Prevention of Double Deductions of a Single Loss: Solutions in Search of a Problem

Abstract:     
Congress has enacted several nonrecognition corporate provisions where changes are made to the form of ownership and where forcing the recognition of income could prevent those changes from taking place even though they would provide a more efficient and economically beneficial structure. One such provision is § 351 which provides nonrecognition treatment to shareholders who contribute property to a controlled corporation in exchange for corporate stock. When § 351 applies, the shareholder's basis in the corporate stock received and the corporation's basis in the contributed property are calculated to carry forward any realized but unrecognized gains or losses (subject to certain exceptions described in this article).

For example, assume A, an individual taxpayer, exchanges Blackacre, unimproved land, to X Corporation in a § 351 exchange for 100 shares of X Corporation stock. A's basis in Blackacre is $50,000 and the fair market value of the property is $20,000. Ignoring limitations, A's basis in the X Corporation stock received in the exchange would be the same basis that A had in Blackacre ($50,000); and X would also take a $50,000 basis in Blackacre.

It is not difficult to understand why some commentators and Congress view this example as abusive. A has used the corporate tax system to create two depreciated assets from one. That is, A took the depreciated asset Blackacre and, through a nonrecognition exchange with X, created the depreciated asset of X Corporation stock while also the corporation keeps Blackacre as a depreciated asset. A was able to create two tax losses (the loss that X will recognize when it sells Blackacre and the loss that A will recognize when he sells his X Corporation stock) from one depreciated asset.

In Part V of the article, we explore the question of the extent to which the creation of a double loss should be considered an abuse of the tax system. As our title suggests, we conclude that it is an abuse only in limited circumstances and that Congress has overreacted in prohibiting all duplications of net built-in losses. It would be better to tailor the restrictions to deal with those situations that are abusive. However, Congress believes that any duplication of a net loss is an abuse and has passed several provisions that prevent taxpayers from creating a double net loss. As discussed in detail below, Parts II through IV of the article review the operation of those provisions and illustrate significant problems with their approaches. While those provisions provide useful background material and illustrate the history of Congressional attempts to restrict the areas in which double losses can be utilized, a reader interested only in our discussion of why the creation of a double loss often is not an abuse may skip directly to that section of the article.

Number of Pages in PDF File: 65

Keywords: Tax, Corporate, Loss, Deduction

JEL Classification: H20, H25, H26, K34

Accepted Paper Series