84 FR 34775 - Income Inclusion When Lessee Treated as Having Acquired Investment Credit Property

This document contains final regulations that provide guidance concerning the income inclusion rules under section 50(d)(5) of the Internal Revenue Code (Code) that are applicable to a lessee of investment credit property when a lessor of such property elects to treat the lessee as having acquired the property. These final regulations also provide rules to coordinate the section 50(a) recapture rules with the section 50(d)(5) income inclusion rules. In addition, these final regulations provide 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. Accordingly, 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.

[Federal Register Volume 84, Number 139 (Friday, July 19, 2019)]
[Rules and Regulations]
[Pages 34775-34782]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2019-15497]



[[Page 34775]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9872]
RIN 1545-BM74


Income Inclusion When Lessee Treated as Having Acquired 
Investment Credit Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that provide guidance 
concerning the income inclusion rules under section 50(d)(5) of the 
Internal Revenue Code (Code) that are applicable to a lessee of 
investment credit property when a lessor of such property elects to 
treat the lessee as having acquired the property. These final 
regulations also provide rules to coordinate the section 50(a) 
recapture rules with the section 50(d)(5) income inclusion rules. In 
addition, these final regulations provide 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. Accordingly, 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.

DATES: 
    Effective date: These regulations are effective on July 17, 2019.
    Applicability date: For date of applicability, see Sec.  1.50-1(f).

FOR FURTHER INFORMATION CONTACT: Barbara J. Campbell or Michael J. 
Torruella Costa, (202) 317-4137 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

I. Overview

    This document amends the Income Tax Regulations (26 CFR part 1) to 
finalize rules under section 50(d)(5) of the Code. On July 22, 2016, 
the Department of the Treasury (Treasury Department) and the IRS 
published in the Federal Register a notice of proposed rulemaking by 
cross-reference to temporary regulations ((REG-102516-15) (81 FR 
47739)) (proposed regulations) and final and temporary regulations ((TD 
9776) (81 FR 47701)) (temporary regulations) that amended Sec.  1.50-1 
of the Income Tax Regulations. On September 23, 2016, the Treasury 
Department and the IRS published corrections to the temporary 
regulations in the Federal Register (81 FR 65541). (Subsequent 
references in this preamble to the temporary regulations are to the 
temporary regulations as so corrected.) The Treasury Department and the 
IRS received two written comments on the proposed regulations. No 
requests for a public hearing were made, and no public hearing was 
held. After consideration of the comments received, these final 
regulations adopt the proposed regulations without modification.

II. Section 50 Background

    Section 50(d) provides special rules applicable to the investment 
credit determined under section 46 (investment credit property). 
Section 50(d)(5) provides the income inclusion rules applicable to a 
lessee of investment credit property when a lessor elects to treat the 
lessee as having acquired the property. Section 50(d)(5) provides that, 
for purposes of the investment credit, rules similar to former section 
48(d) (as in effect prior to the enactment of the Revenue 
Reconciliation Act of 1990 (Pub. L. 101-508, 104 Stat 1388 (November 5, 
1990))) apply.
    Former section 48(d)(1) permitted a lessor of new section 38 
property to elect to treat that property as having been acquired by the 
lessee for an amount equal to its fair market value (or, if the lessor 
and lessee were members of a controlled group of corporations, equal to 
the lessor's basis). Former section 48(d)(3) provided that if the 
lessor made the election provided in former section 48(d)(1) with 
respect to any such property, the lessee would be treated for all 
purposes of subpart E, part IV, subchapter A, Chapter 1, subtitle A, as 
having acquired such property. Section 50(a)(5)(A) replaced the term 
``section 38 property'' with the term ``investment credit property.''
    Under former section 48(q), if a credit was determined under 
section 46 with respect to section 38 property, the basis of the 
property was reduced by 50 percent of the amount of the credit 
determined (or 100 percent of the amount of the credit determined in 
the case of a credit for qualified rehabilitation expenditures). Former 
section 48(d)(5) provided specific rules coordinating the effect of the 
former section 48(d) election with the basis adjustment rules under 
former section 48(q). Because the lessee would have no basis in the 
property that the lessee was deemed to have acquired pursuant to the 
election, former section 48(d)(5)(A) provided that the basis adjustment 
rules under former section 48(q) did not apply. Section 50(c) replaced 
former section 48(q) and provides the current basis adjustment rules.
    In lieu of a basis adjustment, former section 48(d)(5)(B) provided 
that the lessee was required to include ratably in gross income, over 
the shortest recovery period which could be applicable under section 
168 with respect to the property, an amount equal to 50 percent of the 
amount of the credit allowable under section 38 to the lessee with 
respect to such property. In the case of the rehabilitation credit, 
former section 48(q)(3) provided that former section 48(d)(5)(B) was to 
be applied without the phrase ``50 percent of.''
    Former section 48(d)(5)(C) provided that, in the case of a 
disposition of property to which former section 47 (the former 
recapture rules) applied, the income inclusion rules of former section 
48(d)(5) applied in accordance with regulations prescribed by the 
Secretary. Section 50(a) replaced former section 47 and provides the 
current recapture rules.
    The temporary regulations provide the applicable rules that the 
Secretary determined are similar to the rules of former section 
48(d)(5). The temporary regulations are limited in scope to the income 
inclusion rules that apply when a lessor elects under Sec.  1.48-4 to 
treat the lessee as having acquired investment credit property.
    The temporary regulations provide general rules for coordinating 
the basis adjustment rules under section 50(c) (the successor to former 
section 48(q)) with the rules under Sec.  1.48-4 pursuant to which a 
lessor may elect to treat the lessee of investment credit property as 
having acquired such property for purposes of calculating the 
investment credit. Similar to the rule in former section 48(d)(5)(A), 
which provided that the basis adjustment rules under former section 
48(q) did not apply when a Sec.  1.48-4 election was made, the 
temporary regulations provide that section 50(c) does not apply when 
the election is made. Thus, the lessor is not required to reduce its 
basis in the property by the amount of the investment credit (or 50 
percent of the amount of the credit in the case of the energy credit 
under section 48) determined under section 46.
    The temporary regulations require that, in lieu of a basis 
adjustment, and similar to the rule contained in former section 
48(d)(5)(B), a lessee must include in gross income an amount

