to a § 965 year without exclusion. If a taxpayer carries back an NOL to a § 965 year without making the exclusion election, the taxpayer is deemed to have made a § 965(n) election. This election limits the amount of the loss that can be carried back to each § 965 year. An NOL can be carried back only to reduce income in excess of the amount of the § 965(a) inclusion net of the § 965(c) deduction. (§ 172(b)(1)(D)(iv)) (IRS FAQs on Carrybacks of NOLs for Taxpayers with § 965 Inclusions)
• CAUTION. If the taxpayer has § 965 years within the carryback period, model both scenarios (excluding § 965 years vs. carrying back subject to the deemed § 965(n) limitation) to determine which produces the better result. The § 965 year exclusion and the § 965(n) deemed election have different computational effects.
• Interaction with the general carryback waiver under § 172(b)(3). A taxpayer may make both the § 965 year exclusion election under § 172(b)(1)(D)(v)(I) and the general carryback waiver election under § 172(b)(3). The elections are independent. (Rev. Proc. 2020-24, § 4.01)

Step 18. Documentation, Reporting, and State Tax Conformity

Step 18A. IRS Forms and Reporting

• Form 172 for individuals, estates, and trusts. For tax years beginning after 2023, individuals, estates, and trusts must use Form 172, Net Operating Losses (NOLs), to compute net operating loss carryovers. The form was created for taxpayers (other than corporations) to figure the amount of NOL available to carry back or carry forward. It provides a structured computation of NOLs, carryovers, and the 80 percent limitation. Attach Form 172 to Form 1040 or Form 1041 when claiming an NOL deduction. (Instructions for Form 172 (Rev. December 2024))
• Form 172 Part I (NOL computation). Part I computes the current year NOL by adjusting taxable income for nonbusiness deductions, capital losses, and other items. Line 24 reports the final NOL amount (if negative, that is the NOL. if zero or more, no NOL exists). (Instructions for Form 172 (Rev. December 2024))
• Form 172 Part II (NOL carryover). Part II computes the NOL deduction for carryback years and the carryover to subsequent years. It requires computation of modified taxable income with adjustments for net capital loss deduction, § 1202 exclusion, QBI deduction, AGI-based item adjustments, and itemized deduction adjustments. (Instructions for Form 172 (Rev. December 2024))
• Form 172 limitation for § 965 years. Individuals, estates, and trusts that carry NOLs back to years in which they have a § 965(a) inclusion may not use Form 172. They must use an amended return to carry back to such years. (Instructions for Form 172 (Rev. December 2024))
• Form 172 integration with Form 461 (excess business loss). Form 172 includes a worksheet to integrate with Form 461. The worksheet combines the Form 172 line 33 amount, any portion carried back and used, and the total excess business loss from Form 461 to compute the NOL to carry over to the next tax year. (Instructions for Form 172 (Rev. December 2024))
• Form 1139 for corporate quick refunds. Corporations (other than S corporations) use Form 1139 to apply for a quick refund from NOL carrybacks. The form must generally be filed within 12 months of the end of the tax year in which the NOL arose. (Instructions for Form 1139 (Rev. December 2025))
• Form 1139 reporting of the 80 percent limitation. For tax years beginning after December 31, 2020, the NOL deduction reported on Form 1139 cannot exceed the aggregate amount of pre-2018 NOLs carried to the year plus the lesser of (1) the aggregate post-2017 NOLs carried to the year, or (2) 80 percent of taxable income computed without any NOL deduction, § 199A deduction, or § 250 deduction, over any pre-2018 NOL carryover. (Instructions for Form 1139 (Rev. December 2025))
• Form 1045 for individual, estate, and trust quick refunds. Form 1045 is used to apply for a quick tax refund from NOL carrybacks, unused general business credit carrybacks, net § 1256 contracts loss carrybacks, or claim of right adjustments under § 1341(b)(1). It must be filed on or after the date the NOL year return is filed, but not later than 1 year after the end of the NOL year. (Instructions for Form 1045 (2024))
• Form 461 for excess business losses. Noncorporate taxpayers compute their excess business loss on Form 461. § 461(l) limits the amount of losses from trades or businesses that noncorporate taxpayers can claim each year. Excess business losses disallowed are treated as an NOL carryover to the following taxable year. For 2025, the threshold is $313,000 ($626,000 for joint returns). The One Big Beautiful Bill Act (P.L. 119-21) permanently extended the disallowance of excess business loss deductions. (Form 461 (2025)) (Instructions for Form 461 (2025))
• Schedule K-1 reporting for pass-through entities. Partnerships and S corporations do not claim NOL deductions at the entity level. Schedule K-1 reports each partner or shareholder's allocable share of business income and loss. The partner or shareholder combines these items with their other income and deductions to determine whether they have an individual NOL. Key K-1 boxes include Box 1 (ordinary business income or loss), Box 2 (net rental real estate income or loss), Box 8 (net short-term capital gain or loss), Box 9a (net long-term capital gain or loss), Box 10 (net § 1231 gain or loss), and Box 13 (§ 179 deduction). (Instructions for Form 1065 (2025)) (Partner's Instructions for Schedule K-1 (Form 1065) (2025))
• TRAP. The partnership or S corporation does not separately report an "NOL" on Schedule K-1. The partner or shareholder must apply § 461(l) at their individual level after taking into account basis, at-risk, and passive activity limitations.
• Consolidated Form 1120 for CNOLs. Consolidated groups report consolidated net operating losses on the consolidated Form 1120 and attach the CNOL computation. Each subsidiary's separate taxable income and NOL contribution must be documented. The group must also track SRLY limitations and § 382 limitations at the subsidiary level. (Treas. Reg. § 1.1502-21)
• Required statement and schedule for NOL deductions. Regardless of whether an NOL deduction is attributable to a carryback or carryover, a taxpayer must provide a statement regarding the deduction and a detailed schedule showing the computation of the deduction. The statement should identify the loss year, the amount of the NOL, and how it was computed.

