Treasury issues proposed regulations on Sec. 47 rehab credit

By Kevin F. Powers, CPA, Hartford, Conn., and Kathy Herbig, CPA, Louisville, Ky.

Editor: Howard Wagner, CPA

On May 22, 2020, the IRS published proposed regulations (REG-124327-19) regarding the Sec. 47 rehabilitation tax credit, including rules to coordinate the new five-year period over which the credit may be claimed with other special rules for investment credit property. The proposed regulations cover three specific investor concerns in response to changes made by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97: (1) the rehabilitation tax credit is one single credit allocated ratably over a five-year period; (2) there is only one credit date for purposes of the basis reduction and credit recapture provisions under Sec. 50(a); and (3) the TCJA changes do not affect the Sec. 50(d) income-inclusion requirement for certain leased property.

While it may seem as though these issues are generally without controversy, it has not been uncommon in recent years for there to be uncertainty regarding the application of revisions to the Code enacted via legislative changes and how they are applied to some of these more nuanced issues. As such, this is welcome guidance, particularly for financial institutions, which historically have been one of the largest investor groups for rehabilitation and other types of investment credits.

TCJA changes

Before the TCJA, a two-tier tax credit system existed for qualified rehabilitation expenditures (QREs). For certified historic structures listed in the National Register of Historic Places or located in a registered historic district and certified by the Department of the Interior as being of historic significance to the district, the rehabilitation credit was equal to 20% of the QREs. For all other qualified rehabilitated buildings (QRBs) other than certified historic structures, the credit amount was equal to 10% of the QREs. In both cases, the full amount of the rehabilitation credit was claimed in the year the QRB was placed in service.

Under pre-TCJA law, buildings other than certified historic structures also had to have been placed in service before 1936, and, in the rehabilitation process, they had to meet certain percentage requirements for the retention of existing external walls and the building's internal structural framework. Other rules also exist around rehabilitations completed in phases and the availability of a 60-month measurement period for QREs eligible for the credit — versus the standard 24-month measurement period — but these issues, among others, are beyond the scope of this discussion.

The TCJA made several changes to the rehabilitation credit provisions. First, the 10% credit for pre-1936 nonhistoric buildings was repealed, leaving only the 20% credit for QREs with respect to certified historic structures. Additionally, the 20% credit is now required to be claimed by taxpayers ratably over a five-year period, starting with the year the QRB is placed in service. Thus, for example, if a taxpayer (or sole credit investor via a partnership structure) incurs $1 million of QREs for a QRB that is a certified historic structure, the total rehabilitation credit will be $200,000 (20% of $1 million), allocated ratably over a five-year period, or $40,000 per year, starting with the year the QRB is placed in service.

The changes enacted by the TCJA generally apply to QREs paid or incurred after Dec. 31, 2017. However, a transition rule applies whereby if a taxpayer owns or leases a building at all times after Dec. 31, 2017, and selected a 24-month period (or a 60-month period, for a rehabilitation completed in phases) beginning not later than 180 days after Dec. 22, 2017, the changes made to the rehabilitation credit by the TCJA will apply only to QREs paid or incurred after the end of the tax year in which that 24-month period, or the 60-month period (as applicable), ends. This transition rule applies both to QREs for a certified historic structure, as well as to pre-1936 nonhistoric structures. As such, there may be ongoing projects eligible for either the 10% or 20% credit, for which the taxpayer may still be eligible to claim 100% of the rehabilitation credit in the year the QRB is placed in service, even though it was placed in service after the effective date of the TCJA changes.

As a final note, the above provisions apply equally to a taxpayer investing directly in a QRB and incurring the QREs on its own behalf, as well as to taxpayers (e.g., financial institution investors) "purchasing" rehabilitation credits via a partnership or a similarly structured investment. The rehabilitation credit itself cannot be bought or sold, but a partnership interest (or S corporation shares) entitling the investor to the credit can be acquired before the QRB's placed-in-service date.

Final regulations on Sec. 50(d)(5) income-inclusion rules

On July 22, 2016, pre-TCJA, the IRS published temporary regulations (T.D. 9776) applicable to master tenant lease structures whereby the lessor of a QRB elects to treat the lessee as directly acquiring the property, and therefore the lessee is deemed to incur the QREs generating the rehabilitation credit. These temporary regulations were subsequently issued as final Regs. Sec. 1.50-1 on July 19, 2019 (T.D. 9872), substantially incorporating the provisions of the temporary regulations, with an effective date applying to QRBs placed in service on or after Sept. 19, 2016.

The primary issue addressed in the final regulations pertains to the coordination of the Sec. 50(c) basis adjustment rules with the rules under Regs. Sec. 1.48-4, pursuant to which a lessor may elect to treat the lessee of the QRB as having acquired the property for purposes of calculating the rehabilitation credit. Specifically, Sec. 50(c) does not apply when the election is made, and thus the lessor is not required to reduce its basis in the property by the amount of the rehabilitation credit. In lieu of the basis adjustment, the lessee must include in gross income an amount equal to the amount of the rehabilitation credit determined under Sec. 46. Generally, the lessee includes that amount ratably over the shortest recovery period applicable under the accelerated cost recovery system provided in Sec. 168 (e.g., 39 years for nonresidential real property), beginning on the date the QRB is placed in service and continuing for each one-year anniversary thereafter until the end of the applicable recovery period.

In the case of a partnership (or S corporation) for which an election is made under Regs. Sec. 1.48-4 to treat that 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, and each partner (or S corporation shareholder) must include in gross income the amount in proportion to its allocable credit. For example, if a partner is allocated 25% of the rehabilitation credit, that partner must also include 25% of the income inclusion amount in its taxable income.

