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Valuation Considerations Relating to Section 382 Limitations

Section 382 of the Internal Revenue Code generally requires a corporation to limit the amount of its income in future years that can be offset by historic losses, i.e. net operating loss (NOL) carryforwards and certain built-in losses, after a corporation has undergone an ownership change. In this issue of the Tax Insight we will provide an overview of the Section 382 limitation and valuation considerations with respect to the calculation of the Section 382 limitation.


A loss corporation is a corporation that is entitled to use a tax attribute carryover, such as an NOL, or a corporation with a net unrealized built-in loss. The following basic example shows the application of Sec. 382:

Alpha Corporation is a highly successful corporation wishing to acquire 100% of the stock of an unrelated company, Zeta Corporation.

  • Zeta Corporation is a private company with valuable IP which was funded with several rounds of preferred financing.
  • Zeta Corporation has generated net operating losses during every tax year since inception. Thus, it is a loss corporation.
  • After the acquisition, Section 382 will limit the amount of Zeta NOLs available to offset the group's future taxable income. In addition, the Zeta NOLs may be subject to additional Section 382 limitations caused by earlier ownership changes incurred during the rounds of financing.

The two major components of Sec. 382 are ownership change and limitation. An ownership change occurs if immediately after an owner shift or an equity structure shift, there is a greater than 50% change in the value of the stock owned by five percent shareholders during the testing period (generally three years). An ownership change is triggered by the purchase and sale, redemption, or new issuance of stock.

Stock may include any of the following:

  • Common stock
  • Convertible preferred stock
  • Certain convertible debt instruments
  • Certain voting preferred stock
  • Certain stock options or warrants


After an ownership change, the new loss corporation may only deduct its pre-change losses against taxable income in an amount equal to the Sec. 382 limitation amount. There are two components to the Sec. 382 limitation: 1) base limitation, which is driven by the value of the stock, and 2) built-in gain/loss, which is driven by the value of the assets.

The Sec. 382 base limitation amount is approximated using the following equation:

Fair Market Value of Old Loss Corporation Stock x Federal Long-term Tax Exempt Rate = Section 382 Base Limitation

The fair market value is subject to potential adjustments described in the regulations, and the federal long-term tax exempt rate is published monthly in the Internal Revenue Bulletin.

In order to utilize its NOLs, a company will strive to calculate the largest Sec. 382 limitation amount possible. As mentioned previously, the base limitation amount is driven by the value of the stock. Determining the value of the stock involves a consideration of the following:

  • All classes of loss company stock, including the pure preferred stock immediately prior to the change. Preferred stock with similar terms, rights and preferences should be valued equally.
  • For publicly traded companies the IRS has acknowledged that the stock value does not necessarily equal the trading value on an exchange, i.e. certain blocks of stock may have higher value due to control rights.
  • For privately held companies, different classes of stock may have different rights and vary in value.

A full discussion of recognized and net unrealized built-in gains and losses is beyond the scope of this article, but it is important to note that if you have a built-in loss it is best to hold onto it for at least the five year recognition period. Otherwise, you will be increasing the NOLs subject to Sec. 382.

NOTICE 2010-50

For Sec. 382 purposes any change in proportionate ownership which is attributable solely to fluctuations in relative FMVs of different classes of stock will not be taken into account. Under Notice 2010-50, the IRS will not challenge reasonable application of the following two methods as long as either is applied consistently: 1) Full Value Methodology, in which the determination of the percentage of stock owned by any person is made on the basis of the relative fair market value of the stock owned by such person to the total fair market value of the outstanding stock of the corporation, or 2) Hold Constant Principal, in which the value of a share, relative to the value of all other stock of the corporation, is established on the date that share is acquired by a particular shareholder.

Valuations for Sec. 382 purposes can be complex; we recommend engaging an independent valuation firm to provide the necessary valuations. For more information, contact your VRC representative.