What happens to tax losses when an AI company is sold

In short

When an AI company that has piled up large net operating losses and R&D tax credits is sold, those tax attributes do not simply vanish. Whether they survive depends on how the deal is structured. In a taxable stock purchase, the losses stay inside the target but are locked behind an annual cap set by Section 382 of the Internal Revenue Code. The cap is the company’s equity value just before the sale multiplied by a tax-exempt interest rate, currently about 3.65%. In a taxable asset purchase, the losses ordinarily do not transfer to the buyer at all. Even when losses survive, separate rules under Sections 383 and 384 apply to credits and to offsetting built in gains, and the IRS can still block the losses under Section 269 if the main purpose of the deal was tax avoidance. The key lesson for buyers and sellers is that the value of a target’s tax losses is not its simple balance sheet number. That value is tightly constrained by federal law and must be modeled before closing.

Why do AI companies carry so many tax losses?

Most AI startups spend heavily on research, cloud computing, and talent for years before they earn meaningful revenue. Those costs create net operating losses, or NOLs. An NOL happens when a company’s deductible business expenses exceed its taxable income for the year. The company can then use that loss to reduce taxable income in other years and cut its future tax bill. I.R.C. § 172

For tax years after 2017, NOLs carry forward indefinitely. But they can offset only 80 percent of taxable income in any single year (for tax years beginning after December 31, 2020). NOLs from years before 2018 still expire after 20 years, but they can offset 100 percent of taxable income when they are used, and they come first. I.R.C. § 172, RSM US

AI companies also build up research and development tax credits under Section 41 and general business credits under Section 39. Like NOLs, those credits can be carried forward to shrink taxes in profitable years. I.R.C. § 39, I.R.C. § 41

A recent twist hits AI companies directly. For tax years 2022 through 2024, the law required them to capitalize software development and domestic R&D costs and spread the deduction over five years, instead of deducting the full cost right away. That change slowed down NOL buildup during those years. Starting in 2025, immediate deduction of domestic R&D is restored. 26 U.S. Code § 174A, SaaS Capital

How does the sale structure decide whether the tax losses survive?

The deal’s structure is the starting point. It determines whether the target’s tax losses ever even reach the buyer. The table below shows the four common paths.

Taxable stock purchase

The buyer buys the target’s stock. The target becomes a subsidiary of the buyer. The target’s NOLs and credits remain inside the target corporation itself. They do not move to the buyer’s other entities. The buyer can use them only against the target’s own future taxable income. And they will be subject to the annual cap under Section 382. 26 U.S.C. § 382, 26 U.S.C. § 383

Taxable asset purchase

The buyer buys the target’s assets, not its stock. The target can use its NOLs to offset any gain on the asset sale. But any NOLs left over stay with the shell of the selling corporation. They do not transfer to the buyer. The buyer gets a fresh, stepped up tax basis in the assets, and none of the target’s historic losses. Congressional Research Service

Tax free reorganization

If the transaction fits one of the tax free reorganization forms in Section 368, such as a stock for stock merger, the acquiring corporation steps into the target’s tax attributes under Section 381, including NOLs. But those attributes are then still subject to the Section 382 limitation, exactly as in a stock purchase. I.R.C. § 381, I.R.C. § 382

Section 338(h)(10) election

The buyer and seller can jointly elect under Section 338(h)(10) to treat a stock purchase as a deemed asset sale followed by a deemed liquidation of the old target. The target uses its NOLs to offset any gain on the deemed sale. Any remaining NOLs are extinguished. The buyer gets a stepped up basis in the target’s assets but loses the remaining NOLs. I.R.C. § 338, Macabacus

What is the Section 382 limitation and how does it cap the use of losses?

If the target’s tax losses survive (as in a stock purchase or tax free reorganization), Section 382 stands in the way. It does not erase the losses. It limits how fast the new owner can use them. The purpose is to stop a profitable company from buying a loss company purely to shelter its own income.

A Section 382 study is not a luxury. A company that has raised several venture rounds can cross the 50 percentage point threshold without realizing it. The study quantifies the exact limitation and tells both sides how much of the NOLs is truly usable. Without it, the seller and the buyer are negotiating without knowing the real cap.

When does an ownership change happen?

An ownership change occurs when, over a rolling three year testing period, one or more shareholders who each own at least 5 percent of the company (by value) increase their collective ownership by more than 50 percentage points. Only increases count. The test ignores decreases. I.R.C. § 382(g)(1)

For AI startups that have raised multiple venture rounds, this is an easy pitfall to overlook. Each financing round creates a new public group of investors who each own less than 5 percent. The tax law treats each of those public groups as a single 5 percent shareholder. A Series A, followed by a Series B, and then a Series C within three years can together push the cumulative ownership increase past 50 percentage points, even if no single investor ever buys a controlling stake. Cerini & Associates

How is the annual Section 382 limitation calculated?

The basic annual cap on pre change NOL usage is a simple formula.

Equity value of the loss company immediately before the ownership change times the highest adjusted federal long term rate in effect during the three months up to and including the month of the change.