Step 18B. Recordkeeping and Substantiation

• Three-year retention rule for NOL records. Taxpayers must keep records for any tax year that generates an NOL for 3 years after the later of (i) the expiration of the carryforward period, or (ii) the year in which the NOL is fully used. (Instructions for Form 172 (Rev. December 2024)) For post-2017 NOLs with indefinite carryforwards, this effectively means permanent retention until the NOL is fully absorbed plus 3 years.
• Items to retain (NOL year). (1) The original NOL year tax return, (2) Form 172 or equivalent worksheets showing the § 172(d) modification computations, (3) supporting documentation for all income and deduction items that created the NOL, (4) business income and expense records, (5) capital gain and loss transaction records, and (6) nonbusiness income and deduction documentation.
• Items to retain (carryback and carryforward years). (1) Each amended return filed to claim carryback refunds (Form 1040-X, Form 1041, or Form 1120-X), (2) Form 1045 or Form 1139 filings if applicable, (3) carryback and carryforward year returns showing NOL absorption year by year, (4) modified taxable income computations for each carryback year, and (5) remaining carryforward balance schedules.
• Items to retain (elections and special limitations). (1) Documentation of all elections made (carryback waiver statements, § 965 year exclusion election statements, SLL elections), (2) § 382 ownership change studies and annual limitation computations, (3) COBE compliance documentation, (4) SRLY register calculations for consolidated groups, and (5) basis calculations for partnership and S corporation interests.
• Contemporaneous documentation requirement. § 382 studies should be prepared at the time of the ownership change, not retroactively. COBE compliance should be documented contemporaneously. Reconstructed records years after the fact may be challenged by the IRS on audit. (Treas. Reg. § 1.382-2T(a)(2)(ii))
• § 382 information statements. Treas. Reg. § 1.382-2T(a)(2)(ii) requires information statements to be filed for any owner shift, equity structure shift, or other transaction. The common parent of a loss group must file information statements with respect to the common parent and any subsidiary stock. Loss corporations must maintain records necessary to determine if they have undergone an ownership change. (Treas. Reg. § 1.382-2T(a)(2)(ii))
• Wisconsin recordkeeping guidance as best practice standard. Wisconsin requires taxpayers to keep accurate records showing (1) the amount of Wisconsin NOL for each loss year, (2) the amount of Wisconsin NOL used in each year to which it is carried, and (3) the amount of Wisconsin NOL remaining to be carried forward. (Wis. DOR Publication 120 (Jan. 2026)) This three-part tracking system should be applied to both federal and state NOLs.
• CAUTION. For multi-year NOL carryovers, maintain a running register that tracks the origin year, original NOL amount, amount used each year, and remaining balance. Update this register annually. Do not rely on tax preparation software reports alone.

