Income inclusion clarified on investment credit property

Tax Hot Topics newsletterThe IRS issued final regulations (T.D. 9872) for income inclusion when a lessee is treated as having acquired investment credit property. The final rules adopt previously issued temporary regulations without modification. They are effective as of July 17, 2019, and apply to investment credit property placed in service on or after Sept. 19, 2016.

A lessor of investment credit property (e.g., qualified rehabilitation or energy credit property) may elect under Treas. Reg. Sec. 1.48-4 to treat the lessee of the property as having acquired the property solely for purposes of the credit. The lessor retains ownership of the property (and the corresponding depreciation deductions), and the lessee claims the credit available under the applicable rules. Section 50(d)(5) provides that in lieu of the lessor having a basis reduction for the credit claimed (by the lessee), the lessee of such property has an income inclusion in the same amount of the credit (or 50% of the credit in the case of the energy credit).

The final regulations provide the rules for the income inclusion by the lessee. Generally, the income must be recognized ratably over the shortest recovery period that could be available under Section 168 for the credit property, without regard to any elections by the lessor of the property or limitations on the amount of the credit utilized under Section 38(c). If the lease is terminated within the credit recapture period, then the income inclusion is generally accelerated as a component of the recapture calculation. However, if the lease is terminated outside the credit recapture period, then the lessee may generally elect to accelerate the income inclusion.

The regulations provide a special rule for partnerships and S corporations that are lessees of property that treats the income inclusion as separate from partnership or S corporation income. The partner or S corporation shareholder is treated as the ultimate credit claimant, and the shareholder is directly allocated the income inclusion in proportion to the credit allocated under Section 46. As the ultimate credit claimant, the income recapture rules and special election described above generally apply to each individual partner or S corporation shareholder.

Sharon Kay
Washington National Tax Office
T +1 202 861 4140

John Suttora
Managing Director
Washington National Tax Office
T +1 202 521 1523

Caleb Cordonnier
Washington National Tax Office
T +1 202 521 1555

Jason Seo
Senior Associate
Washington National Tax Office
T +1 202 521 1556

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