What Is Other-Than-Temporary Impairment (OTTI)?

Other-than-temporary impairment, or OTTI, is an accounting conclusion that a decline in the market value of an investment security is unlikely to reverse, which forces the loss out of a balance sheet reserve and onto the income statement. The term is now largely historical. For debt securities, OTTI was replaced by the current expected credit loss (CECL) model under ASC 326. For most equity securities, the impairment question disappeared entirely once ASU 2016-01 required fair value changes to flow through net income each period. The concept still matters because older financial statements use the OTTI language, auditors and regulators still think in its framework, and one narrow slice of equity investments continues to use an impairment test that looks very similar to the old rule.

The Traditional Three-Step OTTI Test

Under the pre-CECL framework, a company holding a security whose fair value had fallen below its amortized cost worked through three questions in order.

Step One: Intent or Requirement to Sell

Did management intend to sell the security, or was the company likely to be forced to sell it before the value recovered? Evidence of intent included having the security approved for sale, marketing it at roughly fair value, or selling it shortly after the balance sheet date under circumstances suggesting the decision predated that date. A “yes” to either intent or a likely forced sale ended the analysis: the entire unrealized loss moved into net income immediately.

Step Two: Ability to Hold

If the company had no intent to sell and no forced-sale trigger, the next question was whether it had the financial capacity to hold the security long enough for its value to recover. That involved reviewing liquidity, funding sources, and any regulatory or contractual constraints. A company without holding capacity recognized the full loss in earnings, the same result as step one.

Step Three: Credit Loss Analysis

When both intent and ability to hold existed, management estimated whether it would recover the full amortized cost. The mechanic was to discount expected future cash flows at the security’s original effective interest rate and compare that present value to amortized cost. Any shortfall was the credit loss. Under the traditional model, the credit-related portion hit net income; the remaining fair value decline, attributable to non-credit factors like interest rates or liquidity, stayed in other comprehensive income (OCI).

The central weakness of this framework was that it was backward-looking. A loss had to have already occurred before it triggered recognition, which delayed reporting and tended to concentrate write-downs in crisis periods.

What Replaced OTTI, and When

Two Accounting Standards Updates from the Financial Accounting Standards Board effectively retired OTTI.

ASU 2016-01 changed how companies account for equity securities. Equity investments with readily determinable fair values are now carried at fair value with all changes running through net income each reporting period. That eliminated any need for an impairment test on those securities, since gains and losses are captured in earnings automatically.

ASU 2016-13 introduced CECL for debt instruments, codified in ASC 326. CECL replaced the incurred-loss approach with a forward-looking estimate of lifetime expected credit losses. The FDIC has confirmed that CECL took effect for large SEC filers in fiscal years beginning after December 15, 2019, and for all other entities, including smaller reporting companies, in fiscal years beginning after December 15, 2022.¹ By 2026, every reporting entity subject to U.S. GAAP has adopted CECL, and the OTTI concept is no longer relevant for debt securities.

Which Securities Still Get an Impairment Review

Whether a security goes through any impairment analysis today depends on how it is classified.

Trading securities are marked to market through net income every period, so no separate impairment test applies.
Equity securities with readily determinable fair values run through net income at fair value under ASU 2016-01. No impairment analysis.
Equity securities without readily determinable fair values, where management elects the “measurement alternative” under ASC 321, are carried at cost adjusted for observable price changes and are subject to a qualitative impairment assessment.
Available-for-sale (AFS) debt securities are carried at fair value on the balance sheet with unrealized changes in OCI. Credit losses are evaluated under CECL (ASC 326-30).
Held-to-maturity (HTM) debt securities are carried at amortized cost with an allowance for expected credit losses established under CECL (ASC 326-20).²

Investments accounted for under the equity method, where the investor has significant influence over the investee, follow a separate impairment framework and fall outside both the old OTTI rules and CECL.

Equity Securities Under the Measurement Alternative

This is the one place where an impairment concept still operates in something close to the old sense, though the standard has dropped the “other than temporary” label. It applies only to equity securities without readily determinable fair values where management has elected to carry them at cost minus impairment, adjusted for observable price changes.

Each reporting period, management performs a qualitative assessment for indicators that fair value has dropped below carrying value. The codification lists several to consider:

Significant declines in the investee’s earnings, credit rating, asset quality, or business outlook.
Adverse changes in the investee’s regulatory, economic, or technological environment.
A significant downturn in the investee’s geographic region or industry.
A bona fide offer to buy, an offer by the investee to sell, or a completed auction at a price below carrying value.
Negative operating cash flows, working capital shortfalls, or violations of debt covenants or regulatory capital requirements.

