The Section 384 limitation on pre-acquisition losses prevents one corporation’s accumulated losses from wiping out the built-in gains that existed in another corporation’s assets on the day the two came together. If a loss corporation and a gain corporation combine through a qualifying acquisition, the loss side’s net operating losses, current-year losses, and recognized built-in losses cannot offset the gain side’s pre-existing appreciation for five years after closing. The rule targets only the gain that was economically present on the acquisition date; anything the assets earn after that is free game.
When Section 384 Applies
The statute reaches two kinds of deals. The first is a stock acquisition in which one corporation obtains control of another, meaning stock representing at least 80% of total voting power and at least 80% of total value, using the Section 1504 definition.1Legal Information Institute. 26 USC 1504 – Definitions Taxable stock purchases count. A cash acquisition of 80% of a target’s stock triggers Section 384 just as clearly as a tax-free exchange, because the statute only asks whether a corporation acquired control, not how.2Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains
The second channel is asset acquisitions carried out through certain tax-free reorganizations: Type A statutory mergers, Type C stock-for-assets, and Type D acquisitive or divisive reorganizations.2Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains Type G bankruptcy reorganizations are not listed, and their treatment is unsettled when a transaction also qualifies as one of the listed types.
Direction does not matter. Section 384 applies whether the loss corporation acquires the gain corporation or the gain corporation acquires the loss corporation. All the statute needs is a loss corporation and a gain corporation joined through one of the covered transaction types.
Which Losses and Which Gains Are Covered
The Gain Side: Net Unrealized Built-in Gain
A corporation is a “gain corporation” if the fair market value of its assets exceeds their total adjusted tax basis immediately before the acquisition. That excess is the net unrealized built-in gain, or NUBIG. Section 384 borrows the concept and most of its measurement rules from Section 382(h), swapping in the acquisition date for the Section 382 change date.3Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains
A de minimis floor keeps smaller transactions out. NUBIG is treated as zero unless it exceeds the lesser of $10 million or 15% of the corporation’s total asset value. Cash, cash equivalents, and marketable securities whose value tracks their basis are excluded from that computation.4Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change If NUBIG stays under that threshold, Section 384 does not apply at all.
The Loss Side: Three Categories
The losses restricted by Section 384 fall into three groups. Net operating loss carryforwards into the tax year of the acquisition are covered. So is the portion of the current-year NOL allocable to the period on or before the acquisition date, which is generally split ratably by day unless regulations say otherwise. And if the loss corporation carries a net unrealized built-in loss (NUBIL), any loss recognized on assets held at acquisition is treated as a pre-acquisition loss.
The same $10 million / 15% de minimis rule applies to NUBIL, so a small built-in loss position drops out of the analysis.4Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change
How the Limitation Works Once It Applies
The Five-Year Recognition Period
The block runs for five years starting on the acquisition or reorganization date. This “recognition period” comes from Section 382(h), with the acquisition date standing in for Section 382’s change date.4Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change Gains recognized after the window closes are no longer restricted, no matter how much of the appreciation predated the deal.
Recognized Built-in Gain
Inside the window, Section 384 targets recognized built-in gain, or RBIG. RBIG is the gain from selling or disposing of an asset the gain corporation held on the acquisition date, but only up to the built-in gain that existed in that asset on that date. An asset carrying $100,000 of built-in gain at closing that later sells for a $150,000 total gain produces $100,000 of RBIG and $50,000 of ordinary post-acquisition appreciation. Only the $100,000 is fenced off from the pre-acquisition losses.2Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains
RBIG also picks up income that shows up on the return during the recognition period but was economically earned before the acquisition. Accounts receivable held by a cash-method corporation are the standard example: the work was done before closing, the cash arrives after, and the resulting income counts against the NUBIG ceiling.3Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains
Total RBIG across the entire recognition period cannot exceed the NUBIG calculated on the acquisition date. Once cumulative RBIG hits that ceiling, later gains stop being restricted and can be offset by any available losses.
The Burden Sits with the Gain Corporation
Every gain recognized on an asset sale during the recognition period is presumed to be RBIG. To rebut that presumption, the gain corporation has to show either that the asset was not held on the acquisition date or that the gain exceeds the built-in appreciation that existed on that date.2Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains Without a clean acquisition-date appraisal and asset records that survive the five years, the presumption controls.
Blocked Losses Are Not Lost
Pre-acquisition losses that cannot offset RBIG in one year carry forward. They remain subject to the same restriction for the balance of the recognition period, but they can offset other income and, after the five years, any income at all. Section 384 walls the losses off from a specific income stream; it does not destroy them.
The Controlled Group Carve-Out
Section 384 does not apply if the gain corporation and the loss corporation were members of the same controlled group throughout the full five-year period ending on the acquisition date. The controlled-group test here is looser than the standard affiliated-group rule: Section 384 uses the Section 1563 framework but drops the ownership threshold from “at least 80 percent” to “more than 50 percent” on both voting power and value.2Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains If either corporation has existed for less than five years, the shorter period substitutes for the five-year requirement.
The theory is that long-standing common control is not the tax-attribute trafficking the statute was written to police. For an internal restructuring, documenting the ownership history over the full lookback period is what preserves the exception.
Affiliated Groups Are Aggregated
For measuring NUBIG and NUBIL (though not for the controlled-group exception), all members of the same affiliated group immediately before the acquisition are treated as a single corporation.3Office of the Law Revision Counsel. 26 USC 384 – Limitation on Use of Preacquisition Losses to Offset Built-in Gains Isolating built-in gains or losses inside a particular subsidiary does not shrink the numbers; the whole group’s balance sheet feeds the calculation.
How Section 384 Sits Alongside Section 382
Section 382 and Section 384 do different jobs on the same acquisition. Section 382 caps the annual dollar amount of pre-change losses that can be used at all after an ownership change, based on the fair market value of the loss corporation’s stock before the change.5Internal Revenue Service. Notice 2003-65 – Built-in Gains and Losses Under Section 382(h) Section 384 does not cap the dollar amount; it restricts what kind of income the available losses can offset. Both can hit the same pool of losses at the same time.
Take a loss corporation with $50 million of NOLs where the Section 382 annual limit allows $5 million of use in a given year, and the gain corporation recognizes $3 million of RBIG that same year. Section 382 lets $5 million of NOLs into play. Section 384 then bars any of that $5 million from offsetting the $3 million of RBIG. The NOLs can shelter up to $5 million of other income, but the $3 million of built-in gain must be covered by the gain corporation’s own attributes or paid.
What This Means at Closing
Because the burden of proof sits with the gain corporation and the recognition period runs for five full years, the acquisition-date valuation is the document the whole analysis rests on. Asset-level fair market values, adjusted bases, and holding-period records established at closing are what let the corporation later show which portion of a sale gain is post-acquisition appreciation and which is not. Underinvesting in that work at the front end tends to show up years later, when an asset is sold and the default presumption pulls the entire gain into RBIG.