Sec. 1.904(g)-3 Ordering rules for the allocation of net operating losses, net capital losses, U.S. source losses, and separate limitation losses, and for the recapture of separate limitation losses, overall foreign losses, and overall domestic losses.
(a) In general.
This section provides ordering rules for the allocation of net operating losses, net capital losses, U.S. source losses, and separate limitation losses, and for the recapture of separate limitation losses, overall foreign losses, and overall domestic losses. The rules must be applied in the order set forth in paragraphs (b) through (j) of this section.
(b) Step One: Allocation of net operating loss and net capital loss carryovers.
(1) In general.
Net operating losses from a current taxable year are carried forward or back to a taxable year in the following manner. Net operating losses that are carried forward pursuant to section 172 are combined with income or loss in the carryover year in the manner described in this paragraph (b). The combined amounts are then subject to the ordering rules provided in paragraphs (c) through (i) of this section. Net operating losses that are carried back to a prior taxable year pursuant to section 172 are allocated to income in the carryback year in the manner set forth in paragraphs (b)(2), (b)(3), (c), d), and (e) of this section. The income in the carryback year to which the net operating loss is allocated is the foreign source income in each separate category and the U.S. source income after the application of sections 904(f) and 904(g) to income and loss in that previous year, including as a result of net operating loss carryovers or carrybacks from taxable years prior to the current taxable year. See §§1.861-8(e)(8), 1.904(b)-3(d)(2), and 1.1502-4(c)(1)(iii) for rules to determine the source and separate category components of a net operating loss.
(2) Full net operating loss deduction.
If the full net operating loss (that remains after carryovers to other taxable years) is deducted in computing the taxable income in a particular year (carryover year), so that there is no remaining net operating loss that can be carried to other taxable years, U.S. source losses and foreign source losses in separate categories that comprise the net operating loss shall be combined with the U.S. source income or loss and the foreign source income or loss in the same separate categories in the carryover year.
(3) Partial net operating loss deduction.
If the full net operating loss (that remains after carryovers to other taxable years) is not deducted in computing the taxable income in a carryover year, so that there is remaining loss that can be carried to other taxable years, the following rules apply:
(i) Any U.S. source loss (not to exceed the amount of the net operating loss carryover deducted in computing the taxable income in the carryover year (the net operating loss deduction)) shall be carried over to the extent of any U.S. source income in the carryover year.
(ii) If the net operating loss deduction exceeds the U.S. source loss carryover determined under paragraph (b)(3)(i) of this section, then separate limitation losses that are part of the net operating loss shall be tentatively carried over to the extent of separate limitation income in the same separate category in the carryover year. If the sum of the potential separate limitation loss carryovers determined under the preceding sentence exceeds the amount of the net operating loss deduction reduced by any U.S. source loss carried over under paragraph (b)(3)(i) of this section, then the potential separate limitation loss carryovers shall be reduced pro rata so that their sum equals such amount.
(iii) If the net operating loss deduction exceeds the sum of the U.S. and separate limitation loss carryovers determined under paragraphs (b)(3)(i) and (ii) of this section, then a proportionate part of the remaining loss from each separate category shall be carried over to the extent of such excess and combined with the foreign source loss, if any, in the same separate categories in the carryover year.
(iv) If the net operating loss deduction exceeds the sum of all the loss carryovers determined under paragraphs (b)(3)(i), (ii), and (iii) of this section, then any U.S. source loss not carried over under paragraph (b)(3)(i) of this section shall be carried over to the extent of such excess and combined with the U.S. source loss, if any, in the carryover year.
(4) Net capital loss carryovers.
Rules similar to the rules of paragraphs (b)(1) through (3) of this section apply for purposes of determining the components of a net capital loss carryover to a taxable year.
(c) Step Two: Section 904(b) adjustments.
The taxpayer shall make any required adjustments to capital gains and losses and qualified dividend income under section 904(b)(2). The taxpayer also takes into account any adjustments required under section 904(b)(4) and §1.904(b)-3.
(d) Step Three: Allocation of separate limitation losses.
