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Temp regs clarify income inclusion rules for lessees of investment credit property

T.D. 9776, 07/21/2016; Reg. § 1.50-1T; Preamble to Prop Reg 07/21/2016; Prop Reg § 1.50-1

IRS has issued temporary regs, the text of which also serves as the text of contemporaneously issued proposed regs (collectively referred to as the temporary regs), that provide guidance on the income inclusion rules under Code Sec. 50(d)(5) applicable to a lessee of investment credit property when a lessor of such property elects to treat the lessee as having acquired it. They also coordinate such rules with the recapture rules under Code Sec. 50(a). In addition, they provide rules regarding income inclusion upon a lease termination, lease disposition by a lessee, or disposition of a partner’s or S corporation shareholder’s entire interest in a lessee partnership or S corporation outside of the recapture period.

Background. Code Sec. 50(d)(5) provides that, for purposes of the investment credit, rules similar to former Code Sec. 48(d) (relating to certain leased property), as in effect on the day before the enactment of Revenue Reconciliation Act of 1990, apply.

Former Code Sec. 48(d)(1) permitted a lessor of new “section 38 property” to elect to treat that property as having been acquired by the lessee for an amount equal to its fair market value (or, if the lessor and lessee were members of a controlled group of corporations, equal to the lessor’s basis). If such a “pass-through” election was made (i.e., to pass the credit from the lessor to the lessee), under former Code Sec. 48(d)(3), the lessee would be treated as having acquired such property. Code Sec. 50(a)(5)(A) replaced the term “section 38 property” with “investment credit property.”

Under former Code Sec. 48(q), the basis of property that qualified for the investment credit generally was to be reduced by 50% of the amount of the credit determined (or 100% in the case of a credit for qualified rehabilitation expenditures). However, when taxpayers made the former Code Sec. 48(d) election, the basis reduction under former Code Sec. 48(q) didn’t apply. Instead, former Code Sec. 48(d)(5)(B) required the lessee to include in income, over the shortest recovery period which could apply under Code Sec. 168 with respect to the property, an amount equal to 50% of the amount of the credit allowable under section 38 to the lessee with respect to such property (100% in the case of the rehabilitation credit) (“income inclusion rules”).Code Sec. 50(c) replaced former Code Sec. 48(q) and provides the current basis adjustment rules.

Former Code Sec. 48(d)(5)(C) provided that, in the case of a disposition of property to which former Code Sec. 47 (i.e., the former recapture rules) applied, the income inclusion rules of former Code Sec. 48(d)(5) would be applied in accordance with IRS regs. Code Sec. 50(a) replaced former Code Sec. 47 and provides the current recapture rules.

New temporary regs. The temporary regs provide the applicable rules that IRS has determined are similar to the rules of former Code Sec. 48(d)(5). The temporary regs are limited in scope to the income inclusion rules that apply when a lessor elects under Reg. § 1.48-4 to treat the lessee as having acquired investment credit property (the Reg. § 1.48-4 election).

No basis adjustment. The current basis adjustment rules under Code Sec. 50(c) do not apply when the Reg. § 1.48-4 election is made. (Reg. § 1.50-1T(b)) Thus, the lessor is not required to reduce its basis in the property by the amount of the investment credit determined under Code Sec. 46 (or 50% of the amount of the credit in the case of the energy credit under Code Sec. 48). (Reg. § 1.50-1T(b)(1))

Income inclusion rules. In lieu of a basis adjustment, a lessee must include in gross income an amount equal to the amount of the credit (or, in the case of the Code Sec. 48 energy credit, 50% of the amount of the credit) determined under Code Sec. 46. (Reg. § 1.50-1T(b)(2)) Generally, the lessee includes such amount ratably over the shortest recovery period applicable under the accelerated cost recovery system provided in Code Sec. 168, beginning on the date the investment credit property is placed in service and continuing on each one year anniversary date thereafter until the end of the applicable recovery period. The amount required to be included by the lessee is not subject to any limitations under Code Sec. 38(c) on the amount of the credit allowed based on the amount of the lessee’s income tax. (Reg. § 1.50-1T(b)(2)(i))

