05.26.2020 IRS Issues Proposed Regs on Rehabilitation Credit
The IRS has released 26 CFR Part 1, resolving questions regarding the five-year period to claim rehabilitation credits for qualified rehabilitation buildings (QRBs). Prior to the proposed regulation, practitioners were unclear on the special rules of Internal Revenue Code (the Code) sections 47 and 50, relating to recapture, basis adjustment and leased property. Practitioners also were unclear on whether rehabilitation credits are allocated ratably over the five-year period or whether five different rehabilitation credits are determined in each year of the five-year period. Rehabilitation credits are no longer fully allowed in the taxable year the QRB is placed into service but must be claimed ratably over the five-year period beginning in the year the QRB is placed into service. The rehabilitation credit is determined in the year the QRB is placed into service (consistent with prior law).
The proposed section describes coordination with the rules of Code section 50 and makes clear that, for the purposes of applying section 50, the full rehabilitation credit is determined in the first year of the five-year period and then allocated ratably over that five-year period. Determination of the credit in the same manner under section 47 and section 50 provides certainty and reduces the complexities under section 50 that would result if taxpayers were required to determine five separate rehabilitation credits. As noted by the IRS:
“Therefore, taxpayers claiming rehabilitation credits under section 47 with respect to qualified rehabilitation expenditures paid or incurred after December 31, 2017, generally will have the same Federal income tax consequences from the rules under section 50 for recapture, basis adjustment, and leased property as taxpayers claiming the rehabilitation credit under prior law.”
The proposed regulations contain several examples regarding the interplay between Code section 47 and Code section 50. An example relating to section 50(a) recapture is provided below:
“Between February 1, 2021 and October 1, 2021, X, a calendar year C corporation, incurred qualified rehabilitation expenditures of $200,000 with respect to a QRB. X placed the building in service on October, 15, 2021. In 2021 and 2022, X claimed the full amount of the ratable share allowed under Code Sec. 46, or $8,000 per tax 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.”
“Under Code Sec. 50(a)(1)(B)(iii), because the period of time between when the QRB was placed in service is more than two, but less than three full years, the applicable recapture percentage is 60%. Based on these facts, X has an increase in tax of $9,600 under Code Sec. 50(a) ($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 in credits in each of the years 2023 through 2025 ($8,000 x 0.60). (Prop Reg Section 1.47-7(e)(3))"
It should be noted that the regulations make it clear that the full basis adjustment is taken into account at the time the property is placed in service. An open issue is whether such mandate requires the capital account of the members to be adjusted in the year the property is placed in service year or ratably over five years.
The regulations are proposed to apply to taxable years beginning on or after the date the Treasury decision adopting these regulations as final regulations is published in the Federal Register. Taxpayers may rely on these proposed regulations for qualified rehabilitation expenditures paid or incurred after December 31, 2017, in taxable years beginning before the date the Treasury decision adopting these regulations as final regulations is published in the Federal Register, provided the taxpayers follow the proposed regulations in their entirety and in a consistent manner.
Those seeking the proposed regulations in full can find them at federalregister.gov/d/2020-09879.
Please note: This alert contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.