Final Regulations Dealing With Lessees Claiming Investment Credit
IRS final regulations provide rules that apply when the lessor of investment tax credit property elects to pass the credit through to a lessee. If this election is made, the lessee is generally required to include the credit amount in income (50% of the energy investment credit). The income is included in income ratably over the shortest Modified Accelerated Cost Recovery System (MACRS) depreciation period that applies to the investment credit property. No basis reduction is made to the investment credit property. Partners and S shareholders who receive the credit (i.e., the ultimate credit claimants) must make income inclusions in proportion to their share of the credit.
No Basis Increase for Partners and S Shareholders
The regulations resolve a contentious issue against taxpayers. They provide that a partner’s income inclusions are not treated as an item of partnership income under subchapter K. A similar rule applies to S corporations. Therefore, basis adjustment rules that would increase a partner’s outside basis or S Corporation’s shareholder’ stock basis if the income inclusion amounts were treated as items of income do not apply. The IRS says its interpretation is appropriate because the investment credit and limitations on the investment credit are determined at the partner and S shareholder level.
Coordination with Recapture Rules
If a recapture event occurs, an adjustment is made to the lessee’s (or ultimate claimant’s) gross income to account for any difference between the amounts that were included in income and the credit that is allowed after recapture. Special rules are provided when the amount of the unrecaptured credit exceeds the income inclusions and when the income inclusions exceed the unrecaptured credit.
Election to Accelerate Income Inclusion Upon Lease Termination
The lessee (or ultimate claimant) may make an irrevocable election to include any remaining income inclusion amounts in gross income in the tax year in which a lease terminates. If a partner or S shareholder disposes of its partnership or S corporation interest, the partner or S shareholder may also make an irrevocable election to include remaining inclusion amounts in income in the year of disposition. These elections may only be made if the recapture period has expired and a recapture event had not occurred during the recapture period.
Effective Date
The final regulations were effective July 17, 2019 and apply to investment credit property placed in service on or after September 19, 2016.
For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).