If the indicators point to impairment, management estimates the security’s fair value. If fair value is below carrying amount, the difference is recognized as a loss in net income and the carrying value is written down. There is no threshold for how large the decline has to be, and management cannot avoid the write-down by arguing the decline is temporary. The write-down establishes a new, lower cost basis, and it is permanent in the accounting records even if the investment later recovers.

Debt Securities Under CECL

CECL requires an estimate of lifetime expected credit losses from the moment a debt security lands on the balance sheet, drawing on historical loss experience, current conditions, and reasonable forecasts of future economic activity.¹ The mechanics differ between HTM and AFS.

Held-to-Maturity

For HTM securities, the company establishes an allowance for credit losses against amortized cost.² The allowance is reassessed each period, and any change flows through the income statement as credit loss expense. The amortized cost itself is not written down unless the investment is deemed uncollectible. If credit conditions improve, the company can reverse a portion of the previously recorded loss, producing a gain on the income statement.

Available-for-Sale

AFS debt uses a split approach. When fair value drops below amortized cost, management separates the decline into a credit portion and a non-credit portion.

The credit loss is measured by discounting expected cash flows at the security’s effective interest rate and comparing that present value to amortized cost. Any shortfall is recognized in net income through an allowance for credit losses rather than a direct write-down.² The allowance is capped at the total fair value decline, creating a “fair value floor” that prevents the credit loss from exceeding the overall unrealized loss.

The non-credit portion stays in OCI, keeping rate-driven volatility out of core earnings. If credit quality later improves, the allowance can be reversed and the reversal reduces credit loss expense. It cannot be reversed below zero, so you cannot create a credit gain beyond what was previously recognized as a loss.

One key difference from the old OTTI framework: CECL does not ask whether management intends or is able to hold the security. The expected credit loss estimate applies regardless of holding plans.

How the Losses Appear on the Financial Statements

The presentation depends on the security type, and reading it correctly matters.

For equity securities under the measurement alternative, an impairment loss flows directly into net income as a write-down. Carrying value drops to fair value and becomes the new cost basis. If the security later recovers, the gain is only recognized when an observable price change occurs or the security is sold. The write-down itself cannot be reversed.

For AFS debt under CECL, the credit loss hits net income through a provision, recorded via an allowance account rather than by writing the asset down. The non-credit portion of the fair value decline appears in OCI. The income statement reflects only credit risk; the balance sheet still shows the security at fair value. Because the loss sits in an allowance, it can be reversed if conditions improve, a meaningful change from the permanent write-downs that characterized OTTI.

For HTM debt under CECL, the allowance offsets amortized cost on the balance sheet, and changes each period run through the income statement. HTM securities are not carried at fair value, so there is no OCI component; the full credit loss estimate and any adjustment affect reported earnings.

A practical read for an investor: check the income statement for the credit loss provision, then look at OCI to see how much additional unrealized loss exists from non-credit factors. A company with a large OCI loss but a small credit provision is telling you its portfolio has taken rate-driven hits while the underlying borrowers are still expected to pay.

Tax Treatment of an Impairment Loss

An impairment loss recognized under GAAP does not automatically produce a tax deduction, and the mismatch catches people off guard.

For securities held as capital assets, IRC Section 165(g) allows a deduction only when a security becomes “wholly worthless” during the tax year.³ The loss is treated as though the security were sold on the last day of the tax year and is subject to the normal capital loss limitations. The IRS applies this treatment to worthless securities, including those that are abandoned.⁴

A partial impairment recorded for book purposes, where the security still has some value, generally produces no tax deduction until the security is sold or becomes wholly worthless. A company can therefore report a significant impairment on its income statement while getting no current tax benefit, and the timing difference between book and tax recognition shows up as a deferred tax asset.

One exception is worth flagging. When a domestic corporation owns stock in an affiliated domestic corporation and that stock becomes worthless, the loss can be treated as ordinary rather than capital if certain ownership and gross receipts tests are met, which is a more favorable outcome than the standard capital loss rule.³

1
FDIC. Current Expected Credit Losses (CECL)
2
National Credit Union Administration. CECL Accounting Standards
3
Office of the Law Revision Counsel. 26 USC 165 – Losses
4
Internal Revenue Service. Losses (Homes, Stocks, Other Property) 1