Brookfield US Inc. is fighting a $4.3 million tax bill and an $861,709 penalty after the IRS rejected how Brookfield claimed losses from picking up Lehman Brothers leftovers in bankruptcy. The Tax Court hasn’t weighed in yet.
Procedural Status
Brookfield filed a petition to fight the IRS’s August 2026 notice of deficiency for its 2018 taxes. Yes, the wheels of tax justice turn slowly.
The IRS reduced Brookfield’s claimed net operating loss (NOL) deduction by $20,516,891. An NOL generally arises when allowable tax deductions exceed taxable income and may offset income in other tax years, subject to statutory limitations.
The IRS determined:
Income tax deficiency: $4,308,547.
Section 6662 penalty: $861,709.
Disputed NOL deduction reduction: $20,516,891.
Brookfield disputes the entire deficiency and penalty.
The filing presents Brookfield’s allegations and legal arguments. It does not establish the facts in dispute or provide a judicial determination of the applicable tax treatment.
Why It Matters
Bankruptcy exception to loss limitations. The dispute concerns whether a corporate acquisition qualifies for the section 382(l)(5) exception, which can permit a corporation emerging from bankruptcy to use pre-change NOLs without the ordinary annual limitation imposed after an ownership change.
Constructive ownership of stock. The IRS challenges the consequences of a two-stage acquisition in which Brookfield first purchased minority equity interests and debt, then acquired complete common stock ownership through a bankruptcy restructuring. The dispute concerns whether the earlier agreement effectively accelerated an ownership change for section 382 purposes.
Substance over form and tax avoidance. The IRS separately invokes substance-over-form principles and section 269. These arguments raise questions about whether legitimate commercial objectives and compliance with a tax provision's literal requirements are sufficient when a transaction also preserves valuable tax attributes.
Limits of the development. This is a taxpayer petition, not a ruling. It identifies a significant dispute over acquired tax losses but establishes no judicial interpretation or precedent. The IRS’s underlying notice and any subsequent government response are not included in the supplied source.
Key Facts
Lehman Brothers Holdings Inc. filed for bankruptcy on September 15, 2008. Its restructuring ultimately involved numerous subsidiaries, creditor claims, and asset liquidations.
Its remaining subsidiaries included Lehman Brothers U.K. Holdings (Delaware) Inc. (LUK) and Lehman Pass-Through Securities Inc. (LPTSI).
LUK held investment assets, intercompany claims, and approximately $8.9 billion in NOL carryforwards. LPTSI held mortgage-backed securities, other financial assets, and approximately $1 billion in NOL carryforwards.
In 2016, Lehman’s investment banker, Houlihan Lokey, approached Brookfield about acquiring the subsidiaries and their remaining assets.
Brookfield maintains that it pursued the acquisitions to obtain investments at favorable prices while preserving the value of the acquired entities, including their tax attributes.
At the time of internal investment approval, Brookfield allocated approximately $703 million of the aggregate transaction value to investment assets and $280 million to a premium that included value attributable to the NOLs.
The transactions proceeded in two stages.
First transaction: August 10, 2017
Brookfield acquired 45% of the outstanding common stock of each subsidiary and the notes owed by those subsidiaries to Lehman.
Brookfield paid $485 million at closing and subsequently paid $80 million in incentive payments tied to collections on certain intercompany claims.
Total consideration under the stock and note purchase agreement reached $565 million.
The agreement also contemplated subsequent Chapter 11 proceedings and capital restructurings.
Brookfield maintains that the initial transaction transferred genuine legal and economic ownership interests. It also asserts that completion of the contemplated bankruptcy restructurings remained uncertain.
Second transaction: March 15, 2018
LUK and LPTSI filed a joint Chapter 11 petition on August 31, 2017.
The bankruptcy Court confirmed their reorganization plan on March 9, 2018. The plan became effective on March 15, 2018.
Under the LUK restructuring:
Brookfield exchanged its existing 45% common stock interest and its ownership of LUK debt for 100% of LUK’s restructured common stock.
Lehman exchanged its remaining 55% common stock interest for preferred stock carrying a $345 million liquidation preference.
The restructuring eliminated LUK's outstanding debt.
LUK redeemed Lehman’s preferred stock by June 15, 2018.
Lehman ultimately received $804 million for its former debt and equity interests in LUK, including payments under the original purchase agreement.
LPTSI underwent a similar restructuring, and Lehman ultimately received $181 million for its interests in that company.
LUK subsequently became Brookfield Special Opportunities Inc. and joined Brookfield’s consolidated federal income tax group.
Brookfield claims that the restructuring satisfied the statutory requirements allowing continued use of LUK’s NOLs without the ordinary ownership-change limitation.
Statutory and Regulatory Framework
Section 382(a) generally restricts a loss corporation’s ability to use pre-change NOLs after a qualifying change in ownership. The annual limitation generally depends on the corporation’s value immediately before the ownership change and the applicable long-term tax-exempt rate.
Section 382(l)(5) provides an exception for certain ownership changes involving corporations under bankruptcy Court jurisdiction. The exception generally requires qualifying pre-change shareholders and creditors to own at least 50% of the reorganized corporation’s stock, measured by vote and value, as a result of their previous interests.
Section 382(l)(3)(A) and its implementing regulations address constructive stock ownership, including circumstances in which options can affect the timing and measurement of ownership changes.
Section 269(a) authorizes the IRS to disallow specified tax benefits arising from certain acquisitions undertaken principally to evade or avoid federal income tax.
Section 6662 provides accuracy-related penalties, including a penalty for substantial understatement of income tax. Section 6751(b)(1) generally requires written supervisory approval of the initial penalty determination, subject to statutory exceptions.