[[Page 34776]]

equal to the amount of the credit (or 50 percent of the amount of the 
credit in the case of the energy credit under section 48) determined 
under section 46. The lessee includes the amount ratably over the 
shortest recovery period applicable under the accelerated cost recovery 
system provided in section 168, beginning on the date the investment 
credit property is placed in service and continuing on each one-year 
anniversary date thereafter until the end of the applicable recovery 
period. The amount required to be included by the lessee is not subject 
to any limitations under section 38(c) on the amount of the credit 
allowed based on the amount of the lessee's income tax.
    Because section 50(c) replaces the old basis adjustment rules under 
former section 48(q), the amount the lessee is required to include in 
gross income under the temporary regulations corresponds to the current 
basis adjustment amounts required under section 50(c), rather than the 
former basis adjustment amounts provided in former section 48(q).
    The temporary regulations include special rules for partnerships 
and S corporations. In the case of a partnership (other than an 
electing large partnership) or an S corporation for which an election 
is made under Sec.  1.48-4 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 under the temporary regulations. 
The term ultimate credit claimant is defined in the temporary 
regulations as any partner or S corporation shareholder that files (or 
that would file) Form 3468, ``Investment Credit'' (or its successor 
form), with such partner's or S corporation shareholder's income tax 
return to claim the investment credit determined under section 46 that 
results in the corresponding income inclusion under the temporary 
regulations. Each partner or S corporation shareholder that is the 
ultimate credit claimant must include in gross income the amount 
required under the temporary regulations in proportion to the amount of 
the credit determined under section 46 (or 50 percent of the amount of 
the credit in the case of the energy credit under section 48) with 
respect to the partner or S corporation shareholder.
    The temporary regulations also coordinate the income inclusion 
rules with the credit recapture rules in section 50(a). The temporary 
regulations provide that, when the investment credit recapture rules 
under section 50(a) are triggered (including when there is a lease 
termination), causing a recapture of the credit or a portion of the 
credit, an adjustment will be made to the lessee's (or, as applicable, 
the ultimate credit claimant's) gross income for any discrepancies 
between the total amount included in gross income under the income 
inclusion requirement in the temporary regulations and the total credit 
allowable after recapture. The adjustment amount is taken into account 
in the taxable year in which the property is disposed of or otherwise 
ceases to be investment credit property. The temporary regulations 
provide rules for when the amount of the unrecaptured credit (that is, 
the allowable credit after taking into account the recapture amount, or 
50 percent of the unrecaptured credit in the case of the energy credit) 
exceeds the income inclusion, and when the income inclusion exceeds the 
unrecaptured credit.
    The temporary regulations also allow a lessee or an ultimate credit 
claimant to make an irrevocable election to include in gross income any 
remaining income required to be taken into account under Sec.  1.50-
1T(b)(2) in the taxable year in which the lease terminates or is 
otherwise disposed of. Similarly, the temporary regulations provide 
that if an ultimate credit claimant disposes of its entire interest, 
either direct or indirect, in a partnership (other than an electing 
large partnership) or an S corporation, the ultimate credit claimant 
may make an irrevocable election to include in gross income any 
remaining income required to be taken into account by the temporary 
regulations in the taxable year of the disposition. The availability of 
this election allows a lessee or an ultimate credit claimant to account 
for any remaining required gross income inclusion in the taxable year 
in which the lease terminates or is otherwise disposed of or in which 
an ultimate credit claimant exits its investment.
    This election is available only outside of the section 50(a) 
recapture period, and only if the lessee or the ultimate credit 
claimant was not already required to accelerate the gross income 
required to be included under Sec.  1.50-1T(b)(2) because of a 
recapture event during the recapture period. Additionally, a former 
partner or S corporation shareholder that no longer owns a direct or 
indirect interest in the lessee partnership or S corporation may not 
elect to accelerate the gross income required to be included under the 
temporary regulations at the time of a termination or disposition of 
the lease by the lessee partnership or S corporation. 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 it disposes of its entire interest in a lessee partnership or 
S corporation.

