Notice 2003-65: Section 382 Built-In Gains and Losses

IRS Notice 2003-65 gives a loss corporation two safe harbor methods for measuring built-in gains and losses under Section 382(h) after an ownership change: the 1374 approach and the 338 approach. Both determine how much post-change income or deduction counts as a “recognized” built-in item during the five-year recognition period, which in turn adjusts the annual cap on how much pre-change net operating loss the corporation can use. The IRS withdrew proposed regulations on July 2, 2025 that would have eliminated the 338 approach, so both methods remain in force as originally issued and as modified by Notice 2018-30.¹

When Notice 2003-65 Matters

The notice only comes into play once a loss corporation has undergone an ownership change under Section 382. That change is defined statutorily as a greater-than-50-percentage-point increase in stock ownership by one or more 5-percent shareholders during a testing period that generally covers three years.² A “loss corporation” is one entitled to use a net operating loss carryforward, one with a net operating loss in the year of the change, or one carrying a net unrealized built-in loss.³

After the change, an annual limitation caps how much pre-change loss the corporation can deduct. Notice 2003-65 does not set that base cap. What it does is provide the framework for adjusting it: recognized built-in gain (RBIG) during the five-year recognition period increases the limitation for that year, and recognized built-in loss (RBIL) is itself treated as a pre-change loss subject to the cap.²

The NUBIG and NUBIL Threshold

The safe harbors only matter if the corporation clears a statutory threshold first. Net Unrealized Built-in Gain and Net Unrealized Built-in Loss measure the aggregate difference between the fair market value of all corporate assets and their aggregate adjusted tax basis immediately before the ownership change. If the NUBIG or NUBIL does not exceed the lesser of $10 million or 15% of the fair market value of the assets, it is treated as zero and the built-in gain and loss rules simply do not apply.²

For a corporation with $50 million in assets, 15% is $7.5 million, which is less than $10 million, so anything below $7.5 million zeroes out. Corporations that clear the threshold then choose one of the two safe harbor methods.

The 1374 Approach

The 1374 approach borrows its framework from the rules governing S corporations that converted from C corporation status. It identifies RBIG and RBIL based on actual transactions during the five-year recognition period.² When the corporation sells an asset it held on the change date, the gain up to the amount of built-in gain at the time of the change counts as RBIG. Losses work the same way in reverse.

Accrual-type items follow the same logic. Collecting an account receivable that existed before the change produces RBIG. Paying a liability already owed on the change date generates RBIL. If the economic event originated before the change, the resulting income or deduction is treated as a built-in item when it hits the return during the recognition period.²

Cancellation of Debt Income

One rule specific to this approach involves cancellation of debt income. If a corporation’s debt is discharged during the first 12 months of the recognition period, and that debt existed before the ownership change, the COD income included in gross income counts as RBIG. Any tax basis reduction under Sections 108(b)(5) and 1017(a) resulting from that COD is treated as if it happened immediately before the ownership change for purposes of measuring future built-in gains and losses, though it does not alter the original NUBIG or NUBIL calculation.² COD income recognized later in the recognition period does not automatically qualify.

What This Method Looks Like in Practice

Because RBIG and RBIL tie to specific dispositions, the corporation needs a ledger matching every post-change sale back to an asset held on the change date. Assets acquired after the change generally do not produce built-in items. The method appeals to corporations that prefer tracking real transactions, but it can produce lumpy year-to-year results: a single large sale in year three might generate a significant limitation increase, while other years see little.

The 338 Approach

The 338 approach works from a hypothetical premise. The corporation is treated as if it sold all its assets at fair market value and immediately repurchased them on the change date. No actual sale occurs, but the fiction creates a stepped-up tax basis for every asset, which generates larger hypothetical depreciation and amortization deductions than the corporation is actually claiming on its returns.²

The gap between the hypothetical cost recovery deduction (built on stepped-up basis) and the actual deduction each year becomes RBIG. This “wasting asset” concept is what defines the method: built-in gain is recognized gradually through the difference in depreciation schedules, even if the corporation never sells the underlying asset. For companies holding significant intangibles like patents or goodwill, where a sale during the five-year window is unlikely, the 338 approach can unlock limitation increases that the transaction-dependent 1374 approach would miss.

Tangible assets follow standard IRS recovery periods under MACRS; Section 197 intangibles are amortized over 15 years for purposes of the hypothetical calculation.⁴ Because those schedules are predictable, the annual RBIG tends to be smoother than under the sale-driven 1374 approach.