Arguments
Taxpayer argued:
Brookfield advances four principal defenses.
1. The restructuring qualified for section 382(l)(5).
Brookfield contends that the March 2018 restructuring satisfied the objective requirements of the bankruptcy exception.
Immediately before the ownership change, LUK operated under bankruptcy Court jurisdiction.
After the restructuring, Brookfield owned all of LUK’s common stock. According to the petition, Brookfield received 61.33% of that common stock by reason of its pre-restructuring common stock ownership.
Brookfield also held LUK debt before the restructuring.
It argues that the preferred shares issued to Lehman do not count as stock for section 382 purposes because they lacked voting rights, participation in corporate growth, and other characteristics of common equity.
Brookfield therefore maintains that the restructuring satisfied the statutory ownership requirements.
2. Constructive ownership rules do not accelerate the ownership change.
Brookfield disputes the IRS’s asserted application of the constructive ownership rules.
The petition characterizes the IRS’s position as treating the 2017 stock and note purchase agreement as an option deemed exercised when the agreement closed.
Brookfield argues that the agreement did not constitute an option under Treasury Regulation §1.382-4(d)(9).
Alternatively, Brookfield maintains that:
The bankruptcy reorganization exception in Treasury Regulation §1.382-9(o)(1) prevents application of the relevant option rules.
The agreement does not satisfy the regulatory ownership, control, or income tests for treating an option as exercised.
The agreement qualifies for the regulatory safe harbor applicable to certain contracts to acquire stock.
Brookfield contends that the August 2017 transaction and March 2018 restructuring produced distinct legal and economic consequences.
3. Substance-over-form principles and section 269 do not justify disallowance.
Brookfield argues that the two-stage acquisition reflected genuine commercial arrangements rather than artificial steps designed principally to avoid section 382.
The petition identifies several business objectives:
Acquiring investment assets at attractive prices.
Providing funds for distributions to Lehman creditors.
Resolving uncertainty surrounding undisclosed liabilities.
Preserving the commercial value of LUK and LPTSI.
Integrating the acquired assets and employees into Brookfield’s existing businesses.
Brookfield emphasizes that the bankruptcy Court confirmed the reorganization plan after finding that the plan had legitimate business purposes, resulted from arm’s-length negotiations, and did not have tax avoidance as its principal purpose.
Those findings concern the bankruptcy proceeding. The Tax Court has not determined their significance for the federal income tax dispute.
Brookfield separately argues that section 269 does not apply because avoiding federal income tax was not the principal purpose of the acquisitions.
It also maintains that LUK conducted more than an insignificant business during and after the bankruptcy proceedings, contesting the application of Treasury Regulation §1.269-3(d).
4. The accuracy-related penalty is unwarranted.
Brookfield disputes the $861,709 penalty on four alternative grounds:
It did not understate its 2018 income tax.
The IRS has not demonstrated compliance with the written supervisory approval requirements of section 6751(b)(1).
Substantial authority supported its interpretation of section 382(l)(5).
Brookfield had reasonable cause and acted in good faith.
The petition does not establish whether the IRS obtained supervisory approval. It alleges that the IRS has not demonstrated compliance.
IRS position, as described in the petition:
The constructive ownership rules require limiting the claimed NOL deduction.
Substance-over-form principles justify the same adjustment because Brookfield structured the acquisition to avoid the section 382 limitation.
Section 269 independently permits disallowance because the acquisition principally sought to avoid federal income tax.
The resulting tax understatement supports an accuracy-related penalty under section 6662.
These positions come from Brookfield’s description of the notice of deficiency. The supplied document does not contain an independent statement of the government’s complete arguments.
Result
Brookfield is asking the Tax Court to reinstate the disputed $20,516,891 NOL deduction, to remove the $4,308,547 deficiency and the $861,709 penalty and to allow any appropriate computation adjustments or refund. The petition makes no mention of any court decision on those requests.
The Takeaway
Corporate taxpayers buying businesses with large NOLs should be aware of the difference between the statutory requirements for preserving those NOLs and the separate risks of constructive ownership, transaction substance and anti-avoidance rules. Brookfield's petition is a good example of how the IRS can attack various aspects of the same transaction even where the taxpayer is claiming to be in compliance with the bankruptcy exception.
The case will not alter the law unless a later judicial decision establishes a controlling interpretation.
List of Citations
IRC §382(a): Establishes the general annual limitation on the use of pre-change losses after an ownership change.
IRC §382(g): Defines an ownership change for purposes of the loss limitation.
IRC §382(l)(5): Provides the bankruptcy exception at the center of the dispute.
IRC §382(l)(3)(A): Addresses constructive ownership relevant to applying section 382 in bankruptcy-related ownership changes.
IRC §382(k)(6)(A): Defines stock for purposes of section 382, including exclusions relevant to certain preferred shares.
Treas. Reg. §1.382-2(a)(3): Supplies regulatory rules regarding stock classifications.
Treas. Reg. §1.382-4(d): Governs the treatment of options in determining ownership changes.
Treas. Reg. §1.382-9(o)(1): Addresses options associated with qualifying bankruptcy reorganizations.
IRC §269(a): Authorizes disallowance of certain tax benefits arising from acquisitions undertaken principally for federal income tax avoidance.
Treas. Reg. §1.269-3(d): Addresses the application of section 269 in specified acquisition circumstances, including considerations involving business activity.
IRC §6662: Governs accuracy-related penalties, including substantial understatement penalties.
IRC §6751(b)(1): Establishes the written supervisory approval requirement for covered penalties.
IRC §6213(a): Governs petitions seeking Tax Court redetermination of deficiencies.