Summary of Comments and Explanation of Provisions

I. Reconsideration of the Special Rule for Partnerships and S 
Corporations

    The temporary regulations (Sec.  1.50-1T(b)(3)) 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 Treasury 
Department and the IRS reconsider the rules in Sec.  1.50-1T(b)(3) 
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.
    As explained in the preamble to the temporary regulations, because 
the investment credit and any limitations on the credit itself are 
determined at the partner or S corporation shareholder level it is 
appropriate that the income inclusion occurs at the partner or 
shareholder level. In the case of a partnership that owns the 
investment credit property, a partner in a partnership is treated as 
the taxpayer with respect to the partner's share of the basis of 
partnership investment credit property under Sec.  1.46-3(f)(1) and 
separately computes the investment credit based on its share of the 
partnership's basis in the investment credit property. Similarly, in 
the case of a lessee partnership where the lessor makes an election 
under Sec.  1.48-4 to treat the partnership as having acquired 
investment credit property, each partner in the lessee partnership is 
the taxpayer with respect to whom the investment credit is determined 
under section 46. Each partner in the lessee partnership will 
separately compute the investment credit based on each partner's share 
of the investment credit property. The credit is therefore computed at 
the partner level based on partner level limitations. Section 1.704-
1(b)(4)(ii), which requires allocations with respect to the investment 
tax credit provided by section 38 to be made in accordance with the 
partners' interests in the partnership, provides that allocations of 
cost or qualified investment (as opposed to the investment credit 
itself, which is

[[Page 34777]]

not determined at the partnership level) made in accordance with Sec.  
1.46-3(f) shall be deemed to be made in accordance with the partners' 
interests in the partnership.
    Under similar principles, in the case of a lessor that makes an 
election under Sec.  1.48-4 to treat a lessee S corporation as having 
acquired investment credit property, each shareholder in the lessee S 
corporation is the taxpayer with respect to whom the investment credit 
is determined under section 46. The credit is therefore computed at the 
S corporation shareholder level based on shareholder level limitations.
    The Treasury Department and the IRS have determined that the burden 
of income inclusion should match the benefits of the allowable credit. 
Therefore, because the investment credit and any limitations on the 
credit are determined at the partner or shareholder level, these 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. Accordingly, the basis 
adjustment rules that would apply if such gross income was an item of 
income under section 702 or section 1366, such as section 705(a) 
(providing for an increase in a partner's outside basis for items of 
partnership income) or section 1367(a) (providing for an increase in an 
S corporation shareholder's stock basis for items of S corporation 
income), do not apply.
    When the temporary regulations were issued, the Treasury Department 
and the IRS were aware that some partnerships and S corporations had 
taken the position that this income is includible by the partnership or 
S corporation and that their partners or S corporation shareholders 
were entitled to increase their bases in their partnership interests or 
S corporation stock as a result of the income inclusion. The Treasury 
Department and the IRS determined that such basis increases are 
inconsistent with Congressional intent as they 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 investment credit rules operate to allow a taxpayer to claim 
the benefit of the credit in exchange for the recoupment of that amount 
(or 50 percent of that amount in the case of the section 48 energy 
credit) over time. Where the taxpayer claiming the credit owns the 
investment credit property, the basis reduction provided in section 
50(c) results in reduced cost recovery deductions over the life of the 
property or the realization of gain (or a reduction in the amount of 
loss realized) upon the disposition of the property. In the case of a 
lessor that elects under Sec.  1.48-4 to treat the lessee of investment 
credit property as having acquired such property, Sec.  1.50-1T(b)(2) 
instead requires the lessee to ratably include this amount in gross 
income over the life of the property.
    If that lessee is a partnership or an S corporation, however, some 
partnerships and S corporations contend that this income inclusion is 
treated as an item of partnership or S corporation income that entitles 
their partners or S corporation shareholders to a corresponding outside 
basis increase under section 705(a) or section 1367(a). If these 
partners or S corporation shareholders were entitled to an outside 
basis increase equal to their share of the income inclusion, they would 
be able to claim an offsetting loss (or reduce the amount of gain 
realized) upon the disposition of their partnership interests or S 
corporation shares.
    As noted, the Treasury Department and the IRS have concluded that 
the income inclusion is not properly treated as an item of partnership 
income or of S corporation income. Nonetheless, had the Treasury 
Department and the IRS determined otherwise, the Treasury Department 
and the IRS have decided that in addition to being inconsistent with 
the purpose of section 48(d)(5)(B), allowing a basis increase for the 
income inclusion would also be inconsistent with the purpose of 
sections 705 and 1367. The income to be included is a notional amount, 
which has no current or future economic effect on the basis of assets 
held by a partnership or S corporation. In general, Congress intended 
for sections 705 and 1367 to preserve inside and outside basis parity 
for partnerships and S corporations so as to prevent any unintended tax 
benefit or detriment to the partners or shareholders. See H.R. Rep. No. 
1337, 83d Cong., 2d Sess. A225 (1954); S. Rep. No. 1622, 83d Cong., 2d 
Sess. 384 (1954); H.R. Rep. No. 97-826, 97th Cong., 2d Sess. p. 17 
(1982); S. Rep. No. 97-640, 97th Cong., 2d Sess. 16, 18 (1982); and 
Rev. Rul. 96-11 (1996-1 CB 140). Ultimately, the Treasury Department 
and the IRS have determined that, under any approach, allowing partners 
and S corporation shareholders a basis increase to offset the income 
inclusion required by the temporary regulations upon disposition of 
their partnership interests or S corporation shares is inappropriate, 
and that Congress did not intend to allow partners and S corporation 
shareholders the full benefit of the credit without any of the 
corresponding burden.
    Additionally, the Treasury Department and the IRS are aware that 
one practitioner questioned whether the Supreme Court's holding in U.S. 
v. Basye, 410 U.S. 441 (1973), is contrary to the position taken in the 
temporary regulations that the notional income created under section 
50(d)(5) is not an item of partnership income computed under section 
703. In Basye, the partnership entered into a contractual arrangement 
whereby a portion of the payments it received for services rendered was 
redirected to a trust established for the benefit of the partnership's 
partner and non-partner physicians. The payments were not forfeitable 
by the partnership or recoverable by the payor upon the happening of 
any contingency. The Court held that because the payments represented 
compensation for services rendered by the partnership, the partnership 
was required to include them in current income and each partner was 
required to include his distributive share of those amounts in his 
income. The Court stated:

    This conclusion rests on two familiar principles of income 
taxation, first, that income is taxed to the party who earns it and 
that liability may not be avoided through an anticipatory assignment of 
that income, and, second, that partners are taxable on their 
distributive or proportionate shares of current partnership income 
irrespective of whether that income is actually distributed to them.

