New proposed regulations released on claiming the Section 47 rehabilitation tax credit

The IRS has released proposed regulations with respect to claiming the rehabilitation tax credit under Internal Revenue Code (IRC) Section 47. The rules specifically pertain to the five-year period for claiming the credit.

The proposed regulations were made necessary due to Section 13402(a) of the 2017 Tax Cuts and Jobs Act (TCJA), which modified the rules for claiming the 20-percent credit under Section 47 that are applicable to Qualified Rehabilitation Expenditure (QRE) amounts paid or incurred after Dec. 31, 2017, subject to transition rules. 

Per the proposed regulations:

“As amended by the TCJA, Section 47(a)(1) provides that for purposes of the investment credit under Section 46, for any taxable year during the five-year period beginning in the taxable year in which a QRB [Qualified Rehabilitated Building] is placed in service, the rehabilitation credit for such taxable year is an amount equal to the ratable share for the year. … Section 47(a)(2) defines the ratable share for any taxable year during the credit period as the amount equal to 20 percent of the QREs with respect to the QRB, as allocated ratably to each year during the credit period.” 

“…These proposed regulations provide that the rehabilitation credit is properly determined in the year the QRB is placed in service (consistent with prior law) but allocated ratably over the five-year period as required by the TCJA, rather than resulting in the determination of five separate rehabilitation credits.”

“…These proposed regulations follow this same prior law approach for the determination of a single rehabilitation credit for purposes of applying the rules of Section 50. Therefore, taxpayers claiming the rehabilitation credit under Section 47 with respect to QREs paid or incurred after Dec. 31, 2017, generally will have the same federal income tax consequences from the rules under Section 50 for recapture, basis adjustment, and leased property as taxpayers claiming the rehabilitation credit under prior law.”

The examples confirm that the credit is claimed evenly over five years and that any depreciable basis adjustment related to the credit is made entirely in the placed-in-service year. In a situation where there is a lease and the credit is passed through to the tenant, the full amount of the credit is amortized over the shortest depreciable life starting in the placed-in-service year. 

The approach to recapture is not what we had expected, and the example in the proposed regulations highlights the calculation. Assume there is a $50,000 credit claimed $10,000 per year and a recapture event in Year 3 such that 60% of the credit is to be recaptured. A recapture tax of $12,000 is due ($20,000 x 60%) and a credit of $4,000 per year will be claimed in Years 3-5. The recapture tax is not netted against the future credits to be claimed, and the total credit ultimately claimed is $20,000 ($50,000 x 40%).

The regulations are proposed to apply to taxable years beginning on or after the date the Treasury decision adopting them as final is published in the Federal Register. Taxpayers may rely on them for QREs paid or incurred after Dec. 31, 2017, in taxable years beginning before the date the Treasury decision adopts these regulations as final.

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