IRS Clarifies Federal Historic Tax Credit Rulesby
On May 22, the Internal Revenue Service released proposed amendments to Treasury Regulation 1.47-7 concerning the federal historic rehabilitation tax credit, including coordinating the new five-year period over which the credit may be claimed with other rules for the credit.
Below we will discuss the history of the amendments and ultimate impact this clarification has for federal tax credits on qualified rehabilitated buildings and how to apply the special rules relating to recapture, basis adjustment and leased property.
Background and What the Amendments Would Change
Section 13402(a) of the 2017 Tax Cuts and Jobs Act (TCJA) repealed the 10 percent historic rehabilitation credit for pre-1936 buildings, and modified the rules for claiming the 20 percent credit for certified historic structures. For qualified rehabilitated buildings that have not been owned or leased continuously from January 1, 2018 (QRB), the TCJA provided that, for any taxable year during the 5-year period beginning in the taxable year in which a QRB is placed in service (PIS), the rehabilitation credit for such taxable year is an amount equal to the ratable share for the year.
The ratable share for any taxable year is the amount equal to 20 percent of the QREs incurred with respect to the QRB, as allocated ratably to each year during the 5-year period. However, the TCJA did not amend Section 47(b)(1), which provides that QREs with respect to any QRB are taken into account for the taxable year in which PIS of the QRB occurs.
Practitioners questioned whether a single rehabilitation credit amount is to be determined for the PIS year and allocated ratably over the 5-year period, or whether five separate rehabilitation credit amounts are determined for each year of the 5-year period. Practitioners also questioned how to apply the special rules relating to recapture, basis adjustment and leased property.
The proposed regulations provide that a single rehabilitation tax credit amount is properly determined for the PIS year of the QRB and is allocated ratably 20 percent per year over the 5-year period starting with the PIS year, rather than determining five separate rehabilitation credit amounts that would each be allocated over five separate 5-year periods.
The amount of the credit is generally 20 percent of the qualified rehabilitation expenditures (QREs) incurred through the end of the PIS year. However, if the QRB owner claims Section 168(k) bonus first-year depreciation for the QREs, then the credit is 20 percent of the remaining QREs incurred through the end of the PIS year after reduction for the bonus first-year depreciation.
For purposes of applying the credit recapture rules, the proposed amendments similarly confirm that the full credit is determined in the PIS year for the QRB. For a QRB that is leased to a lessee that is treated as the owner of the QREs, the full credit amount also is determined in the PIS year for the QRB to determine the applicable lessee income inclusion requirement.
Example of the Amended Credit in Action
The proposed regulations provide some examples to illustrate the rules. Assume between February 1, 2021 and October 1, 2021, X taxpayer incurred QREs of $200,000 with respect to a QRB. The ARB has a PIS date of October 15, 202 and X’s rehabilitation credit determined in 2021 is $40,000 ($200,000 x 0.20).
For each taxable year during the 5-year period beginning in 2021, the ratable share for such year is $8,000 ($40,000 x 0.20). The amount of X’s basis adjustment in 2021 under Code Section 50(c) is $40,000, the full amount of the rehabilitation credit.
Assume in 2021 and 2022, X claimed the full credit of $8,000 per year. X’s total allowable ratable share for 2023 through 2025 is $24,000 ($8,000 per taxable year). On November 1, 2023, X disposes of the QRB, triggering credit recapture under Code Section 50(a) with an applicable recapture percentage of 60 percent. Then, X has an increase in tax of $9,600 ($16,000 of credit claimed in 2021 and 2022 x 0.60) and has $3,200 of credits remaining in each of 2023 through 2025, after forgoing $4,800 ($8,000 x 0.60) in credits for each of 2023 through 2025.
Now assume X leases non-residential real property from Y. The property is a QRB with a PIS date of October 15, 2021. The amount of Y’s rehabilitation credit is $100,000. And Y elects to treat X as having acquired the property. The shortest recovery period available to the property is 39 years and Y does not reduce its basis in the property under Code Section 50(c).
Pursuant to Code Section 50(d)(5) and Treas. Reg. §1.50-1, the property lessee (X) must include ratably in gross income over 39 years beginning with 2021 an amount equal to $100,000.
Finally, assume AB partnership, with A and B as its partners, leases the nonresidential real property from Y upon the same facts as otherwise stated above. Instead of AB partnership recognizing the Section 50(d)5) income, A and B are the ultimate credit claimants under Treas. Reg. § 1.50-(b)(3)(ii) and must include their allocable shares of the $100,000 credit ratably in gross income over 39 years beginning with 2021.
The amendments confirm existing practices with respect to the credit, and the amendments are expected to be finalized after the comment period. Tax credit investment and syndication transactions are rewarding but complex, and require significant legal analysis and consideration by counsel experienced in such transactions and the multiple issues involved.
The Hirschler Tax Credit Group, including James W.C. Canup, N. Pendelton Rogers, Laura Lee Garrett and Paul H. Davenport contributed to this article.
David Lionberger is a partner at the law firm Hirschler Fleischer in their business section. His practice focuses on taxation and business planning, tax credit transactions, trusts and estates, and mergers and acquisitions. David represents clients ranging from family and closely-held growth and middle market companies to regional and multi-...