Basye at 447-448.
    The Treasury Department and the IRS believe that Basye is 
inapplicable to the determination that the notional income created 
under section 50(d)(5) is not an item of partnership income computed 
under section 703. Unlike the income at issue in Basye, the income 
created under section 50(d)(5) is not ``earned'' by the partnership. It 
has no economic effect as it is merely a notional item created to mimic 
the effect of the basis adjustment under former section 48(q) with 
respect to a lessee. Further, treating it as a partnership income item 
would generate an inappropriate basis increase to the partners under 
section 705 that would allow them to take a non-economic loss.

II. Basis Reduction Election

    The temporary regulations (Sec.  1.50-1T(c)) allow a lessee or an 
ultimate

[[Page 34778]]

credit claimant, under certain circumstances, to elect to accelerate 
the income inclusion outside of the section 50(a) recapture period 
(income acceleration election). This income acceleration election is 
available in the taxable year in which the lease terminates or is 
otherwise disposed of or when an ultimate credit claimant disposes of 
their entire interest in the partnership or the S corporation. One 
commenter requested that the final regulations permit the lessor and 
lessee of investment credit property, together with the ultimate credit 
claimant, to make an irrevocable ``basis reduction election.'' This 
election would allow the lessor of investment credit property to reduce 
the basis of the property by the remaining amount of the ultimate 
credit claimant's income inclusion in lieu of requiring the ultimate 
credit claimant to continue to account for the income inclusion or make 
the income acceleration election. The commenter suggested that the 
``basis reduction election'' be permitted after the recapture period 
when a lease termination occurs or when an ultimate credit claimant 
disposes of their entire interest in the partnership or S corporation. 
The commenter requested that the Treasury Department and the IRS adopt 
the ``basis reduction election'' based on policy considerations the 
Treasury Department and the IRS took into account when incorporating 
the income acceleration election in the temporary regulations.
    As previously noted, the investment credit rules operate to allow a 
taxpayer to claim the benefit of the credit in exchange for the 
recoupment of that amount (or 50 percent of that amount in the case of 
the section 48 energy credit) over time. In the case of a lessee, in 
lieu of a basis adjustment, and similar to the rule contained in former 
section 48(d)(5)(B), the lessee (or an ultimate credit claimant) must 
include in gross income an amount equal to the amount of the credit (or 
50 percent of the amount of the credit in the case of the energy credit 
under section 48) determined under section 46. The Treasury Department 
and the IRS did consider the administrative convenience and reduced 
reporting burden for taxpayers when permitting the income acceleration 
election. The Treasury Department and the IRS also determined that such 
an election is consistent with the applicable rules in former section 
48(d)(5)(B), because a lessee (or an ultimate credit claimant) that 
benefitted from the credit is the appropriate party to recognize the 
gross income inclusion described in the statute.
    The Treasury Department and the IRS have determined that the 
suggested ``basis reduction election'' is inconsistent with the 
applicable rules in former section 48(d)(5)(B) because the election 
would allow the lessee or ultimate credit claimant that recognized the 
benefit of the credit to transfer the burden of the offsetting income 
inclusion to the lessor. The suggested ``basis reduction election'' 
would essentially permit participants in investment credit leasing 
transactions to unwind the transactions after the section 50(a) 
recapture period. For these reasons, the Treasury Department and the 
IRS do not adopt this recommendation in the final regulations.

III. Amount of Credit Included Ratably in Gross Income

    The temporary regulations (Sec. Sec.  1.50-1T(b)(2) and (3)) 
require a lessee or an ultimate credit claimant to include ratably in 
gross income, over the shortest recovery period which could be 
applicable under section 168 with respect to that property, an amount 
equal to the amount of the credit (or 50 percent of the amount of the 
energy credit under section 48). The temporary regulations made 
applicable the rule in former section 48(d)(5) that required the lessee 
of investment credit property to recognize the gross income inclusion 
over the shortest applicable recovery period under section 168. One 
commenter suggested that the final regulations allow a lessee or 
ultimate credit claimant to calculate the income inclusion based on the 
depreciation methods and conventions applicable to the underlying 
investment credit property. The commenter described an example where an 
owner-lessor of investment credit property elects to depreciate rental 
property over 40 years instead of over the usual 27\1/2\ year recovery 
period, and the lessee or ultimate credit claimant reports the 
offsetting income inclusion over the same 40-year period instead of the 
shortest recovery period. The commenter suggested that the approach is 
equitable and can be justified under the ``rules similar to'' language 
in section 50(d)(5), which provides that for purposes of the investment 
credit, rules similar to former section 48(d) apply.
    The Treasury Department and the IRS have determined that the 
applicable rules from the temporary regulations (Sec.  1.50-1T(b)(2) 
and (3)) are the correct interpretation of the language in section 
50(d)(5). A rule that permits a lessee or ultimate credit claimant to 
calculate the income inclusion based on the depreciation methods and 
conventions applicable to the underlying investment credit property is 
dissimilar to the rule in former section 48(d)(5)(B), because it 
contradicts the plain language of the statute. Adopting a rule that 
would allow a lessor or an ultimate credit claimant to recognize the 
income inclusion over a longer recovery period would facilitate an 
inappropriate income deferral, and create additional reporting and 
monitoring burden. For these reasons, the Treasury Department and the 
IRS are not adopting this recommendation in the final regulations.

