On July 17, 2019, the US Internal Revenue Service (IRS) issued final regulations (T.D. 9872) providing guidance on the rules under Internal Revenue Code (IRC) section 50(d)(5) requiring an income inclusion by the lessee in the so-called “pass-through lease” structure. In this structure, the lessor of investment tax credit property elects to pass through the investment tax credit to the lessee, and the lessee claims the investment tax credit as if it acquired the property for its fair market value.
The final regulations adopt, without change, the proposed regulations (REG-102516-15) issued in July 2016. The corresponding temporary regulations (T.D. 9776) are removed. The final regulations apply to investment tax credit property placed in service after September 18, 2016, which corresponds to the applicability date of the temporary regulations. The proposed and temporary regulations are discussed in more detail in this July 25, 2016 Legal Update. Accordingly, this Legal Update does not discuss the rules in detail; instead, it focuses on taxpayer comments. In addition, it discusses modifications to Revenue Procedure 2014-12, which is the safe harbor for transactions involving IRC section 47 rehabilitation credits.
The regulations clarify that the gross income inclusion is not an item of partnership income or an item of S corporation income to which the rules of subchapter K or subchapter S apply. One commenter requested that the US Treasury Department (Treasury) and the IRS reconsider those rules based on a concern that the operation of the rules will decrease the amount of investment that flows into the credit programs, which will result in less cash available for projects. The commenter also expressed a related concern that requiring credit claimants to identify and track the income inclusion will add additional complexity to the investments. The Treasury and the IRS determined that the burden of income inclusion should match the benefits of the allowable credit. It follows that, because the investment credit and any limitations on the credit are determined at the partner or shareholder level, the final regulations adopt the rule from the proposed regulations that provides that the gross income required to be ratably included is not an item of partnership income for purposes of subchapter K or an item of S corporation income for purposes of subchapter S. Therefore, the basis adjustment rules that would apply if that gross income were an item of income under IRC section 702 or IRC section 1366 do not apply. In the preamble, the Treasury and the IRS further explained their conclusion, addressing congressional intent and case law.
The regulations allow a lessee or an ultimate credit claimant, under certain circumstances, to elect to accelerate the income inclusion outside the IRC section 50(a) recapture period. The final regulations do not adopt a suggested “basis reduction election” because the Treasury and the IRS determined that election would allow participants in investment credit leasing transactions to unwind the transactions after the IRC section 50(a) recapture period.
The regulations require a lessee or an ultimate credit claimant to include ratably in gross income, over the shortest recovery period that could be applicable under IRC section 168, an amount equal to the credit. The final regulations do not adopt a suggestion to allow a lessee or ultimate credit claimant to calculate the income inclusion based on the depreciation methods and conventions applicable to the underlying investment tax credit property.
Modifications to Revenue Procedure 2014-12
The final regulations also modify Revenue Procedure 2014-12 (Rev. Pro. 2014-12), which was issued in January 2014 in response to the decision in Historic Boardwalk Hall, LLC v. Commissioner, 694 F.3d 425 (3d Cir. 2012), cert. denied, 133 S.Ct. 2734 (2013) and which provides the requirements under which the IRS will not challenge a partnership’s allocation of IRC section 47 rehabilitation credits to its partners. The final regulations modify Rev. Pro. 2014-12 by changing all references to allocation of IRC section 47 rehabilitation credits to refer instead to allocations of qualified rehabilitation expenditures under IRC section 47(c)(2). Additionally, the final regulations modify Revenue Procedure 2014-12 by removing any references to allocation by a partnership of the income inclusion required under IRC section 50(d)(5). Comments are requested as to whether additional guidance under IRC section 50(a) is needed to coordinate recapture of the rehabilitation credit in light of changes made to IRC section 47(c) by the Tax Cuts and Jobs Act.