Contingent Liabilities Get Locked In

The 338 approach has a specific rule for contingent liabilities. When calculating NUBIG or NUBIL, contingent liabilities such as pending litigation or warranty obligations are estimated and factored into the initial computation. Unlike an actual Section 338 election, no later adjustment is made when the contingent amount is finally resolved. If the corporation estimates a $40 million contingent liability at the change date and it ultimately settles for $10 million, the original NUBIG stands.² The initial estimate carries real consequences because it is not revisited.

Pick One and Apply It Consistently

A corporation can use either approach, but it must pick one and apply it consistently for each ownership change. Mixing elements of the two methods for the same ownership change is not permitted. The IRS has stated it will not assert an alternative interpretation of Section 382(h) against a corporation that consistently applies either safe harbor.²

The choice tends to track what the corporation owns. Companies with assets they plan to sell during the recognition period often find the 1374 approach simpler to administer. Companies with valuable intangibles or appreciated property they intend to hold generally benefit more from the 338 approach, which recognizes built-in gain through depreciation differentials rather than requiring a sale. The 338 approach also offers more modeling certainty because the hypothetical cost recovery schedule is known from day one.

Depreciation as Presumptive RBIL

Under both methods, depreciation, amortization, and depletion deductions taken during the recognition period are presumptively treated as RBIL. The corporation bears the burden of proving that a particular deduction is not attributable to the asset’s built-in loss at the change date.² Because RBIL is treated as pre-change loss, that presumption can effectively cap the deduction unless the corporation documents that it relates to post-change appreciation.

How the Adjustment Flows Through

Once RBIG or RBIL is identified for a given year, the adjustment is mechanical. RBIG increases the annual Section 382 limitation for that year, allowing more pre-change losses to offset current income. RBIL is treated as a pre-change loss subject to the same annual cap.² The five-year recognition period runs from the change date, and every year within that window the corporation should maintain workpapers linking its chosen safe harbor to the final adjustment. These workpapers are not filed but need to be available on audit.

Notice 2018-30 and Bonus Depreciation

Notice 2018-30 modified both safe harbors to address Section 168(k) bonus depreciation. When calculating hypothetical cost recovery under either approach, the corporation must disregard bonus depreciation entirely.⁵ Without this rule, a 338-approach corporation could generate an outsized RBIG in year one by claiming hypothetical 100% bonus depreciation on stepped-up basis, artificially inflating the Section 382 limitation. Standard recovery periods spread the RBIG over the asset’s useful life instead of front-loading it.

Installment Sale Anti-Abuse Rule

Taxpayers cannot defer RBIG past the five-year recognition period by using installment sales. Under rules originally announced in Notice 90-27 and carried into Notice 2003-65, if a corporation sells a built-in gain asset before or during the recognition period and reports the gain on the installment method, the RBIG continues to increase the Section 382 limitation as payments come in, even after the recognition period ends.² The same treatment applies when a built-in gain asset is transferred to an affiliate, the gain is deferred under consolidated return regulations, and the affiliate later sells on installment terms. The gain retains its RBIG character regardless of when the cash arrives.

Reporting on the Return

A loss corporation must attach a disclosure statement to its income tax return for every year in which an ownership shift or equity structure shift occurs. Treasury Regulation 1.382-11 requires the statement to include the dates of any owner shifts, the dates of any resulting ownership changes, and the amount of tax attributes (net operating losses, carryforwards, or net unrealized built-in losses) that made the corporation a loss corporation.⁶ The statement must be titled with the corporation’s name and employer identification number. Certain elections can also be included, such as an election to close the books on the change date for allocating income between pre-change and post-change periods.

Where the Guidance Stands After July 2025

In 2019 and 2020, the IRS published proposed regulations under Section 382(h) that would have mandated the 1374 approach as the sole method and eliminated the 338 approach. On July 2, 2025, the IRS and Treasury formally withdrew both sets of proposed regulations.¹ Corporations can continue relying on Notice 2003-65 as modified by Notice 2018-30, and both the 1374 and 338 approaches remain available. The IRS has said it intends to study these issues further and may issue new guidance, but no timeline has been set. Corporations that had been holding off pending the outcome of the proposed regulations can proceed with either approach and expect the IRS to respect the choice.

1
Federal Register. Regulations Under Section 382(h) Related to Built-In Gain and Loss – Withdrawal
2
Internal Revenue Service. Notice 2003-65 – Built-in Gains and Losses under Section 382(h)
3
Office of the Law Revision Counsel. 26 US Code 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership Change
4
Office of the Law Revision Counsel. 26 US Code 197 – Amortization of Goodwill and Certain Other Intangibles
5
Internal Revenue Service. Notice 2018-30 – Modification of Notice 2003-65
6
eCFR. Reporting Requirements