IV. Request for Comments in the Proposed Regulations

    The preamble to the proposed regulations included a specific 
request for comments regarding whether guidance is needed to address 
the applicability of the income inclusion rules under section 50(d)(5) 
to trusts, estates, and/or electing large partnerships. No comments 
were received in response to this request. However, the Treasury 
Department and the IRS are aware that, given the reference to electing 
large partnerships, some questioned how the temporary regulations would 
interact with the centralized partnership audit regime enacted as part 
of the Bipartisan Budget Act of 2015. Such guidance is beyond the scope 
of these final regulations.

V. Effective and Applicability Dates

    The temporary regulations were effective on July 22, 2016, and 
applicable to investment credit property placed in service on or after 
the date that is 60 days after the date of filing in the Federal 
Register (September 19, 2016). The preamble to the temporary 
regulations states that the effective date of the regulations should 
not be construed to create any inference concerning the proper 
interpretation of section 50(d) prior to the effective date of the 
regulations. Both commenters requested that the final regulations 
clarify the treatment of pre-effective date transactions.
    Both commenters also requested that the effective date be modified 
to limit the application of the rules for investment partnership 
transactions entered into in prior years. Both commenters noted that 
different portions of a project could be placed in service both before 
and after the effective date, because some historic rehabilitation 
projects involve multiple placed in service dates (for example, if a 
project involves renovating multiple buildings over a period of years). 
One commenter proposed to deem an entire project as placed in service 
on the first

[[Page 34779]]

placed in service date when contemporaneous evidence shows that the 
project will include more than one building. The other commenter 
suggested that the effective date be based on timing of investment in 
the investment partnership, rather than the placed in service date.
    The Treasury Department and the IRS do not adopt these 
recommendations in the final regulations. These final regulations are 
effective on July 17, 2019, and are applicable to investment credit 
property placed in service on or after September 19, 2016. Section 
7805(b)(1)(B) provides that a final regulation may apply to a taxable 
period ending on or after the date on which a proposed or temporary 
regulation to which the final regulation relates was filed with the 
Federal Register. The applicability date of the rules in the final 
regulations is September 19, 2016, the same date as the applicability 
date of the rules as set forth in the temporary regulations. Those 
regulations were issued as temporary regulations to address investment 
credit transactions in which partnerships and S corporations treated 
the income inclusion as an item of partnership or S corporation income 
that entitled their partners or S corporation shareholders to a 
corresponding outside basis increase under section 705(a) or section 
1367(a). Such a basis increase would allow these partners or S 
corporation shareholders to claim an inappropriate loss (or reduce the 
amount of gain realized) upon the disposition of their partnership 
interests or S corporation shares. Revising the rules in accordance 
with commenters' suggestions would conflict with the purpose of these 
regulations. Accordingly, the applicability date of the final 
regulations corresponds to the applicability date of the temporary 
regulations. Similar to the temporary regulations, the applicability 
date of these final regulations should not be construed to create any 
inference concerning the proper interpretation of section 50(d) prior 
to the applicability date of these regulations.

VI. Revenue Procedure 2014-12

    As explained in the Effect on Other Documents section of TD 9776, 
the temporary regulations modified Revenue Procedure 2014-12 (2014-3 
IRB 415). Because these final regulations remove the temporary 
regulations from the Federal Register, this Treasury decision includes 
an identical modification to Rev. Proc. 2014-12 in the Effect on Other 
Documents section. Rev. Proc. 2014-12 establishes the requirements 
under which the IRS will not challenge partnership allocations of 
section 47 rehabilitation credits by a partnership to its partners. 
Section 3 states that Rev. Proc. 2014-12 does not address how a 
partnership is required to allocate the income inclusion required by 
section 50(d)(5). Furthermore, section 4.07 of Rev. Proc. 2014-12 
provides that, solely for purposes of determining whether a partnership 
meets the requirements of that section, the partnership's allocation to 
its partners of the income inclusion required by section 50(d)(5) shall 
not be taken into account.
    Because Sec.  1.704-1(b)(4)(ii) provides that allocations of cost 
or qualified investment, and not the investment credit itself (which is 
not determined at the partnership level), made in accordance with Sec.  
1.46-3(f) shall be deemed to be made in accordance with the partners' 
interests in a partnership, this Treasury decision modifies Rev. Proc. 
2014-12 by changing all references to allocations of section 47 
rehabilitation credits to refer instead to allocations of qualified 
rehabilitation expenditures under section 47(c)(2). Additionally, 
because Sec.  1.50-1(b)(3) provides that the gross income required to 
be included under section 50(d)(5) is not an item of partnership income 
to which the rules of subchapter K apply, this Treasury decision 
modifies Rev. Proc. 2014-12 by deleting the sentences in section 3 and 
section 4.07 that refer to allocation by a partnership of the income 
inclusion required under section 50(d)(5).

