September 18, 2020
IRS issues final regulations on rehabilitation credits without change
The IRS has released final regulations (TD 9915) on the rehabilitation credits for historic buildings under IRC Section 47, as amended by the Tax Cuts and Jobs Act (TCJA). These credits must be allocated ratably over five years, beginning in the tax year the building was placed into service. In addition, the final regulations contain a rule on how to coordinate the new requirements with the investment credits related to recapture, basis adjustment and leased property.
The final regulations adopted the proposed regulations without modification (see Tax Alert 2020-1402).
In August 2020, the IRS had extended the deadline for taxpayers to satisfy the requirements of the substantial rehabilitation test, which is required before claiming the rehabilitation credit, until March 31, 2021 (see Tax Alert 2020-1985).
Former IRC Section 47(a) established a two-tier credit for qualified rehabilitation expenditures (QREs) incurred in rehabilitating a qualified rehabilitated building. The credit was fully allowed in the tax year the qualified rehabilitated building was placed in service. The former credit amounts were 20% for QREs for a certified historic structure and 10% for QREs for a QRB first placed in service before 1936.
The TCJA repealed the 10% credit for pre-1936 qualified rehabilitated buildings and modified the rules for claiming the 20% credit for historic structures. Under the post-TCJA rules, the 20% credit must be claimed ratably over five years, beginning in the tax year in which the qualified rehabilitated building was placed in service.
The post-TCJA rules apply to QREs paid or incurred after December 31, 2017, except if: (1) the taxpayer owned or leased the building on January 1, 2018, and continues to own or lease the building after that date, and (2) the 24- or 60-month period selected by the taxpayer for phased rehabilitation begins by June 20, 2018. The pre-TJCA credit structure still applies to QREs that fall under these conditions.
The final regulations adopted the proposed regulations, which clarified that the rehabilitation credit is properly determined in the year the qualified rehabilitated building is placed in service. Regarding investment credits under IRC Section 50, the final regulations follow the same pre-TCJA approach for determining a single rehabilitation credit in applying the IRC Section 50 rules on recapture, basis adjustment and leased property. As a result, claiming the rehabilitation credit under IRC Section 47 for QREs paid or incurred after December 31, 2017, generally will have the same federal income tax consequences as the rules under IRC Section 50.
Details in Treas. Reg. Section 1.47-7
The final regulations add Treas. Reg. Section 1.47-7(a) through (e).
Treas. Reg. Section 147-7(a): For purposes of the investment credit under IRC Section 46, the rehabilitation credit for the year is the ratable share for any tax year during the five-year period.
Treas. Reg. Section 147-7(b): A "ratable share" is 20% of the "rehabilitation credit determined" for the qualified rehabilitated building, as allocated ratably to each tax year during the five-year credit period.
Treas. Reg. Section 147-7(c): The "rehabilitation credit determined" is 20% of the QREs under IRC Section 47(b)(1) for the tax year in which the qualified rehabilitated building is placed in service. If the taxpayer claims the additional first year depreciation for the QREs under Treas. Reg. Section 1.168(k)-2(g)(9), however, the "rehabilitation credit determined" is 20% of the remaining rehabilitated basis of the QRB for the tax year in which the qualified rehabilitated building is placed in service.
Treas. Reg. Section 147-7(d): The rehabilitation credit for the purpose of IRC Section 50 is determined in the same manner as for IRC Section 47.
Treas. Reg. Section 147-7(e): This regulation contains examples illustrating the interaction of IRC Section 47 with rules in IRC Section 50(a) (recapture in case of dispositions), IRC Section 50(c) (basis adjustment to investment credit property) and IRC Section 50(d)(5) (relating to certain leased property when the lessee is treated as owner and subject to an income-inclusion requirement).
Preamble addresses partnerships
The Preamble to the final regulations stated that the IRS received three comments about the proposed regulations. While two comments agreed with the proposed regulations, a third comment raised the issue of the interaction of the new rules under IRC Section 47 and the partnership accounting rules under IRC 704.
In the Preamble, the IRS said that, while the partnership rules were addressed in the regulations to IRC 704, and therefore not in IRC Section 47 regulations, "the Treasury Department and the IRS agree that there would be a capital account adjustment that would not take into account the [five]-year credit period. In other words, the full amount of the capital account adjustment under [Treas. Reg. Section] 1.704-1 is reflected in a partner's capital account in the year the rehabilitation credit is determined."
In addition, the IRS noted that the rehabilitation credit is calculated at the partner level and claimed by the partner ratably over the five-year credit period. Under the pre-TCJA IRC Section 47, it added, the partnership allocates QREs to its partners, and then QREs with respect to any qualified rehabilitated building are taken into account for the tax year in which the QRB is placed in service.
Finally, the Preamble said that partners compute the investment credit at the partner level based on partner-level limitations.
While there were no changes to the regulations as part of the finalization process, the Preamble clarified an important issue for tax-equity investors. It simplifies the structuring of tax-equity transactions by clarifying that (1) the QREs are allocated in the year in which the project is placed in service and (2) the taxpayer then calculates the tax credit based on the QREs. This approach avoids the potential for reallocation of tax credits after Year 1 if other tax attributes are reallocated under IRC Section 704(b).