The taxpayer shall allocate separate limitation losses sustained during the taxable year (increased, if appropriate, by any losses carried over under paragraph (b) of this section), in the following manner --
The taxpayer shall allocate its separate limitation losses for the taxable year to reduce its separate limitation income in other separate categories on a proportionate basis, and increase its separate limitation loss accounts appropriately. To the extent a separate limitation loss in one separate category is allocated to reduce separate limitation income in a second separate category, and the second category has a separate limitation loss account from a prior taxable year with respect to the first category, the two separate limitation loss accounts shall be netted against each other.
(2) If the taxpayer's separate limitation losses for the taxable year exceed the taxpayer's separate limitation income for the year, so that the taxpayer has separate limitation losses remaining after the application of paragraph (d)(1) of this section, the taxpayer shall allocate those losses to its U.S. source income for the taxable year, to the extent thereof, and shall increase its overall foreign loss accounts to that extent in accordance with § 1.904(f)-1.
(e) Step Four: Allocation of U.S. source losses.
The taxpayer shall allocate U.S. source losses sustained during the taxable year (increased, if appropriate, by any losses carried over under paragraph (b) of this section) to separate limitation income on a proportionate basis, and shall increase its overall domestic loss accounts to the extent of such allocation in accordance with § 1.904(g)-1.
(f) Step Five: Recapture of overall foreign loss accounts.
If the taxpayer's separate limitation income for the taxable year (reduced by any losses carried over under paragraph (b) of this section) exceeds the sum of the taxpayer's U.S. source loss and separate limitation losses for the year, so that the taxpayer has separate limitation income remaining after the application of paragraphs (d)(1) and (e) of this section, then the taxpayer recaptures prior year overall foreign losses, if any, in accordance with §1.904(f)-2, and reduces overall foreign loss accounts in accordance with §1.904(f)-2. The recapture in this paragraph (f) includes amounts determined under §1.904(f)-2(c) and (d)(3) but not §1.904(f)-2(d)(4), which is covered in paragraph (i) of this section.
(g) Step Six: Recapture of separate limitation loss accounts.
To the extent the taxpayer has remaining separate limitation income for the year after the application of paragraph (f) of this section, then the taxpayer shall recapture prior year separate limitation losses, if any, in accordance with § 1.904(f)-8 and reduce separate limitation loss accounts in accordance with § 1.904(f)-7.
(h) Step Seven: Recapture of overall domestic loss accounts.
If the taxpayer's U.S. source income for the year (reduced by any losses carried over under paragraph (b) of this section or allocated under paragraph (d) of this section, but not increased by any recapture of overall foreign loss accounts under paragraph (f) of this section) exceeds the taxpayer's separate limitation losses for the year, so that the taxpayer has U.S. source income remaining after the application of paragraph (d)(2) of this section, then the taxpayer shall recapture its prior year overall domestic losses, if any, and reduce overall domestic loss accounts in accordance with § 1.904(g)-2.
(i) Step Eight: Dispositions under section 904(f)(3) in which gain would not otherwise be recognized.
The taxpayer determines the amount of gain that would otherwise not be recognized but that must be recognized in accordance with §1.904(f)-2(d)(4) (not exceeding the taxpayer's applicable overall foreign loss account) and then applies §1.904(f)-2(a) and (b) to recapture and reduce its overall foreign loss accounts in an amount equal to the gain recognized. To the extent this recognition of gain in a taxable year reduces the amount of a current year net operating loss or increases the amount of a net operating loss carryover to that taxable year, paragraphs (b) through (e) of this section are applied to determine the allocation of any additional net operating loss deduction and other deductions or losses and the applicable increases in the taxpayer's overall foreign loss, separate limitation loss, and overall domestic loss accounts, but only after the applicable overall foreign loss account has been recaptured as provided in this paragraph (i).
(j) Step Nine: Dispositions that result in additional income recognition under the branch loss recapture and dual consolidated loss recapture rules.
(1) In general. If, after any gain is required to be recognized under section 904(f)(3) on a transaction that is otherwise a nonrecognition transaction, an additional amount of income is recognized under section 91(d), section 367(a)(3)(C) (as applicable to losses incurred before January 1, 2018), or §1.1503(d)-6, and that additional income amount is determined by taking into account an offset for the amount of gain recognized under section 904(f)(3) and so is not initially taken into account in applying paragraph (b) of this section, then paragraphs (b) through (h) of this section are applied to determine the allocation of any additional net operating loss deduction and other deductions or losses and the applicable increases in the taxpayer’s overall foreign loss, separate limitation loss, and overall domestic loss accounts, as well as any additional recapture and reduction of the taxpayer’s separate limitation loss, overall foreign loss, and overall domestic loss accounts.
