The Section 382 Trap: How Ownership Changes Evaporate Corporate Tax Losses
In the high-stakes world of Mergers & Acquisitions, the target company's Net Operating Losses (NOLs) are often its most valuable hidden asset. These paper losses can theoretically be used to shield future profits from taxation, making the acquisition significantly cheaper. However, the IRS views the "trafficking" of tax losses with extreme hostility. Under Section 382, if a corporation undergoes an "ownership change" (generally a shift of more than 50 percentage points by major shareholders over three years), its NOLs are immediately subjected to a brutal annual usage limit. If this limit is low, millions of dollars in tax-shielding value can simply evaporate overnight. Our Corporate M&A Group specializes in executing Section 382 studies to protect and model NOL preservation in private equity and venture capital exits.
The Calculation of the Annual Limit
When a change of control occurs, the annual limit on NOL usage is calculated by multiplying the fair market value of the company's stock immediately before the change by the federal "long-term tax-exempt rate."
For example, if a struggling biotech startup worth $10M with $50M in NOLs is acquired, and the tax-exempt rate is 3%, the acquiring company can only use $300,000 of those NOLs per year. At that rate, it would take 166 years to use all $50M in losses—effectively destroying their value since NOLs carryforward with expiration constraints (depending on the year they were generated). This is why valuation engineering prior to the close of an acquisition is critical.
The Built-in Gain (BIG) Escape Hatch
One of the few ways to bypass a low Section 382 limit is to identify "Net Unrealized Built-in Gains" (NUBIG) in the company's assets at the time of the change.
Under Section 382(h), if the target company sells assets with built-in gains within five years of the acquisition, the annual NOL opening is increased by the amount of those gains. This allows for a massive "unlock" of losses that would otherwise be trapped. Identifying NUBIG requires a rigorous, forensic appraisal of intellectual property, goodwill, and real estate components to ensure the limit is expanded to its legal maximum before the IRS examines the transaction.