VII. Recapture of the Rehabilitation Credit

    These regulations finalize the rules described in Sec.  1.50-1T(c) 
that coordinate the credit recapture rules in section 50(a) with the 
income inclusion rules in Sec.  1.50-1T(b)(2) and (3). These final 
regulations incorporate the rule from the temporary regulations 
requiring the lessee or ultimate credit claimant to make an adjustment 
to gross income for any discrepancies between the total amounts 
included in gross income under the income inclusion rules and the total 
unrecaptured credit. When the temporary regulations were published in 
2016, section 47(a) provided that the rehabilitation credit was 20% of 
the qualified rehabilitation expenditures (QREs) with respect to a 
certified historic structure. Section 47(a) was amended by section 
13402 of the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054, 
2134 (TCJA). Section 47(a)(1) now provides that for any taxable year 
during the 5-year period beginning in the taxable year in which the 
qualified rehabilitated building is placed in service, the 
rehabilitation credit for the year is an amount equal to the ratable 
share. Section 47(a)(2) defines the ratable share as 20 percent of the 
qualified rehabilitation expenditures with respect to the qualified 
rehabilitated building, as allocated ratably to each year during the 
period. The TCJA did not amend section 47(b), which provides that 
qualified rehabilitation expenditures with respect to any qualified 
rehabilitated building are taken into account for the taxable year in 
which the building is placed in service. These final regulations adopt 
the rules from the temporary regulations, but the Treasury Department 
and the IRS request comments addressing whether additional guidance 
under section 50(a) is needed to coordinate recapture of the 
rehabilitation credit.

Effect on Other Documents

    Rev. Proc. 2014-12 (2014-3 IRB 415) is modified by: (1) Changing 
all references to allocations of section 47 rehabilitation credits to 
refer instead to allocations of qualified rehabilitation expenditures 
under section 47(c)(2); and (2) deleting the sentences in section 3 and 
section 4.07 that refer to allocation by a partnership of the income 
inclusion required under section 50(d)(5).

Statement of Availability of IRS Documents

    Rev. Proc. 2014-12 (2014-3 IRB 415) is published in the Internal 
Revenue Bulletin (or Cumulative Bulletin) and is available from the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations. Therefore, a 
regulatory impact assessment is not required. Because these regulations 
do not impose a collection of information on small entities, the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 
Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact on small businesses. No comments were received from the 
Small Business Administration.

[[Page 34780]]

Drafting Information

    The principal authors of these temporary regulations are Barbara J. 
Campbell and Michael J. Torruella Costa, Office of the Associate Chief 
Counsel (Passthroughs and Special Industries), IRS. However, other 
personnel from the Treasury Department and the IRS participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.50-1T to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.50-1 is revised to read as follows:


Sec.  1.50-1  Lessee's income inclusion following election of lessor of 
investment credit property to treat lessee as acquirer.

    (a) In general. Section 50(d)(5) provides that, for purposes of 
computing the investment credit, rules similar to the rules of former 
section 48(d) (relating to certain leased property) (as in effect on 
the day before the date of the enactment of the Revenue Reconciliation 
Act of 1990 (Pub. L. 101-508, 104 Stat. 1388 (November 5, 1990))) 
apply. This section provides rules similar to the rules of former 
section 48(d)(5) that the Secretary has determined shall apply for 
purposes of determining the inclusion in gross income required when a 
lessor elects to treat a lessee as having acquired investment credit 
property.
    (b) Coordination with basis adjustment rules. In the case of any 
property with respect to which an election is made under Sec.  1.48-4 
by a lessor of investment credit property to treat the lessee as having 
acquired the property--
    (1) Basis adjustment. Section 50(c) does not apply with respect to 
such property.
    (2) Amount of credit included ratably in gross income--(i) In 
general. A lessee of the property must include ratably in gross income, 
over the shortest recovery period which could be applicable under 
section 168 with respect to that property, an amount equal to the 
amount of the credit determined under section 46 with respect to that 
property. The ratable income inclusion under this paragraph begins on 
the date the investment credit property is placed in service and 
continues on each one year anniversary date thereafter until the end of 
the applicable recovery period. The lessee will include in gross income 
the amount of its credit determined under section 46 regardless of 
limitations on the amount of the credit allowed under section 38(c) 
based on the amount of the lessee's income tax.
    (ii) Special rule for the energy credit. In the case of any energy 
credit determined under section 48(a), paragraph (b)(2)(i) of this 
section applies only to the extent of 50 percent of the amount of the 
credit determined under section 46.
    (3) Special rule for partnerships and S corporations--(i) In 
general. For purposes of paragraph (b)(2) of this section, if the 
lessee of the property is a partnership (other than an electing large 
partnership) or an S corporation, the gross income includible under 
such paragraph is not an item of partnership income to which the rules 
of subchapter K of Chapter 1, subtitle A of the Code apply or an item 
of S corporation income to which the rules of subchapter S of Chapter 
1, subtitle A of the Code apply. Any partner or S corporation 
shareholder that is an ultimate credit claimant (as defined in 
paragraph (b)(3)(ii) of this section) is treated as a lessee that must 
include in gross income the amounts required under paragraph (b)(2) of 
this section in proportion to the credit determined under section 46 
with respect to such partner or S corporation shareholder.
    (ii) Definition of ultimate credit claimant. For purposes of this 
section, the term ultimate credit claimant means any partner or S 
corporation shareholder that files (or that would file) Form 3468, 
``Investment Credit,'' with such partner's or S corporation 
shareholder's income tax return to claim an investment credit 
determined under section 46 with respect to such partner or S 
corporation shareholder.
    (c) Coordination with the recapture rules--(1) In general. If 
section 50(a) requires an increase in the lessee's or the ultimate 
credit claimant's tax or a reduction in the carryback or carryover of 
an unused credit (or both) as a result of an early disposition 
(including a lease termination), etc., of leased property for which an 
election had been made under Sec.  1.48-4, the lessee or the ultimate 
credit claimant is required to include in gross income an amount equal 
to the excess, if any, of the amount of the credit that is not 
recaptured over the total increases in gross income previously made 
under paragraph (b)(2) of this section with respect to the property. 
Such amount is in addition to the amounts the lessee or the ultimate 
credit claimant previously included in gross income under paragraph 
(b)(2) of this section.
    (2) Income inclusion exceeds unrecaptured credit. If section 50(a) 
requires an increase in the lessee's or ultimate credit claimant's tax 
or a reduction in the carryback or carryover of an unused credit (or 
both) as a result of an early disposition (including a lease 
termination), etc., of leased property for which an election had been 
made under Sec.  1.48-4, the lessee's or the ultimate credit claimant's 
gross income shall be reduced by an amount equal to the excess, if any, 
of the total increases in gross income previously included under 
paragraph (b)(2) of this section over the amount of the credit that is 
not recaptured.
    (3) Special rule for the energy credit. In the case of any energy 
credit determined under section 48(a), paragraphs (c)(1) and (2) of 
this section apply by substituting the phrase ``50 percent of the 
amount of the credit that is not recaptured'' for the phrase ``the 
amount of the credit that is not recaptured.''
    (4) Timing of income inclusion or reduction following recapture. 
Any adjustment required by paragraphs (c)(1) and (2) of this section is 
taken into account in the taxable year in which the property is 
disposed of or otherwise ceases to be investment credit property.
    (d) Election to accelerate income inclusion outside of the 
recapture period--(1) In general. If after the recapture period 
described in section 50(a), but prior to the expiration of the recovery 
period described in paragraph (b)(2) of this section, there is a lease 
termination, the lessee otherwise disposes of the lease, or a partner 
or S corporation shareholder that is an ultimate credit claimant 
disposes of its entire interest, either direct or indirect, in a lessee 
partnership (other than an electing large partnership) or S 
corporation, the lessee, or, in the case of a partnership or S 
corporation, the ultimate credit claimant may irrevocably elect to take 
into account the remaining amount required to be included in gross 
income under this section in the taxable year of the disposition or 
termination.
    (2) Exceptions. The election provided under paragraph (d)(1) of 
this section is not available to--
    (i) Lessees or ultimate credit claimants required by paragraph (c) 
of this section to account for the remaining amount required to be 
included in gross income after accounting for recapture in

