## Facts

- Rite Aid Corporation, the common parent of a consolidated group, acquired Penn Encore, Inc. (Encore) in two stages (1984 and 1988), with a total stock basis of $4,659,730.
- Encore was included in Rite Aid’s consolidated federal income tax returns under I.R.C. §§ 1501–1502.
- By 1994, Encore had grown in sales but performed poorly overall and incurred substantial losses in its final year.
- In 1994, Rite Aid sold Encore to an unrelated buyer; the buyer declined to make a § 338(h)(10) election.
- Rite Aid computed its stock-sale loss under I.R.C. § 1001 and claimed a loss deduction under I.R.C. § 165, including:
  - A basis increase reflecting an intercompany-debt-to-capital contribution on the sale date; and
  - A basis reduction reflecting Encore’s negative earnings and profits.
- Rite Aid’s computation produced an adjusted stock basis of $38,644,400 and, after selling expenses, a net realized loss of $22,136,739.
- Treasury Regulation § 1.1502-20 (the consolidated return loss disallowance rule) disallowed a parent’s loss on disposition of subsidiary stock to the extent of the subsidiary’s “duplicated loss factor,” measured largely by the excess of the subsidiary’s aggregate adjusted asset basis over the assets’ value immediately before disposition.
- Encore’s duplicated loss factor exceeded Rite Aid’s realized loss, so the regulation disallowed Rite Aid’s entire claimed stock loss.
- Rite Aid paid the resulting tax and sued for a refund and interest.

## Issues

1. Whether Treas. Reg. § 1.1502-20’s duplicated loss component is a valid exercise of the Secretary’s consolidated return regulatory authority under I.R.C. § 1502.
2. Whether disallowing Rite Aid’s realized stock loss under the duplicated loss factor is arbitrary, capricious, or manifestly contrary to the Internal Revenue Code’s loss-deduction scheme.

## Decision

- The Federal Circuit reversed the Court of Federal Claims’ summary judgment for the government.
- The court held that Treas. Reg. § 1.1502-20’s duplicated loss component was not within the authority delegated by I.R.C. § 1502 and therefore was invalid.
- The case was remanded for further proceedings consistent with the holding, leaving Rite Aid’s loss recognizable absent some other valid limitation.

## Legal Principles

- I.R.C. § 1502 grants Treasury broad authority to issue consolidated return regulations needed to clearly reflect group income and prevent tax avoidance, but that authority is not unlimited.
- Consolidated return regulations may not override or materially alter substantive loss-recognition and loss-deduction rules otherwise permitted by the Code (including I.R.C. §§ 1001 and 165) without adequate statutory grounding.
- A regulation that mechanically disallows a realized stock loss based on a subsidiary asset basis/value comparison, even where duplication is not shown in the transaction at issue, can exceed § 1502’s delegated scope and be invalid as contrary to the statute.

## Conclusion

The Federal Circuit invalidated the duplicated loss portion of Treas. Reg. § 1.1502-20, holding that Treasury’s consolidated return authority under I.R.C. § 1502 did not permit a broad, automatic disallowance of a parent’s otherwise deductible realized loss on subsidiary stock.


Rite Aid Corp. v. United States, 255 F.3d 1357 (Fed. Cir. 2001)