(2) Rules for additional recapture of loss accounts. For the purpose of recapturing and reducing loss accounts under paragraph (j)(1) of this section, the taxpayer also takes into account any creation of or addition to loss accounts that result from the application of paragraphs (b) through (i) of this section in the current tax year. If any of the additional income described in paragraph (j)(1) of this section is foreign source income in a separate category for which there is a remaining balance in an overall foreign loss account after applying paragraph (i) of this section, the section 904(f)(1) recapture amount under §1.904(f)-2(c) for that additional income is determined by first computing a hypothetical recapture amount as it would have been determined prior to the application of paragraph (i) of this section but taking into account the additional foreign source income described in this paragraph (j)(2) and then subtracting the actual overall foreign loss recapture determined prior to the application of paragraph (i) of this section (that did not take into account the additional foreign source income). The remainder is the overall foreign loss recapture amount with respect to the additional foreign source income described in this paragraph (j)(2).
(k) Examples.
The following examples illustrate the rules of this section. Unless otherwise noted, all corporations use the calendar year as the U.S. taxable year.
(1) Example 1.
(i) Facts.
(A) USC is a domestic corporation with foreign branch operations in Country X. For Year 1, USC had the following taxable income and losses after application of section 904(f) and (g) to income and loss in Year 1:
Foreign Branch | Passive | US |
|---|---|---|
$400x | $200x | $110x |
(B) For Year 2, USC has a net operating loss of ($500x), determined as follows:
Foreign Branch | Passive | US |
|---|---|---|
($300x) | $0 | ($200x) |
(ii) Analysis.
(A) Net operating loss allocation. Because USC's taxable income for Year 1 exceeds its total net operating loss for Year 2, the full net operating loss is carried back. Under paragraph (b) of this section (Step 1), each component of the net operating loss is carried back and combined with its same category in Year 1. See paragraph (b)(2) of this section. After allocation of the net operating loss, USC has the following taxable income and losses for Year 1:
Foreign Branch | Passive | US |
|---|---|---|
$100x | $200x | ($90x) |
(B) Loss allocation. Under paragraph (e) of this section (Step 4), the ($90x) of U.S. loss is allocated proportionately to reduce the foreign branch category and passive category income. Accordingly, $30x ($90x × $100x/$300x) of the U.S. loss is allocated to foreign branch category income and $60x ($90x × $200x/$300x) of the U.S. loss is allocated to passive category income, with a corresponding creation or increase to USC's overall domestic loss accounts.
(2) Example 2.
(i) Facts.
(A) USC is a domestic corporation with foreign branch operations in Country X. As of January 1, Year 1, USC has no loss accounts subject to recapture. For Year 1, USC has a net operating loss of ($1,400x), determined as follows:
Foreign Branch | Passive | US |
|---|---|---|
($400x) | ($200x) | ($800x) |
(B) For Year 2, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$500x | ($100x) | $1200x |
(ii) Analysis.
(A) Net operating loss allocation. Under paragraph (b) of this section (Step 1), because USC's total taxable income for Year 2 of $1600x ($1,200x + $500x - $100x) exceeds the total Year 1 net operating loss, the full $1,400x net operating loss is carried forward. Under paragraph (b)(2) of this section, each component of the net operating loss is carried forward and combined with its same category in Year 2. After allocation of the net operating loss, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$100x | ($300x) | $400x |
(B) Loss allocation. Under paragraph (d) of this section (Step 3), $100x of the passive category loss offsets the $100x of foreign branch category income, resulting in a passive category separate limitation loss account with respect to foreign branch category income, and the other $200x of passive category loss offsets $200x of the U.S. source taxable income, resulting in the creation of an overall foreign loss account in the passive category.
(3) Example 3.