The regulations also conclude that, because the rehabilitation credit and any limitations on the credit are determined at the partner (or S corporation shareholder) level, the income inclusion amount is not an item of partnership income for Subchapter K purposes or an item of S corporation income for Subchapter S purposes. Accordingly, the rules that would apply were this gross income an item of income under Sec. 702 or Sec. 1366, such as Sec. 705(a) (providing for an increase in the partner's outside basis for items of income) or Sec. 1367(a) (providing for an increase in the S corporation shareholder's stock basis for items of income) do not apply. Likewise, because the income inclusion is determined at the partner (or S corporation shareholder) level, it survives either the termination of the partnership (or S corporation) or the disposition of the partnership interest (or S corporation shares).

The discussion in the preamble to the temporary regulations indicated that Treasury 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 its 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." However, Treasury and the IRS concluded "that such basis increases are inconsistent with congressional intent as they thwart the purpose of the income-inclusion requirement in former Sec. 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." In other words, the partners (or S corporation shareholders) would derive a double benefit in that they would not have to reduce their tax basis in their respective ownership interests by the amount of the initial rehabilitation credit claimed, and they would claim a tax loss (or reduced tax gain) upon the disposition of their partnership interests (or S corporation shares) as a result of the basis increase.

The final regulations also provide that if the credit recapture rules under Sec. 50(a) are triggered (including if there is a lease termination), an adjustment will be made to the credit claimant's gross income — either up or down — for any discrepancies between the total amount included in gross income under the final regulations and the total credit allowable after recapture, with the adjustment amount being taken into account in the tax year in which the QRB is disposed of or otherwise ceases to be investment credit property. Additionally, the final regulations provide that the credit claimant may make an irrevocable election to include in gross income any remaining income inclusion amount in the tax year in which the claimant disposes of its entire interest in a partnership or an S corporation. The election is only available outside of the Sec. 50(a) recapture period and only if the claimant was not already required to accelerate the income inclusion amount because of a recapture event.

Why are these proposed regulations needed?

The preamble to the proposed regulations notes that Treasury and the IRS are aware that taxpayers and practitioners have questioned how the five-year rehabilitation credit period under the TCJA affects taxpayers claiming the rehabilitation credit, including the application of the Sec. 50(d) provisions discussed above. Specifically, the proposed regulations confirm the following items:

  • For QRBs placed in service after Dec. 31, 2017 (and not otherwise eligible for the pre-TCJA transition rules as discussed above), the total credit amount — defined as the "rehabilitation credit determined" in the proposed regulations — is computed in the year the QRB is placed in service and then allocated ratably over the five-year credit recognition period, defined as the "ratable share"; in other words, it is one rehabilitation credit allocated ratably over a five-year period (and not five separate credits generated over five tax years). This also prevents expenditures incurred after the tax year the QRB is placed in service from potentially qualifying for additional credits in those subsequent years, which would violate congressional intent — i.e., the rehabilitation credit for a QRB is effectively fixed, or determined, as of that first tax year. The proposed regulations also cross-reference Regs. Sec. 1.168(k)-2(g)(9), clarifying that the rehabilitation credit determined is equal to 20% of the remaining rehabilitated basis of the QRB, after being reduced for the amount the taxpayer claims as additional first-year depreciation for the QREs.
  • There is only one credit date for purposes of determining potential recapture of the credit under Sec. 50(a), as well as the basis reduction under Sec. 50(c). For example, if five separate rehabilitation credits were determined, then there would be five separate recapture periods for a single QRB, which would increase the length of the recapture period and increase the recapture amount as compared with results under Sec. 50(a) before the TCJA changes. Additionally, the amount of the rehabilitation credit determined (i.e., the full amount of the rehabilitation credit computed in the year the QRB is placed in service) reduces a taxpayer's basis in the QRB — or a partner's basis in its partnership interest (or an S corporation shareholder's basis in his or her S corporation stock) — in the initial year the QRB is placed in service; in other words, the basis is not reduced over a five-year period but rather all in the initial year, similar to the treatment pre-TCJA.
  • The TCJA changes do not alter the treatment of the Sec. 50(d)(5) income-inclusion requirement for leased property where the lessee is treated as the owner of the QRB (i.e., the master tenant lease structure), as nowhere in the Conference Report or the Joint Committee on Taxation's Bluebook for the TCJA is there any suggestion that the results for taxpayers claiming the rehabilitation credit under the rules of Sec. 50 were intended to be different.

The proposed regulations provide examples that illustrate these rules for the most relevant fact patterns. For instance, two examples illustrate the interaction of the new TCJA provisions with Sec. 50(d)(5). The first example describes a transaction in which the lessee is a corporation; the second example describes a transaction in which the lessee is a partnership subject to the special rules of Regs. Sec. 1.50-1(b)(3)(i), treating the income inclusion amount as a partner-level item versus an item of partnership income to which the rules of Subchapter K would otherwise apply. In general, the examples provided are consistent with the discussion of these items throughout this article, modified to account for the five-year rehabilitation credit allocation period under the TCJA.

What's next?

Given that the guidance included in the proposed regulations generally appears to be noncontroversial, the authors do not anticipate any significant changes to the provisions of the regulations once they are finalized.


Howard Wagner, CPA, is a partner with Crowe LLP in Louisville, Ky.

For additional information about these items, contact Mr. Wagner at 502-420-4567 or

Contributors are members of or associated with Crowe LLP.

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