Step 18C. State Tax Conformity

• Full federal conformity states. Most states with corporate income taxes start with federal taxable income and thus conform to federal NOL rules. Nineteen states and the District of Columbia use rolling conformity and automatically adopt the current version of the IRC, including the 80 percent taxable income limitation, unlimited carryforward period, and prohibition on carrybacks (with exceptions for farming and insurance). Rolling conformity states include Iowa, Kansas, Louisiana, Massachusetts, North Dakota, and Nebraska. (COST State IRC Conformity Chart) (Tax Foundation, "State Net Operating Loss Provisions" (Jan. 13, 2022))
• Fixed-date (static) conformity states. States with fixed-date conformity adopt the IRC as of a specific date and must proactively update their conformity date. Kentucky conforms to the IRC as of December 31, 2024. Maine conforms as of December 31, 2024. Maryland conforms as of December 31, 2024 and automatically decouples from any federal law change with state revenue impact exceeding $5 million. Wisconsin conforms to the IRC as of December 31, 2022, subject to specific exceptions. States with static conformity as of a date before the TCJA may still follow pre-TCJA rules (20-year carryforward, 100 percent offset, 2-year carryback) depending on when they last updated. (COST State IRC Conformity Chart) (Tax Foundation)
• Selective conformity and decoupling. Many states adopt a hybrid approach, conforming to the general IRC framework but decoupling from specific federal NOL provisions. Thirteen states do not conform to the federal provisions because they limit carryforward years to 20 and impose no cap on loss deduction. Twelve states restrict carryforwards below the 20-year threshold. (Tax Foundation, "State Net Operating Loss Provisions" (Jan. 13, 2022))
• States allowing carrybacks despite federal prohibition. Five states continue to allow carrybacks for post-2020 losses.
• Idaho permits up to $100,000 of losses to be carried back up to 2 years.
• Mississippi allows unlimited losses to offset up to 2 previous years of tax liability.
• Missouri allows unlimited losses to offset up to 2 previous years of tax liability.
• New York allows unlimited losses to be carried back to any tax liability in the previous 3 years (but no loss can be carried back to a taxable year beginning before January 1, 2015).
• Montana uses a 3-year carryback rule but only allows $500,000 of losses to be applied over that time. (Tax Foundation, "State Net Operating Loss Provisions" (2022))
• California NOL suspension for 2024 through 2026. California suspended the NOL deduction for taxable years 2024 through 2026 for taxpayers with net income of $1 million or more. Both corporations and individuals may continue to compute and carry over an NOL during the suspension period. The suspension does not apply if the taxpayer has net business income or modified adjusted gross income of less than $1 million for individuals, or if corporate income subject to California taxation is less than $1 million. (Cal. Rev. & Tax. Code §§ 17276.23, 24416.23) (FTB.ca.gov, "Net Operating Loss" (updated Dec. 2025))
• TRAP. California's suspension applies even if the taxpayer has no federal tax liability after applying federal NOLs. The $1 million threshold is based on California net income computed before NOLs. Do not assume that a taxpayer with zero federal taxable income after federal NOLs is exempt from the California suspension.
• California NOL carryover period extension. The NOL carryover period is extended for each year the deduction is suspended. Losses incurred before January 1, 2024 receive a 3-year extension. Losses incurred in taxable years beginning on or after January 1, 2024 and before January 1, 2025 receive a 2-year extension. Losses incurred in taxable years beginning on or after January 1, 2025 and before January 1, 2026 receive a 1-year extension. Disaster loss carryovers are not affected. (Cal. Rev. & Tax. Code §§ 17276.23, 24416.23)
• California 20-year carryforward and other key differences. California limits NOL carryovers to 20 years (not indefinite). California does not have an 80 percent of taxable income limitation. California does not conform to the CARES Act 5-year carryback for post-2017 losses. California has a corporation franchise alternative minimum tax, so California may require the computation of an alternative tax net operating loss (ATNOL). (Cal. Rev. & Tax. Code §§ 17276, 24416) (Spidell, "Net Operating Losses" (2023))
• California carryback history. California allowed a 2-year carryback for NOLs incurred during taxable years 2013 through 2018, but eliminated carrybacks beginning with the 2019 taxable year. California previously suspended NOL deductions for taxable years 2020 and 2021 as well. (Cal. Rev. & Tax. Code §§ 17276.21, 24416.21)