[[Page 34781]]

the taxable year in which the property was disposed of or otherwise 
ceased to be investment credit property under section 50(a); or
    (ii) Former partners or S corporation shareholders that own no 
interest, either direct or indirect, in a lessee partnership or S 
corporation at the time of a lease termination or disposition.
    (3) Manner and time for making election. The election under 
paragraph (d)(1) of this section is made by including the remaining 
amount required to be included under this section in gross income in 
the taxable year of the lease termination or disposition or the 
disposition of the ultimate credit claimant's entire interest, either 
direct or indirect, in a partnership or S corporation. The election 
must be made on or before the due date (including any extension of 
time) of the lessee's income tax return, or, in the case of a 
partnership or S corporation, the ultimate credit claimant's income tax 
return for the taxable year in which the lease termination or 
disposition or the disposition of the ultimate credit claimant's entire 
interest, either direct or indirect, in a partnership or S corporation 
occurs.
    (e) Examples. The provisions of this section may be illustrated by 
the following examples:

     (1) Example 1. X, a calendar year C corporation, leases 
nonresidential real property from Y. The property is placed in 
service on October 1, 2016. Y elects under Sec.  1.48-4 to treat X 
as having acquired the property. X's investment credit determined 
under section 46 for 2016 with respect to such property is $9,750. 
The shortest recovery period that could be available to the property 
under section 168 is 39 years. Because Y has elected to treat X as 
having acquired the property, Y does not reduce its basis in the 
property under section 50(c). Instead, X, the lessee of the 
property, must include ratably in gross income over 39 years an 
amount equal to the credit determined under section 46 with respect 
to such property. Under paragraph (b)(2) of this section, X's 
increase in gross income for each of the 39 years beginning with 
2016 is $250 ($9,750/39 year recovery period).
     (2) Example 2. The facts are the same as in Example 1 in 
paragraph (e)(1) of this section, except that instead of 
nonresidential real property, X leases from Y solar energy equipment 
for which an energy credit under section 48 is determined under 
section 46. X's investment credit determined under section 46 for 
2016 with respect to the property is $9,750. The shortest recovery 
period that could be available to the property under section 168 is 
5 years. X, the lessee of the property, must include ratably in 
gross income over 5 years an amount equal to 50% of the credit 
determined under section 46 with respect to such property. Under 
paragraph (b)(2) of this section, X's increase in gross income for 
each of the 5 years beginning with 2016 is $975 ($4,875/5 year 
recovery period).
     (3) Example 3. A and B, calendar year taxpayers, form a 
partnership, the AB partnership, that leases nonresidential real 
property from Y. The property is placed in service on October 1, 
2016. Y elects under Sec.  1.48-4 to treat the AB partnership as 
having acquired the property. A's investment credit determined under 
section 46 for 2016 is $3,900 and B's investment credit determined 
under section 46 for 2016 is $7,800 with respect to the property. 
The shortest recovery period that could be available to the property 
under section 168 is 39 years. Because Y has elected to treat the AB 
partnership as having acquired the property, Y does not reduce its 
basis in the building under section 50(c). Instead, A and B, the 
ultimate credit claimants, must include the amount of the credit 
determined with respect to A and B under section 46 ratably in gross 
income over 39 years, the shortest recovery period available with 
respect to such property. Therefore, A and B must include ratably in 
gross income over 39 years under paragraph (b)(2) of this section an 
amount equal to $3,900 and $7,800, respectively. Under paragraph 
(b)(2) of this section, A's increase in gross income for each of the 
39 years beginning with 2016 is $100 ($3,900/39 year recovery 
period) and B's is $200 ($7,800/39 year recovery period). Because 
the gross income A and B are required to include under paragraph 
(b)(2) of this section is not an item of partnership income, the 
rules under subchapter K applicable to items of partnership income 
do not apply with respect to such income. In particular, A and B are 
not entitled to an increase in the outside basis of their 
partnership interests under section 705(a) and are not entitled to 
an increase in their capital accounts under section 704(b).
     (4) Example 4. The facts are the same as in Example 3 in 
paragraph (e)(3) of this section, except that on January 1, 2019, 
the lease between AB partnership and Y terminates (Y retains 
ownership of the property), which is a recapture event under section 
50(a). A's and B's income tax for 2019 is increased under section 
