Section 382 of the U.S. Internal Revenue Code limits a corporation's ability to use its pre-acquisition net operating losses (NOLs) — and certain other tax attributes — after a significant change in ownership. Because NOLs can be valuable assets (they shelter future profits from tax), a buyer acquiring a company with large NOLs must understand how much of that value survives the deal. "NOL preservation" is the practice of structuring and diligencing a transaction to protect those attributes.
The policy behind it
NOLs let a company carry losses forward to offset future taxable income. Without a limit, profitable companies could buy loss companies purely to "traffic" in their NOLs — acquiring tax shelters rather than businesses. Section 382 exists to stop that: it restricts how quickly a new owner can use a target's old losses, so NOLs are worth their full value only to the business that generated them.
The trigger: an "ownership change"
Section 382 is triggered by an "ownership change" — broadly, when one or more 5%-or-greater shareholders increase their ownership by more than 50 percentage points over a rolling three-year testing period. A typical acquisition of a company easily clears this threshold, so most M&A deals involving a loss target trigger §382.
The limitation
Once an ownership change occurs, the target's pre-change NOLs do not disappear, but their use becomes capped annually:
Annual §382 limitation ≈ (Equity value of the loss company at the change date) × (the IRS long-term tax-exempt rate)
So a company with a modest market value and a low prescribed rate may only be able to use a small slice of its NOLs each year — stretching their use over many years and, given carryforward limits and time value, potentially wasting much of them. Rules on net unrealized built-in gains/losses (NUBIG/NUBIL) can increase or further restrict the usable amount.
Implications for deals
For a buyer, §382 means the headline NOL balance overstates the usable benefit. Quantifying the post-change limitation is a standard part of tax due diligence and of valuing a loss-company target. Considerations include:
- Modeling the annual limitation and the present value of the deductions actually usable;
- structuring to maximize preserved value (the change-date equity value drives the limit, so timing and structure matter); and
- avoiding inadvertent prior ownership changes that already burned the NOLs.
NOL preservation is especially central in distressed M&A, where loss companies are common and their NOLs may be a significant part of the deal's value (special §382 rules apply in bankruptcy). It is a reminder that a target's tax attributes are real assets whose value depends on the transaction's structure.
See also
- Tax due diligence — The tax-focused workstream of buy-side diligence: federal/state/local income tax exposure, sales-and-use tax, payroll tax, transfer pricing, R&D credits, and the tax history of the target entity.
- Taxable vs tax-free reorganization — The threshold tax-structure question in U.S. M&A: whether the seller recognises gain at closing (taxable) or whether the transaction qualifies for non-recognition under the reorganization rules of Section 368.
- Distressed M&A — M&A involving financially distressed or insolvent targets, often executed via Section 363 sales, Chapter 11 restructurings or out-of-court workouts. Speed, certainty and free-and-clear title dominate the value drivers.
- Deferred tax in M&A — The deferred tax assets and liabilities recognised on differences between book and tax basis of assets and liabilities acquired in a business combination.