That rate is called the long term tax exempt rate. In May 2026, the rate is 3.65%. For comparison, in July 2020 it was only 0.89%. The rate rose sharply as broader interest rates climbed. [Rev. Rul. 2026-9] IRS, IRS [Rev. Rul. 2020-14] IRS

An example makes it concrete. An AI startup with $100 million of NOLs is sold. Its equity value right before the ownership change is $500 million. The long term tax exempt rate is 3.65%. The annual Section 382 limitation is $500 million times 3.65%, which is $18.25 million. At that pace, it would take roughly 5.5 years to fully absorb the $100 million of NOLs, even if the company earns far more than $18.25 million each year. I.R.C. § 382(b)(1), Rev. Rul. 2026-9

Unused limit is not wasted. Any portion of the annual cap not used in a given year carries forward and adds to the cap in the next year. I.R.C. § 382(b)(2)

What happens if the business changes after the sale?

Section 382(c) requires continuity of the business enterprise for two full years after the ownership change. The buyer must continue the old loss company’s historic business, or must use a significant portion of its historic assets in a business. If that requirement is violated, the annual cap drops to zero retroactively, and all the pre change NOLs become unusable except to the extent of recognized built in gains under section 382(c)(2). I.R.C. § 382(c)

This rule bites when an AI company is bought mainly for its engineering team or its intellectual property, and the acquirer plans to shut down the legacy product. If the historic business is discontinued within two years, the NOLs vanish.

How are R&D credits treated after an ownership change?

NOLs are not the only tax asset at risk. AI companies often hold large R&D tax credits. Section 383 applies a parallel limitation to excess credits, such as the research credit under Section 41 and the general business credit under Section 39. The amount of those credits that can be used after an ownership change depends on the remaining Section 382 limitation after the pre change NOLs and other losses are absorbed. Treasury regulations lay out a strict ordering sequence. I.R.C. § 383, Treas. Reg. § 1.383-1

In practice, if the annual Section 382 cap is modest and the company uses most of it to absorb NOLs, there may be little room left to apply R&D credits that year. The credits do carry forward, but they stay stuck behind the same cap.

Can pre sale losses offset post sale built in gains?

Sometimes the buyer owns assets whose fair market value is much higher than their tax basis. Those are built in gains. Section 384 generally says that a loss company’s pre acquisition NOLs cannot be used to offset the recognized built in gains of the gain corporation during the five year recognition period that follows the acquisition. Only the gain corporation’s own pre acquisition losses can do that, and only if certain conditions hold. I.R.C. § 384(a)

This stops a profitable company from buying a loss company and then selling its own appreciated assets to burn through the NOLs. An exception exists when the two companies were part of the same controlled group for the entire five years before the acquisition. I.R.C. § 384(b)

There is a mirror image opportunity. If the target itself has a net unrealized built in gain (NUBIG) that exceeds a de minimis threshold (the lesser of $10 million or 15 percent of asset fair market value), any recognized built in gains during the five year recognition period can increase the Section 382 limit for that year. This is particularly relevant for AI companies whose primary assets are intangible, like software and goodwill, and carry a low tax basis and a high market value. Even without selling assets, depreciable intangibles can generate recognized built in gains under existing IRS guidance, effectively lifting the annual cap. Notice 2003-65

Are there other ways the IRS can disallow the losses even if the formulas are met?

Yes. Section 269 is a separate backstop. Even if every mechanical test under Section 382 and 383 is passed, the IRS can disallow the deductions and credits if it finds that the principal purpose of the acquisition was to avoid or evade federal income tax. This is a subjective intent test. The question is whether tax avoidance exceeded in importance any other purpose. Treas. Reg. § 1.269-3(a)

The IRS examines whether the buyer had real business reasons for the deal that were documented and were independent of tax savings. Courts have allowed NOLs when the buyer showed genuine business motivations, such as replacing reserves or diversifying operations. For an AI company acquisition, prepared documentation of the non tax business purpose can be a useful defense. Tax alert

What special rules stop companies from inflating the Section 382 cap?

Congress wrote several rules to prevent a seller from artificially pumping up the equity value used in the cap calculation right before closing.

Anti stuffing rule

Any capital contribution received during the two years before the ownership change is presumed to be part of a plan to increase the Section 382 limitation. If that is the case, the contribution is deducted from the corporation’s equity value for purposes of calculating the cap. I.R.C. § 382(l)(1)

Nonbusiness asset reduction

If at least one third of the loss corporation’s total assets are nonbusiness assets, like cash, marketable securities, or investment assets not used in the active trade or business, the stock value in the Section 382 formula is reduced by the value of those nonbusiness assets above any debt tied to them. A startup that raised significant cash but has not yet deployed it into business assets can be hit by this rule. I.R.C. § 382(l)(4)

What can AI companies do to protect their tax losses before a sale?

Several practical steps help keep the losses usable.

