Partner treated as lessee, lessor elects to pass through investment tax credits

Partner treated as lessee, investment tax credits

The Treasury Department and IRS today released for publication in the Federal Register temporary regulations (T.D. 9776) and, by cross-reference, proposed regulations (REG-102516-15) concerning the income inclusion rules under section 50(d)(5) that apply to a lessee of investment credit property when a lessor of that property elects to treat the lessee as having acquired the property.


The temporary regulations [PDF 212 KB] also provide: (1) rules to coordinate the section 50(a) recapture rules with the section 50(d)(5) income inclusion rules; and (2) rules regarding income inclusion upon a lease termination, lease disposition by a lessee, or disposition of a partner’s or S corporation shareholder’s entire interest in a lessee partnership or S corporation outside of the recapture period. 

These regulations will affect lessees of investment credit property when the lessor of the property makes an election to treat the lessee as having acquired the property and an investment credit is determined under section 46 with respect to such lessee. 

The proposed regulations [PDF 224 KB] withdraw two notices of proposed rulemaking (from 1985 and 1987). Written comments and requests for a public hearing on today’s proposed regulations must be received by a date that is 90 days after publication in the Federal Register on July 22, 2016.

Income inclusion rules

The preamble explains that today’s regulations provide the income inclusion rules under section 50(d)(5) as applicable to a lessee of investment credit property when a lessor elects to treat the lessee as having acquired the property. 

Generally, if an owner of investment credit property claims the investment tax credit, the owner must reduce the basis in such property by an amount of the investment tax credit (for energy property, the basis is reduced by 50% of the investment tax credit, and for qualified rehabilitation expenditures, the basis is reduced by 100% of the investment tax credit).  However, when the lessor of investment credit property elects to pass through the credit to a lessee under Reg. section 1.48-4, the lessee is deemed as acquiring the property for fair market value. Because the lessee would have no basis in the property that the lessee only deemed to have acquired, the basis adjustment rules do not apply. In lieu of such basis adjustment, the lessee is required to include in gross income over the shortest recovery period applicable under the depreciation rules, an amount equal to 50% of the allowable energy credit amount, and 100% of the allowable rehabilitation credit amount. 

The temporary regulations provide general rules for coordinating the basis adjustment rules with the rules under Reg. section 1.48-4, pursuant to which a lessor may elect to treat the lessee of investment credit property as having acquired the property for purposes of calculating the investment credit. 

Addressing position taken by some partnerships, S corporations

As noted in the preamble, the IRS and Treasury are aware that some partnerships and S corporations have taken the position that this income is includible by the partnership or S corporation and that their partners or S corporation shareholders are entitled to increase their bases in their partnership interests or S corporation stock as a result of the income inclusion. The position of the IRS and Treasury is that such basis increases are inconsistent with congressional intent as this would thwart the purpose of the income inclusion requirement in former section 48(d)(5)(B) and confer an unintended benefit upon partners and S corporation shareholders of lessee partnerships and S corporations that is not available to any other credit claimant.

The IRS and Treasury believe that the burden of income inclusion should match the benefits of the allowable credit. Any 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. Accordingly, the rules that would apply were such gross income an item of income under section 702 or section 1366, such as section 705(a) and (providing for an increase in the partner’s outside basis for items of income) or section 1367(a) (providing for an increase in the S corporation shareholder’s stock basis for items of income), do not apply.

The regulations provide a special rule for partnerships and S corporations. When an election is made to treat such entity as having acquired the investment credit property, each partner or S corporation shareholder that is the “ultimate credit claimant” is treated as the lessee for purposes of the income inclusion rules. An “ultimate credit claimant” is defined as any partner or S corporation shareholder that files Form 6438, Investment Credit, with its income tax return. Thus, each partner or S corporation shareholder that is the “ultimate credit claimant” must include in gross income the credit amount required under the regulations in proportion to the credit amount with respect to such partner or S corporation shareholder. 

The temporary regulations also provide that if after the recapture period but prior to the expiration of the recovery period, there is a lease termination, the lessee disposes of the lease, the lessee make an irrevocable election to include in gross income any remaining income required to be taken into account under Temp. Reg. section 1.50-1T((b)(2) in the tax year in which the lease terminates or is disposed of (or if ultimate credit claimant, in the tax year when that claimant no longer owns its entire direct or indirect interest in the lessee partnership or S corporation).

Applicability date

The temporary regulations apply for investment credit property placed in service on or after September 19, 2016.

Modification of Rev. Proc. 2014-12 (rehabilitation tax credit safe harbor)

With today’s release, the IRS is modifying Rev. Proc. 2014-12—the guidance that establishes the requirements under which the IRS will not challenge partnership allocations of section 47 rehabilitation credits by a partnership to its partners—by deleting references to allocation by a partnership of the income inclusion required under section 50(d)(5) to conform with the regulations.

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