50(a) by $2,340 and $4,680, respectively (60% of $3,900 and $7,800, 
respectively, assuming that the aggregate decrease in the credits 
allowed under section 38 was the full amount of the investment 
credits determined as to A and B under section 46). Therefore, the 
amount of the unrecaptured credit as to A and B is $1,560 and 
$3,120, respectively (40% of $3,900 and $7,800, respectively). The 
amounts that A and B previously included in gross income under 
paragraph (b)(2) of this section are $300 ($100 for each of 2016, 
2017, and 2018) and $600 ($200 for each of 2016, 2017, and 2018), 
respectively. A and B are required under paragraph (c)(1) of this 
section to include in gross income an amount equal to the excess of 
the credit that is not recaptured ($1,560 and $3,120, respectively) 
over the total increases in gross income previously made under 
paragraph (b)(2) of this section with respect to the property ($300 
and $600, respectively). Therefore, A and B must include in gross 
income $1,260 and $2,520, respectively, in the taxable year of the 
lease termination (2019) in addition to the recapture amounts 
described above.
     (5) Example 5. (i) The facts are the same as in Example 4 in 
paragraph (e)(4) of this section, except that instead of 
nonresidential real property, the AB partnership leases from Y solar 
energy equipment for which an energy credit under section 48 is 
determined under section 46. Because the shortest recovery period 
that could be available to the property under section 168 is 5 
years, A and B are required under paragraph (b)(2)(ii) of this 
section to include ratably in gross income over 5 years an amount 
equal to 50% of the credit determined under section 46 with respect 
to such property (50% of $3,900/5, or $390, per year for A, and 50% 
of $7,800/5, or $780, per year for B).
    (ii) The January 1, 2019 lease termination requires A's and B's 
income tax for 2019 to be increased under section 50(a) by $2,340 
and $4,680, respectively (60% of $3,900 and $7,800, respectively). 
Therefore, the amount of the unrecaptured credit as to A and B is 
$1,560 and $3,120, respectively (40% of $3,900 and $7,800, 
respectively). Under paragraph (b)(2)(ii) of this section, the 
amounts A and B previously included in gross income are $1,170 ($390 
for each of 2016, 2017, and 2018) and $2,340 ($780 for each of 2016, 
2017, and 2018), respectively. A and B are entitled to a reduction 
in gross income under paragraph (c)(2) of this section equal to the 
excess of the total increases in gross income made under paragraph 
(b)(2)(ii) of this section ($1,170 and $2,340, respectively) over 
50% of the amount of the credit that is not recaptured ($780 and 
$1,560, respectively). Therefore, A and B are entitled to a 
reduction in gross income in the amount of $390 and $780, 
respectively, in the taxable year of the lease termination (2019).
     (6) Example 6. (i) The facts are the same as in Example 3 in 
paragraph (e)(3) of this section, except that on December 1, 2021, A 
sells its entire interest to C, and on January 1, 2022, the lease 
between AB partnership and Y terminates. At the time of the lease 
termination, B is still a partner in the AB partnership. There is no 
recapture event under section 50(a) because both the lease 
termination and the disposition of A's interest in the partnership 
occurred outside of the recapture period.
    (ii) At the time that A sold its interest in the AB partnership 
to C, A had previously included $500 ($100 for each of 2016-2020) in 
gross income under paragraph (b)(2) of this section. Under paragraph 
(b)(2) of this section, A must continue to include the remaining 
$3,400 (including $100 in 2021) in gross income ratably over the 
remaining portion of the applicable recovery period of 39 years. 
Alternatively, under paragraph (d)(1) of this section, A may 
irrevocably elect to include the remaining $3,400 in gross income in 
the taxable year that A sold its entire interest in the AB 
partnership to C (2021). Pursuant to paragraph (d)(2) of this 
section, A cannot make this election in the taxable year of the 
lease termination (2022).
    (iii) At the time of the lease termination, B had previously 
included $1,200 ($200 for each of 2016-2021) in gross income under 
paragraph (b)(2) of this section. Under

[[Page 34782]]

paragraph (b)(2) of this section, B must continue to include the 
remaining $6,600 required in gross income ratably over the remaining 
portion of the applicable recovery period of 39 years. 
Alternatively, under paragraph (d)(1) of this section, B may 
irrevocably elect to include the remaining $6,600 in gross income in 
the taxable year of the lease termination (2022).

    (f) Applicability date. This section applies to property placed in 
service on or after September 19, 2016.


Sec.  1.50-1T   [Removed]

0
Par. 3. Section 1.50-1T is removed.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.

    Approved: June 21, 2019.
 David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-15497 Filed 7-17-19; 4:15 pm]
BILLING CODE 4830-01-P