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07.21.2016

After much delay, the IRS released today new temporary and proposed regulations (Temp. Reg. § 1.50-1T) addressing the income inclusion rules under section 50(d)(5) of the Internal Revenue Code of 1986, as amended (“Code”) that apply to a lessee of investment credit property when a lessor of such property elects to treat the lessee as having acquired the property and passes investment credit to the lessee under Section 50(d) of the Code.  Investment credits include, for example, historic rehabilitation, low-income housing, new market and energy investment and production credits.

When the election is made to pass investment credits to a lessee under Section 50(d), the lessee must recognize income in an amount equal to the investment credits over the shortest recovery period applicable to the property generating the investment credits, which has been referred to a “§ 50(d) income” to the lessee.  The temporary regulations provide rules regarding such § 50(d) income inclusion upon a lease termination, as well as upon disposition of a partner’s or S corporation shareholder’s entire interest in a lessee partnership or S corporation outside of the recapture period.  The temporary regulation will have an important impact on lessees of investment credit property, and investors in lessees of investment credit property, and how such investment are structured.

The temporary regulation creates a new requirement that the “ultimate credit claimant” in a lessee partnership or S corporation must include in gross income the amount required under Code § 1.50-1T(b)(2) in proportion to the amount of the investment credit allocated to such “ultimate credit claimant”.  An “ultimate credit claimant” is a partner or S corporation shareholder that files (or that would file) IRS Form 3468 claiming an allocation of investment credit on such partner’s or shareholder’s income tax return.  The required income inclusion would apply notwithstanding other allocations or terms of the lessee partnership’s partnership or operating agreement.  The Treasury Department and the IRS based their position (that such income inclusion be mandated to apply to the “ultimate credit claimant”) on their belief that the burden of such income inclusion should match the benefits of the allowable investment credit.

The temporary regulations go on to provide that the § 50(d) income required to be ratably included is not an item of partnership income or S corporation income, and therefore rules applicable to items of partnership and S corporation income (importantly, such as an increase in the partner’s or shareholder’s outside basis for items of partnership income) simply do not apply.  As a result, the lessee partner or shareholder that must recognize the § 50(d) income does not receive the benefit of increased basis in the partnership or stock interest in the lessee.

The temporary regulation notes that under the Code if the investment credit is recaptured, any § 50(d) income remaining to be recognized must be accelerated and included in income of the “ultimate credit claimant” in the year that recapture occurs.  However, once the recapture period applicable to the investment credit has expired, the temporary regulations further provide that a lessee or an “ultimate credit claimant” may make an irrevocable election to accelerate and include in gross income any remaining § 50(d) income required to be taken into account in the taxable year in which the lease is terminated.  Moreover, a former partner or S corporation shareholder that owns no direct or indirect interest in the lessee partnership or S corporation at the time of lease termination may not elect to accelerate the § 50(d) income at the time of a lease termination.

If an “ultimate credit claimant” disposes of its entire interest, either directly or indirectly, in a lessee partnership or S corporation, the “ultimate credit claimant” may make an irrevocable election to accelerate and include in gross income any remaining § 50(d) income required to be taken into account in the taxable year in which the “ultimate credit claimant” no longer owns a direct or indirect interest in the lessee of the investment credit property. The temporary regulation notes that the appropriate time for a former partner or S corporation shareholder that is an “ultimate credit claimant” to elect income acceleration is the taxable year that such “ultimate credit claimant” disposes of its entire interest in a lessee partnership or S corporation.

The election to accelerate the § 50(d) income inclusion must be made by the due date (including any extension of time) of the lessee’s return, or, in the case of an “ultimate  credit claimant” partner or S corporation shareholder, by the due date (including any extension of time) of the “ultimate credit claimant’s” return for the taxable year in which the relevant event occurs (for example, the lease termination, lease disposition, or “ultimate credit claimant’s” disposition of its entire interest in the lessee partnership or S corporation). The election is made by including the remaining § 50(d) income in the taxable year of the relevant event.

The temporary regulations go into effect with respect to investment credit property planed in service on or after September 19, 2016.  However, the IRS has stated that “[t]he temporary regulations should not be construed to create any inference concerning the proper interpretation of section 50(d)(5) prior to the effective date of the regulations.”

Structuring, capitalizing and/or investing in, and successfully concluding real estate and other projects that generate investment credits continue to require careful planning and structuring utilizing experienced counsel, accountants, investors and other financing parties.  Hirschler Fleischer’s Tax Credit Group remains at the forefront in structuring investment projects for developers and owners, investors, banks and financial institutions involving a variety of investment tax credits including, historic, low-income, new market and energy credits (investment and production).  The Tax Credit Group assists developers, real estate companies and landowners with projects intended to generate these credits, and structures, negotiates and prepares the partnership and/or other investment documents and vehicles for syndicating such credits. In addition, the Tax Credit Group counsels investors, investment entities, banks and financial institutions in structuring partnerships, private investment funds (including opportunity funds) and private development entities interested in investing in or financing such credit projects.  Hirschler Fleischer’s Tax Credit Group is ready to assist you with projects involving such credits.

Media Contact

Kristen M. Chatterton
804.771.5637
kchatterton@hirschlerlaw.com

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