IRS Issues Proposed Regulations on Claiming Rehabilitation Tax Credits
On May 21, 2020, the Internal Revenue Service (the “IRS”) issued guidance on how to claim the rehabilitation tax credit under Section 47 of the Internal Revenue of Code of 1986, as amended (the “Code”). The guidance, in the form of proposed regulations, includes rules to coordinate the new 5-year period over which the credit may be claimed with other special rules for investment credit property.
The proposed regulations were made necessary due to Section 13402(a) of the 2017 Tax Cuts and Jobs Act (TCJA), which modified Section 47 of the Code. Prior to the TCJA, Section 47(a) provided a two-tier credit for qualified rehabilitation expenditures (“QREs”) incurred in connection with the rehabilitation of a qualified rehabilitated building (“QRB”). The credit was as follows: (1) a twenty percent (20%) credit for QREs with respect to a certified historic building, and (2) a ten percent (10%) credit for QREs with respect to a QRB other than a certified historic building (for certain buildings first placed in service before 1936). Both credits were fully allowed in the taxable year the QRB was placed in service. For purposes of the above rule, a QRE generally is any amount properly chargeable to a capital account (i) for property for which depreciation is allowable under Section 168 and which is (I) nonresidential real property, (II) residential rental property, (III) real property which has a class life of more than 12.5 years, or (IV) an addition or improvement to property described in (I), (II), or (III) above, and (ii) in connection with the rehabilitation of a QRB.
The TCJA repealed the ten percent (10%) credit for pre-1936 buildings and modified the rules for claiming the twenty percent (20%) credit for certified historic structures. These amendments were generally applicable to QRE amounts paid or incurred after December 31, 2017. In addition, the credit for certified historical structures remained at twenty percent (20%), but was to be claimed ratably over a 5-year period beginning in the tax year in which the QRB was placed in service. The TCJA also provided for a transition rule, which provided that in the case of QREs (for either a certified historic structure eligible for a twenty percent (20%) credit or a pre-1936 building eligible for a ten percent (10%) credit prior to December 31, 2017), with respect to any building owned or leased by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer or the 60-month period selected by the taxpayer under the rule for phased rehabilitation is to begin no later than the end of the 180-day period beginning on December 22, 2017, and the amendments made the TCJA apply to such QREs paid or incurred after the end of the taxable year in which such 24-month or 60-month period ends.
As amended by the TCJA, Code Section 47(a)(1) provided that, for purposes of the investment credit under Code Section 46, for any taxable year during the 5-year period beginning in the taxable year in which a QRB is placed in service, the rehabilitation credit for such taxable year is an amount equal to the ratable share for the year. Also, as amended by the TCJA, Section 47(a)(2) defined the ratable share for any taxable year during the credit period as the amount equal to twenty percent (20%) of the QREs with respect to the QRB, as allocated ratably to each year during the credit period. Section 47(b)(1), which the TCJA did not amend, provides that QREs with respect to any QRB are taken into account for the taxable year in which the QRB is placed in service.
The proposed regulations provide that the rehabilitation credit is properly determined in the year the QRB is placed in service (consistent with prior law) but allocated ratably over the 5-year period as required by the TCJA, rather than resulting in the determination of five separate rehabilitation credits. Similarly, the proposed regulations follow the same prior law approach for the determination of a single rehabilitation credit for purposes of applying the rules of Section 50. Therefore, taxpayers claiming the rehabilitation credit under Section 47 with respect to QREs paid or incurred after December 31, 2017, generally will have the same Federal income tax consequences from the rules under Section 50 relating to recapture, basis adjustments, and leased property as taxpayers claiming the rehabilitation credit under prior law.
The proposed regulations add §1.47-7(a) through (e) and include: a general rule for calculating the rehabilitation credit; definitions of ratable share and rehabilitation credit determined; and a rule coordinating the changes to Section 47 with the special rules in Section 50. The proposed regulations also contain examples, including examples illustrating the interaction of Section 47 with rules in Section 50(a) (recapture in case of dispositions, etc.), Section 50(c) (basis adjustment to investment credit property), and Section 50(d)(5) (relating to certain leased property when the lessee is treated as owner and subject to an income inclusion requirement). The examples confirm that the credit is claimed evenly over a period of five (5) years and that any depreciable basis adjustment related to the credit is made entirely in the placed-in-service year. In a situation involving a lease where the credit is passed through to the tenant, the full amount of the credit must be amortized over the shortest depreciable life starting in the placed-in-service year.
The proposed regulations apply to taxable years beginning on or after the date the Treasury decision adopting them as final is published in the Federal Register. Taxpayers may rely on these proposed regulations for QREs paid or incurred after December 31, 2017, in taxable years beginning before the date the Treasury decision adopts them as final is published in the Federal Register, provided the taxpayers follow the proposed regulations in their entirety and in a consistent manner. The IRS is requesting that comments on the proposed regulations be submitted electronically by July 21, 2020. A request for a public hearing can also be made.
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