Income Inclusion When Lessee Treated as Having Acquired Investment Credit Property, 47701-47706 [2016-16563]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 81, Number 141 (Friday, July 22, 2016)]
[Rules and Regulations]
[Pages 47701-47706]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-16563]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9776]
RIN 1545-BM74


Income Inclusion When Lessee Treated as Having Acquired 
Investment Credit Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that provide 
guidance regarding 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 temporary 
regulations also provide rules to coordinate the section 50(a) 
recapture rules with the section 50(d)(5) income inclusion rules. In 
addition, these temporary 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 such 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 text of these temporary regulations also serves as the text 
of the proposed regulations set forth in the Proposed Rules section in 
this issue of the Federal Register.

DATES: 
    Effective Date: These regulations are effective on July 22, 2016.
    Applicability Date: For date of applicability, see Sec.  1.50-
1T(f).

FOR FURTHER INFORMATION CONTACT: Jennifer A. Records, (202) 317-6853 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    These temporary regulations amend the Income Tax Regulations (26 
CFR part 1) under section 50(d)(5) to provide the income inclusion 
rules applicable to a lessee of investment credit property when a 
lessor elects to treat the lessee as having acquired such 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 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 only 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.

Explanation of Provisions

A. Scope

    These temporary regulations provide the applicable rules that the 
Secretary has determined are similar to the rules of former section 
48(d)(5). Thus, these temporary regulations are limited in scope to the 
income inclusion rules that apply when a lessor elects under Sec.  
1.48-4 of the Treasury Regulations to treat the lessee as having 
acquired investment credit property.

B. In General

    Section 1.50-1T(b) provides the 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, Sec.  1.50-
1T(b)(1) provides 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 determined under 
section 46 (or 50 percent of the amount of the credit in the case of 
the energy credit under section 48).
    Under Sec.  1.50-1T(b)(2), 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 equal to the amount of the 
credit (or, in the case of the section 48 energy credit, 50 percent of 
the amount of the credit) determined under section 46. Generally, the 
lessee includes such 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 these temporary regulations in

[[Page 47702]]

Sec.  1.50-1T(b)(2) 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).

C. Special Rule for Partnerships and S Corporations

    Section 1.50-1T(b)(3) provides that, 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 
Sec.  1.50-1T(b)(2). The term ultimate credit claimant is defined in 
Sec.  1.50-1T(b)(3)(ii) 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 
Sec.  1.50-1T(b)(2). Each partner or S corporation shareholder that is 
the ultimate credit claimant must include in gross income the amount 
required under Sec.  1.50-1T(b)(2) 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 Treasury Department and the IRS believe that, 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 actually 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 
basis of 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 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 an 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 believe 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 
temporary regulations in Sec.  1.50-1T(b)(3) provide that the gross 
income required to be ratably included under Sec.  1.50-1T(b)(2) 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) (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 Treasury Department and the IRS 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 Treasury Department and the IRS believe 
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 immediate benefit of the full amount of the allowable 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 basis 
increase under section 705(a) or section 1367(a). As a result of the 
basis increase, these partners or S corporation shareholders claim a 
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 believe 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 concluded that, under any approach, allowing

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partners and S corporation shareholders a basis increase to offset the 
income inclusion required by Sec.  1.50-1T(b)(2) 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.

D. Coordination With the Recapture Rules

    Section 1.50-1T(c) provides that if the investment credit recapture 
rules under section 50(a) are triggered (including if 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 these temporary 
regulations in Sec.  1.50-1T(b)(2) 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.
    If 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 amount previously included in gross income under Sec.  1.50-
1T(b)(2), the lessee's (or the ultimate credit claimant's) gross income 
is increased. The lessee (or the ultimate credit claimant) is required 
to include in gross income an amount equal to the excess of the amount 
of the credit that is not recaptured (or 50 percent of the amount of 
the credit that is not recaptured in the case of the energy credit) 
over the amount of the total increases in gross income previously made 
under Sec.  1.50-1T(b)(2). This amount is in addition to the amounts 
previously included in gross income under Sec.  1.50-1T(b)(2).
    If the income inclusion prior to recapture under Sec.  1.50-
1T(b)(2) exceeds 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, the lessee's (or 
the ultimate credit claimant's) gross income is reduced. The lessee's 
or ultimate credit claimant's gross income is reduced by an amount 
equal to the excess of the total increases in gross income previously 
made under Sec.  1.50-1T(b)(2) over the amount of the credit that is 
not recaptured (50 percent of the amount of the credit that is not 
recaptured in the case of the energy credit).