(i) Facts. Assume the same facts as in paragraph (k)(2)(i) of this section (the facts in Example 2), except that in Year 2, USC had the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$200x | ($100x) | $1200x |
(ii) Analysis.
(A) Net operating loss allocation. Under paragraph (b) of this section (Step 1), because the total net operating loss for Year 1 of ($1,400x) exceeds total taxable income for Year 2 of $1,300x ($1,200x + $200x - $100x), USC has a partial net operating loss carryover to Year 2 of $1,300x. Under paragraph (b)(3)(i) of this section, first, the $800x U.S. source component of the net operating loss is allocated to U.S. income for Year 2. The tentative foreign branch category carryover under paragraph (b)(3)(ii) of this section ($200x) does not exceed the remaining net operating loss carryover amount ($500x). Therefore, $200x of the foreign branch category component of the net operating loss is next allocated to the foreign branch category income for Year 2. Under paragraph (b)(3)(iii) of this section, the remaining $300x of net operating loss carryover ($1300x - $800x - $200x) is carried over proportionally from the remaining net operating loss components in the foreign branch category ($200x, or $400x total foreign branch category loss - $200x foreign branch category loss already allocated) and passive category ($200x). Therefore, $150x ($300x × $200x/$400x) of the remaining net operating loss carryover is carried over from the foreign branch category for Year 1 and combined with the foreign branch category income for Year 2, and $150x ($300x × $200x/$400x) of the remaining net operating loss carryover is carried over from the passive category for Year 1 and combined with the passive category loss for Year 2. After allocation of the net operating loss carryover from Year 1 to the appropriate categories for Year 2, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
($150x) | ($250x) | $400x |
(B) Loss allocation. Under paragraph (d) of this section (Step 3), the losses in the foreign branch and passive categories fully offset the U.S. source income, resulting in the creation of foreign branch category and passive category overall foreign loss accounts.
(4) Example 4.
(i) Facts. Assume the same facts as in paragraph (k)(2)(i) of this section (the facts in Example 2), except that in Year 2, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$200x | $200x | ($200x) |
(ii) Analysis.
(A) Net operating loss allocation. Under paragraph (b) of this section (Step 1), because the total net operating loss of ($1400x) exceeds total taxable income for Year 2 of $200x ($200x + $200x - $200x), USC has a partial net operating loss carryover to Year 2 of $200x. Because USC has no U.S. source income in Year 2, under paragraph (b)(3)(i) of this section no portion of the U.S. source component of the net operating loss is initially carried into Year 2. Because the total tentative carryover under paragraph (b)(3)(ii) of this section of $400x ($200x in each of the foreign branch and passive categories) exceeds the net operating loss carryover amount, the tentative carryover from each separate category is reduced proportionately by $100x ($200x × $200x/$400x). Accordingly, $100x ($200x - $100x) of the foreign branch category component of the net operating loss is carried forward and $100x ($200x - $100x) of the passive category component of the net operating loss is carried forward and combined with income in the same respective categories for Year 2. After allocation of the net operating loss carryover from Year 1, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$100x | $100x | ($200x) |
(B) Loss allocation. Under paragraph (e) of this section (Step 4), the $200x U.S. source loss offsets the remaining $100x of foreign branch category income and $100x of passive category income, resulting in the creation of overall domestic loss accounts with respect to the foreign branch and passive categories.
(5) Example 5.
(i) Facts. Assume the same facts as in paragraph (k)(2)(i) of this section (the facts in Example 2), except that in Year 2, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$800x | ($100x) | $100x |
(ii) Analysis.
(A) Net operating loss allocation. Under paragraph (b) of this section (Step 1), because USC's total net operating loss in Year 1 of ($1,400x) exceeds its total taxable income for Year 2 of $800x ($100x + $800x - $100x), USC has a partial net operating loss carryover to Year 2 of $800x. Under paragraph (b)(3)(i) of this section, $100x of the U.S. source component of the net operating loss is allocated to U.S. income for Year 2. The tentative foreign branch category carryover under paragraph (b)(3)(ii) of this section does not exceed the remaining net operating loss carryover amount. Therefore, $400x of the foreign branch category component of the net operating loss is allocated to reduce foreign branch category income in Year 2. Under paragraph (b)(3)(iii) of this section, of the remaining $300x of net operating loss carryover ($800x - $100x - $400x), $200x is carried forward from the passive category component of the net operating loss and combined with the passive category loss for Year 2. Under paragraph (b)(3)(iv) of this section, the remaining $100x ($300x - $200x) of net operating loss carryover is carried forward from the U.S. source component of the net operating loss and combined with the U.S. source income (and the previously allocated U.S. source component of the net operating loss) for Year 2. After allocation of the net operating loss carryover from Year 1, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$400x | ($300x) | ($100x) |
(B) Loss allocation.
