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IRS’s Proposed Rehabilitation Tax Credit Regulations Provide Welcome Clarity
The Internal Revenue Service (IRS) recently released proposed regulations concerning the historic rehabilitation tax credit (HTC), including rules to coordinate the new five-year period over which the credit may be claimed with other special rules for investment credit property. The long-awaited rules provide welcome clarity that will allow the historic preservation community to work more confidently with the HTC.
The federal tax reform legislation passed at the end of 2017made some key amendments to the HTC program. Under the 2017 legislation, the 10 percent rehabilitation tax credit was repealed and the 20 percent HTC was modified. Previously, qualified rehabilitation expenditures (QREs) with respect to any qualified rehabilitated building were taken into account for the taxable year in which such qualified rehabilitated building is placed in service. This means that 100 percent of the HTCs were claimed in the tax year the project was placed in service. The new tax law amends the 20 percent HTC to be claimed “ratably” over five years.
Proposed Regulation Overview
The proposed regulations added sections 1.47-7(a) through (e) to address the rules for the new five-year credit, including:
- General rule for calculating the HTC,
- Definitions of ratable share and HTC determined,
- Coordination with IRC Section 50 regarding timing of the basis adjustment, recapture in case of dispositions, and income inclusion related to leased property when the lessee is treated as the owner.
Calculating the HTC
The proposed regulations clarify how the HTC is calculated and claimed. Specifically, the proposed regulation 1.47-7(b) defines the term “ratable share” as the amount equal to 20 percent of HTC determined with respect to the qualified rehabilitated building (QRB), as allocated ratably to each taxable year during the five-year credit period. In addition, proposed regulation 1.47-7(c) defines the term “rehabilitation credit determined” as an amount equal to 20 percent of the QREs taken into account for the taxable year the QRB is placed in service. The proposed regulations clarify that the HTC is determined in the taxable year the QRB is placed in service and allocated over a five-year period for each of those five taxable years, rather than creating five separate rehabilitation credits for a single QRB. This is an important distinction as it provides the foundation for how the changes to IRC 47 under the TCJA interact with certain other provisions within the code, primarily Section 50.
General Coordination with IRC Section 50
When the HTC was amended to be claimed over five years, it was unclear if that meant there were multiple tax credit periods, with each tax credit period commencing when the HTC is claimed, thus five separate tax credit periods. This interpretation would lead to an aggregate tax credit period of 10 years, which the Treasury determined would not be consistent with the written text of the statute as well as the intent of Congress. Therefore, the proposed regulations clarify that there is one five-year tax credit period, which starts from the placed-in-service date of the QREs.
Timing of Basis Adjustment
There has been uncertainty regarding how to account for the section 50(c) basis adjustment to investment credit property (in a direct investment structure) with respect to the timing of when that basis adjustment is accounted for. Prior to the proposed regulations, one possible interpretation for partnerships was the basis adjustment and corresponding capital account adjustment would be recorded as the credits are claimed. However, the proposed regulations provided examples to clarify the section 50(c) basis adjustment is accounted for in the year the QRB is placed-in-service for the full amount of the HTC determined.
Income inclusion under Section 50(d)
Similarly to the timing of the basis adjustment, there has been uncertainty regarding how to account for section 50(d) when the lessee is treated as owner and subject to an income inclusion requirement (in a lease pass-through structure) due to the HTC being claimed over five years. The section 50(d) income, similar to section 50(c) basis adjustment is also calculated on the full amount of HTC determined in the year the QRB is placed-in-service and amortized ratably into income over the shortest depreciable recovery life of the QREs that gave rise to the HTC.
Recapture under Section 50(a)
Coordinating the five-year HTC with recapture provisions under Section 50(a) left much uncertainty as well when it came to determining how the recapture calculation would actually work. As previously discussed herein, where it was unclear if the HTC was actually now multiple tax credit periods, with each tax credit period commencing when the HTC is claimed or is there one tax credit period. Thus with the proposed regulations clarifying that there is one five-year tax credit period, which starts from the placed-in-service date of the QREs, the math behind recapture resulting from dispositions of investment credit property became a bit clearer.
To explain how recapture is determined under the new HTC, the IRS provided an example in the proposed regulations to calculate tax credit recapture in the event of a disposition. The concept that the example below illustrates is how much of the HTC claimed by a taxpayer is recaptured and how much of the remaining HTC is claimable in future periods.
Taxpayer X incurs $200,000 of qualified rehabilitation expenditures and the building is placed in service Oct. 15, 2021. Taxpayer X is eligible to claim total HTCs of $40,000 ($200,000 x 0.20). In 2021 and 2022, X claimed the full amount of the ratable share allowed, or $8,000 per taxable year. X’s total allowable ratable share for 2023 through 2025 is $24,000 ($8,000 allowable per taxable year). On Nov. 1, 2023, X disposes of the qualified rehabilitated building. Because the period between placed in service and recapture event is more than two, but less than three full years, the applicable recapture percentage is 60 percent. Based on these facts, 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 in credits in each of the years 2023 through 2025 ($8,000 x 0.60).
Thus, in summary, a QRB that generated $40,000 of HTCs that was disposed of after two full years caused a recapture of $9,600 (HTC recapture percentage x original amount of credits claimed). However, the taxpayer will continue to claim credits of $3,200 for three more tax years on investment tax credit property that has been disposed of for the remaining three tax years of the original five-year tax credit period.
These regulations are proposed to apply to taxable years beginning on or after the date the Department of the Treasury decision adopting these regulations as final regulations is published in the Federal Register.
Taxpayers may rely on these proposed regulations for QREs paid or incurred after Dec. 31, 2017, in taxable years beginning before the date of the Department of 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.
The proposed regulations provide much clarity with respect to the interaction of certain provisions of section 50 and the post-2017 HTC that taxpayers and tax practitioners have been attempting to determine how to apply. Though these proposed regulations have been long-awaited guidance, they, for the most part, are generally consistent with how tax practitioners have generally been interpreting the new five-year ratable HTC. So there no major surprises, which is welcome news.