E. Election To Accelerate Income Inclusion Outside of the Recapture 
Period

    Section 1.50-1T(d)(1) provides that a lessee or an ultimate credit 
claimant may 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, Sec.  1.50-1T(d)(1) provides 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 under Sec.  1.50-1T(b)(2) in the 
taxable year in which the ultimate credit claimant no longer owns a 
direct or indirect interest in the lessee of the investment credit 
property. 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 it is exiting 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 owns no direct or indirect 
interest in the lessee partnership or S corporation may not elect to 
accelerate the gross income required to be included under Sec.  1.50-
1T(b)(2) 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.
    Section 1.50-1T(d)(2) provides that the election to accelerate the 
income inclusion must be made by the due date (including any extension 
of time) of the lessee's return, or, in the case of a partnership or S 
corporation, by the due date (including any extension of time) of the 
ultimate credit claimant's return for the taxable year in which the 
relevant event occurs (for example, the lease termination, lease 
disposition, or disposition of the entire interest in the lessee 
partnership or S corporation). The election is made by including the 
remaining gross income required by these temporary regulations in the 
taxable year of the relevant event (for example, the lease termination, 
lease disposition, or disposition of the entire interest in the lessee 
partnership or S corporation).

F. Applicability Date

    These temporary regulations apply with respect to investment credit 
property placed in service on or after the date that is 60 days after 
the date of filing of these regulations in the Federal Register. The 
temporary regulations should not be construed to create any inference 
concerning the proper interpretation of section 50(d)(5) prior to the 
effective date of the regulations.

G. Rev. Proc. 2014-12

    Rev. Proc. 2014-12 (2014-3 IRB 415) 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 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.  1.50-1T(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).

Effect on Other Documents

    Rev. Proc. 2014-12 (2014-3 IRB 415) is modified by: (1) Changing 
all

[[Page 47704]]

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 Web site at https://www.irs.gov.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. For applicability of the Regulatory Flexibility Act, 
please refer to the Special Analyses section of the preamble to the 
cross-referenced notice of proposed rulemaking published in the 
Proposed Rules section in this issue of the Federal Register. Pursuant 
to section 7805(f) of the Code, these regulations have been submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on their impact on small business.

Drafting Information

    The principal author of these temporary regulations is Jennifer A. 
Records, 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 continues 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) through (f) [Reserved]. For further guidance, see Sec.  1.50-
1T(a) through (f).

0
Par. 3. Section 1.50-1T is added to read as follows:


Sec.  1.50-1T  Lessee's income inclusion following election of lessor 
of investment credit property to treat lessee as acquirer (temporary).

    (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

[[Page 47705]]

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 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:

    Example 1.  X, a calendar year C corporation, leases 
nonresidential real property from Y. The property is placed in 
service on July 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).
    Example 2.  The facts are the same as in Example 1 of this 
paragraph (e). 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).
    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 July 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).
    Example 4.  The facts are the same as in Example 3 of this 
paragraph (e), 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.
    Example 5.  (i) The facts are the same as in Example 4 of this 
paragraph (e), 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

[[Page 47706]]

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).
    Example 6.  (i) The facts are the same as in Example 3 of this 
paragraph (e), 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 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.
    (g) Expiration date. The applicability of this section will expire 
on or before July 19, 2019.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: June 1, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-16563 Filed 7-21-16; 8:45 am]
 BILLING CODE 4830-01-P