• New York 3-year carryback and 20-year carryforward. New York permits a 3-year carryback for NOLs (the most generous among states), but no loss can be carried back to a taxable year beginning before January 1, 2015. The loss is first carried to the earliest of the 3 taxable years. Any unused amount may be carried forward for 20 taxable years. The maximum NOL deduction is the amount that reduces the tax on the apportioned business income base to the higher of the tax on the capital base or the fixed dollar minimum. A taxpayer may elect to waive the entire carryback period on the original timely filed return, and the election is irrevocable. (N.Y. Tax Law § 210(9)(ix)(4)) (20 NYCRR § 3-9.3)
• New York S corporation and consolidated return rules. The New York NOL deduction does not include any NOL incurred during a New York S year. However, a New York S year must be treated as a taxable year for purposes of determining the number of taxable years to which an NOL may be carried. A taxpayer that files as part of a federal consolidated return but on a separate basis for New York purposes must compute its NOL deduction as if it were filing on a separate basis for federal income tax purposes. (N.Y. Tax Law § 210(9)(ix))
• No-NOL states (gross receipts tax states). Texas and Nevada do not have a corporate income tax. Texas imposes a franchise tax based on taxable margin (revenue minus certain deductions). Nevada imposes a Commerce Tax based on gross revenue. Washington has a business and occupation tax based on gross receipts. Ohio imposes a Commercial Activity Tax based on gross receipts. NOLs have no relevance in these states because the taxes are not based on net income. (Bloomberg Tax) (Tax Foundation)
• Connecticut 30-year carryforward extension. Connecticut extended its NOL carryforward period from 20 years to 30 years for losses incurred in income years beginning on or after January 1, 2025. Connecticut is the first state to provide more than 20 years of carryforwards without an annual utilization limit. (Conn. Pub. Act 24-151 (H.B. 5524), effective June 6, 2024)
• Rhode Island 20-year carryforward extension. Rhode Island extended its NOL carryforward period from 5 years to 20 years for tax years beginning on or after January 1, 2025. Prior to this change, Rhode Island's 5-year carryforward was among the shortest in the nation. (R.I. Ch. 117 (H.B. 7225)) (The Tax Adviser, "States continue to tweak NOL provisions" (Feb. 28, 2025))
• Pennsylvania phased increase to 80 percent limitation. Pennsylvania previously limited NOL deductions to 40 percent of taxable income. Under S.B. 654, this percentage increases by 10 percent each year until it reaches 80 percent. The schedule is 40 percent for 2025, 50 percent for 2026, 60 percent for 2027, 70 percent for 2028, and 80 percent for 2029 and thereafter. For net losses incurred in a pre-2025 tax year, the deduction remains at 40 percent of taxable income. For net losses incurred in 2025 and after, the taxpayer applies the applicable percentage. (72 Pa. Stat. § 7402(b), as amended by S.B. 654 (signed July 11, 2024))
• Illinois 20-year carryforward with $500,000 annual cap. Illinois allows a 20-year carryforward (extended from 12 years in 2021) but caps the annual deduction at $500,000 for corporations for tax years ending on or after December 31, 2024 and before December 31, 2027. The cap was $100,000 for tax years ending on or after December 31, 2021 and before December 31, 2024. The limitation does not apply to S corporations, partnerships, estates, or fiduciaries. (Ill. Admin. Code 86 § 100.2330(b)) (P.A. 102-0665 (Nov. 16, 2021))
• Wisconsin 2-year carryback and 20-year carryforward. Wisconsin allows a 2-year carryback and 20-year carryforward for NOLs incurred in tax years beginning on or after January 1, 2014. Taxpayers can choose not to carry back an NOL and only carry it forward. An NOL may not be used to offset Wisconsin income unless the incurred loss was computed on a return filed within 4 years of the unextended due date. Wisconsin does not conform to the federal 80 percent limitation. (Wis. DOR Publication 120 (Jan. 2026))
• New Hampshire $10 million cap. New Hampshire limits the carryforward amount to $10 million, deductible over a maximum of 10 years. This makes New Hampshire one of only two states (with Pennsylvania) to set a dollar limit on NOL carryforwards. (Tax Foundation, "State Net Operating Loss Provisions" (2022))
• Practitioner workflow for multi-state taxpayers. For multi-state taxpayers, run a separate NOL computation for each state that does not fully conform to federal rules. Identify each state's IRC conformity date (rolling or fixed). Identify any specific decoupling provisions. Identify special rules for the taxpayer's industry. Track state NOLs separately from federal NOLs in a multi-jurisdiction register. Update the register whenever a state changes its conformity date or NOL rules.
• CAUTION. State conformity can change mid-year through legislation. A state that conformed to federal rules in January may decouple from a new federal provision by December. Monitor state legislative sessions for taxpayers with material state NOL positions.