Can OTTI Writedowns be Deducted for Tax Purposes? Date: 7/30/09 The concept of Other than Temporary Impairments (OTTI) on debt securities held by a bank has been around for some time. However, current market conditions have placed it in the spotlight and we expect to see more of these writedowns.   As you are aware, under current GAAP requirements, if a bank doesn’t have both the intent and ability to hold a debt security for a period long enough for its market price to recover from a decline, then the security should be written down to its fair value (FV).  For book purposes, this results in a hit to the bank’s income statement for the credit-loss portion of the FV adjustment. The question arises whether tax treatment will follow book, allowing the deduction to be taken on the tax return.  The answer to this question depends on how the amount of the write down was arrived at.  If one simply looks to one of the various pricing services (Bloomberg or a securities dealer) to obtain a fair market value, then writes the security down to that amount, a tax deduction would likely not meet the requirements to result in a corresponding tax deduction.    If the bank computes the loss based upon a fully-documented credit analysis of the expected future cash flows or underlying collateral, then a tax deduction would have a much better chance of withstanding IRS scrutiny upon audit.  This analysis would not be unlike what a bank would do to justify a partial charge-off on a loan. Assuming the bank performs a proper credit analysis which results in a write down, the amount of the deduction for tax purposes is limited to the lower of the amount determined in the credit analysis or the FV decline.  Thus, while a bank cannot rely alone on a FV from a pricing service, it nonetheless would be well served by obtaining the FV in this manner to determine the limitation on the tax deduction.  Documentation of the analysis and the FV should always be kept in order to provide substantiation to an IRS auditor should one come knocking on the bank’s door in the future.