(1) Under paragraph (d) of this section (Step 3), the $300x passive category loss offsets the $300x of income in the foreign branch category, resulting in the creation of a passive category separate limitation loss account with respect to the foreign branch category.
(2) Under paragraph (e) of this section (Step 4), the $100x U.S. source loss offsets the remaining $100x of the foreign branch category income, resulting in the creation of an overall domestic loss account with respect to the foreign branch category.
(6) Example 6.
(i) Facts.
(A) USC is a domestic corporation with foreign branch operations in Country X. USC has no net operating losses and does not make an election to recapture more than the required amount of overall foreign losses. As of January 1, Year 1, USC has a ($200x) foreign branch category overall foreign loss (OFL) account and a ($200x) foreign branch category separate limitation loss (SLL) account with respect to the passive category. For Year 1, USC has $400x of passive category income that is fully offset by a ($400x) domestic loss in that taxable year, giving rise to the creation of an overall domestic loss (ODL) account with respect to the passive category. As of January 1, Year 2, USC has the following balances in its OFL, SLL, and ODL accounts:
Foreign Branch | US | |
|---|---|---|
OFL | SLL (Passive) | ODL (Passive) |
$200x | $200x | $400x |
(B) In Year 2, USC has the following taxable income and losses:
Foreign Branch | Passive | US |
|---|---|---|
$400x | ($100x) | $600x |
(ii) Analysis.
(A) Loss allocation. Under paragraph (d) of this section (Step 3), the $100x of passive category loss offsets $100x of the foreign branch category income, creating a passive category SLL account of $100x with respect to the foreign branch category. Because there is an offsetting foreign branch category SLL account of $200x with respect to the passive category from a prior taxable year, the two accounts are netted against each other so that all that remains is a $100x foreign branch category SLL account with respect to the passive category.
(B) OFL account recapture. Under paragraph (f) of this section (Step 5), 50% of the remaining $300x, or $150x, of income in the foreign branch category is subject to recharacterization as U.S. source income as a recapture of part of the OFL account in the foreign branch category.
(C) SLL account recapture. Under paragraph (g) of this section (Step 6), $100x of the remaining $150x of income in the foreign branch category is recharacterized as passive category income as a recapture of the foreign branch category SLL account with respect to the passive category.
(D) ODL account recapture. Under paragraph (h) of this section (Step 7), 50% of the $600, or $300, of U.S. source income is subject to recharacterization as foreign source passive category income as a recapture of a part of the ODL account with respect to the passive category. None of the $150x of foreign branch category income that was recharacterized as U.S. source income under paragraph (f) of this section (Step 5) is included here as income subject to recharacterization in connection with recapture of the ODL account.
(E) Results.
(1) After the allocation of loss and recapture of loss accounts, USC has the following taxable income and losses for Year 2:
Foreign Branch | Passive | US |
|---|---|---|
$50x | $400x | $450x |
(2) As of January 1, Year 3, USC has the following balances in its OFL, SLL and ODL accounts:
Foreign Branch | Passive | US | |
|---|---|---|---|
OFL | SLL (Passive) | SLL (Foreign Branch) | ODL (Passive) |
$50x | $0 | $0 | $100x |
(l) Applicability date. This section applies to taxable years ending on or after November 2, 2020.
[Added by T.D. 9371, 72 FR 72592-72606, Dec. 21, 2007. Revised by T.D. 9595, 77 FR 37576-37587, June 22, 2012. Revised by T.D. 9882, 84 FR 69022-69123, Dec. 17, 2019; amended by T.D. 9922, 85 FR 71998-72075, Nov. 12, 2020; corrected at 86 FR 54367-54368, Oct. 1, 2021.]