Special rule—partnerships and S corporations. In the case of a partnership (other than an electing large partnership) or an S corporation for which the Reg. § 1.48-4 election is made, gross income includible under the income inclusion rules (above) is not an item of partnership income or an item of S corporation income subject to the rules of Subchapter K or Subchapter S, respectively. Rather, each partner or S corporation shareholder that is the “ultimate credit claimant” is treated as the lessee and must include in gross income the amounts required under Reg. § 1.50-1T(b)(2) in proportion to the amount of the credit determined under Code Sec. 46 (or 50% of the energy credit under Code Sec. 48) with respect to the partner or shareholder. (Reg. § 1.50T-1(b)(3)(i)) An ultimate credit claimant is any partner or S corporation shareholder that files (or that would file) Form 3468, “Investment Credit” (or its successor), with such partner’s or shareholder’s income tax return to claim the investment credit determined under Code Sec. 46 that results in the corresponding income inclusion. (Reg. § 1.50T-1(b)(3)(ii))

Coordination with recapture rules. If the investment credit recapture rules under Code Sec. 50(a) are triggered (including if there is a lease termination), causing a recapture of the credit or a portion thereof, Reg. § 1.50-1T(c) provides that an adjustment will be made, in the year in which the property is disposed of or otherwise ceases to be investment credit property, to the lessee’s (or ultimate credit claimant’s) gross income for any discrepancies between the income inclusions under Reg. § 1.50-1T(b)(2) and the total credit allowable after recapture. If the amount of the unrecaptured credit (i.e., the allowable credit after taking into account the recapture amount), or 50% of the unrecaptured credit in the case of the Code Sec. 48 energy credit, exceeds the prior income inclusions under Reg. § 1.50-1T(b)(2), then the lessee’s/ultimate credit claimant’s gross income is increased by the excess of the amount of the credit that is not recaptured (or 50% of the unrecaptured credit in the case of the energy credit) over the amount of prior income inclusions under Reg. § 1.50-1T(b)(2). (Reg. § 1.50-1T(c)(1); Reg. § 1.50-1T(c)(3)) If, on the other hand, the income inclusions prior to recapture exceed the unrecaptured credit (or 50%, in the case of the Code Sec. 48 energy credit), the lessee’s (or ultimate credit claimant’s) gross income is reduced by an amount equal to the excess of the total prior income inclusions under Reg. § 1.50-1T(b)(2) over the amount of the credit that is not recaptured (50% in the case of the energy credit). (Reg. § 1.50-1T(c)(2); Reg. § 1.50-1T(c)(3))

Election to accelerate income inclusion outside recapture period. A lessee may make an irrevocable election under Reg. § 1.50-1T(d)(1) (an “acceleration election”) to include in gross income any remaining income inclusions under Reg. § 1.50-1T(b)(2) in the tax year in which the lease terminates or is otherwise disposed of. A similar election may be made by an ultimate credit claimant that disposes of its entire interest in a partnership (other than an electing large partnership) or an S corporation. An acceleration election can be made only outside of the Code Sec. 50(a) recapture period, and only if the lessee or the ultimate credit claimant was not already required to accelerate the income inclusions under Reg. § 1.50-1T(b)(2) due to a recapture event during the recapture period. Additionally, a former partner or S corporation shareholder that owns no interest in the lessee partnership or S corporation may not make an acceleration election at the time of a termination or disposition of the lease by the lessee partnership or S corporation—rather, the appropriate time is the tax year that it disposes of its entire interest in the lessee partnership or S corporation. (Reg. § 1.50-1T(d)(2)) The acceleration election must be made by the due date (including any extension) of the lessee’s return, or, in the case of a partnership or S corporation, by the due date (including any extension) of the ultimate credit claimant’s return for the tax year in which the relevant event (e.g., lease termination, disposition of interest in the lessee partnership) occurs. The election is made by including the remaining gross income in the tax year of the relevant event. (Reg. § 1.50-1T(d)(3))

Applicability date. The temporary regs apply with respect to investment credit property placed in service on or after Sept. 19, 2016 (i.e., 60 days after the regs’ filing date), and will expire on or before July 19, 2019. (Reg. § 1.50-1T(f); Reg. § 1.50-1T(g))

Effect on prior Rev Proc. Rev Proc 2014-12, 2014-3 IRB 415 (see Weekly Alert ¶  8  01/02/2014) is modified by T.D. 9776, by: (i) changing all references to allocations of Code Sec. 47 rehabilitation credits to refer instead to allocations of qualified rehabilitation expenditures under Code Sec. 47(c)(2); and (ii) deleting the sentences in Rev Proc 2014-12, Sec. 3 and Rev Proc 2014-12, Sec. 4.07 that refer to allocation by a partnership of the income inclusion required under Code Sec. 50(d)(5).

References: For investment tax credits of lessors and lessees, see FTC 2d/FIN ¶  L-16506; United States Tax Reporter ¶  504; TaxDesk ¶  381,403; TG ¶  14807.

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