• Run a Section 382 study before every major financing round. The study maps exactly how close the company is to triggering an ownership change. A Section 382 study tracks whether successive funding rounds have triggered an ownership change and is important for due diligence at liquidity events. CohnReznick
• Adopt a shareholder rights plan (poison pill) that restricts any person or group from acquiring more than 4.9 percent of the company’s stock. This discourages a 5 percent shareholder from forming and setting off the test. Bloomberg Tax
• Choose the sale structure with the tax attributes in mind. A taxable stock purchase preserves NOLs inside the target, subject to the cap. An asset purchase does not transfer them. If the buyer wants the NOLs, a stock deal or a tax free reorganization is the path.
• Model the Section 382 cap into the deal price. Buyers adjust the purchase price to reflect the actual after tax value of the NOLs, which is often far less than the face amount. The cap stretches recovery across many years, reducing the present value, and if the NOLs expire or the business continuity test is failed, they can be zero. Breaking Into Wall Street, 26 U.S. Code § 382
• Build and preserve a record of the non tax business purpose for the acquisition. Board minutes, negotiation documents, and contemporaneous analyses help defeat a Section 269 challenge.

Key takeaways

• An AI company’s tax losses can survive a stock purchase or tax free reorganization, but they are trapped by an annual cap under Section 382. Asset purchases do not transfer the losses to the buyer.
• The annual cap equals the loss company’s prechange equity value times the long term tax exempt rate, currently about 3.65%. For a $500 million company, that is roughly $18.3 million per year.
• Multiple venture rounds can quietly trigger an ownership change, suddenly capping NOLs that management believed were fully available.
• R&D credits are separately limited by Section 383 and are often crowded out when the cap is mostly consumed by NOLs.
• Section 384 stops a loss company from sheltering an acquirer’s own built in gains.
• The IRS can still block losses under Section 269 if tax avoidance was the deal’s main purpose, even when the formulas otherwise pass.
• A Section 382 study before any major financing or sale is essential to know how much of the tax attributes is actually usable.

Frequently asked questions

Q:What is a net operating loss?

A:A net operating loss, or NOL, is a tax loss that occurs when a company’s deductible business expenses are larger than its taxable income for the year. The company can use that loss to reduce taxable income in other years. I.R.C. § 172

Q:Can tax losses be transferred to a buyer in an asset sale?

A:No. In a taxable asset purchase, the target’s NOLs stay with the selling corporation. They do not transfer to the buyer. The target can use them to offset gain on the asset sale, but any leftover NOLs are lost to the buyer. Congressional Research Service

Q:What triggers a Section 382 ownership change?

A:An ownership change happens when one or more 5 percent shareholders increase their aggregate ownership by more than 50 percentage points over a rolling three year testing period. Only increases are counted. I.R.C. § 382(g)(1)

Q:How is the Section 382 annual cap calculated?

A:Multiply the loss company’s equity value immediately before the ownership change by the long term tax exempt rate in effect that month. For May 2026, the rate is 3.65%. I.R.C. § 382(b)(1) [Rev. Rul. 2026-9]

Q:Do R&D credits survive a sale?

A:Yes, if the deal is a stock purchase or tax free reorganization. But they are subject to their own limitation under Section 383, which ties their use to the Section 382 cap remaining after the pre change NOLs are absorbed. I.R.C. § 383

Q:Can the IRS disallow losses even if Section 382 is met?

A:Yes. Section 269 lets the IRS disallow deductions and credits if it finds the principal purpose of the acquisition was tax avoidance. Documenting business purpose is essential because Section 269 disallows deductions only when tax avoidance exceeds any other purpose in importance. I.R.C. § 269, Treas. Reg. § 1.269-3

Q:What is the continuity of business enterprise requirement?

A:After an ownership change, the buyer must continue the old loss company’s historic business or use its significant historic assets for at least two years. If that fails, the section 382 limitation for any post-change year is zero, so pre-change NOLs cannot offset post-change income. I.R.C. § 382(c)

Q:How do SAFEs and convertible notes affect Section 382?

A:Convertible instruments can be treated as stock or options for ownership measurement. If they are deep in the money, they may be counted as exercised, which can trigger or accelerate an ownership change. Startups that rely heavily on SAFEs should model this carefully, because whether a SAFE is treated as stock or a forward contract for tax purposes can affect when a Section 382 ownership change occurs, potentially triggering it at issuance rather than at conversion. Practitioner analysis

Q:What is a poison pill and how does it protect NOLs?

A:A shareholder rights plan, often called a poison pill, restricts any investor from buying more than a certain percentage of the company’s stock, often 4.9 percent. This deters a 5 percent shareholder from forming and triggering an ownership change. Bloomberg Tax

Q:Can a company in bankruptcy escape the Section 382 limitation?

A:Yes, under specific conditions. If the loss company is in a Title 11 bankruptcy case and its pre change shareholders and qualified creditors end up owning at least 50 percent of the stock after the ownership change, the Section 382 cap does not apply. However, the NOLs are reduced by certain interest deductions, and if a second ownership change happens within two years, the cap becomes zero. I.R.C. § 382(l)(5)

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Junde Liu, JD, LL.M. (Taxation) candidate at UF Law. Originally published on Compute Law Blog. This article is general information and does not constitute legal advice. Reading it does not create an attorney client relationship. The reader should not act on the basis of any content here without first consulting a licensed attorney in the relevant state. Last reviewed for accuracy May 23, 2026.