(a) Transfer by
reason of death. A transfer by reason of death is not considered to be a
disposition of eligible property, subject to the recapture rule. This exception
to the recapture rule applies to transfers by reason of death of a sole
proprietor, partner, S corporation shareholder, or beneficiary of an estate or
trust.
(b) Example. Subsection (a)
is illustrated as follows:
A, a calendar-year taxpayer, places in service in 1988,
eligible property with a basis of $5,000. In 1988, A takes a credit in the
amount of $150 ($5,000 x 3%). A dies in 1989, and the property is transferred
to A's heir. In 1989, no credit is required to be recaptured. Further, the heir
can immediately dispose of the property without the possibility of credit
recapture.
(c) Transaction
to which I.R.C. §381(a) applies. A disposition of eligible property in a
transaction to which I.R.C. §381(a) (with respect to carryovers in certain
corporate acquisitions) applies is not considered to be a disposition of
eligible property, subject to the recapture rule. However, if the acquiring
corporation disposes of the eligible property before the close of the recapture
period, there will be an early disposition and the recapture rule will be
triggered.
(d) Mere change in form
of conducting a trade or business.
(1) In
general. Recapture is not required as a result of a mere change in the form of
conducting a trade or business if:
(A) the
property is retained as eligible property in the same trade or business;
(B) the transferor (or in a case
where the transferor is a partnership, estate or trust, or S corporation, the
partner, beneficiary, or shareholder) of eligible property retains a
substantial interest in the trade or business;
(C) substantially all the property (whether
or not eligible property) necessary to operate the trade or business is
transferred in the change of form; and
(D) the basis of eligible property in the
hands of the transferee is determined in whole or in part by reference to the
basis of eligible property in the hands of the transferor (i.e., carryover
basis).
(2) Paragraph
(1) shall not apply to the transfer of eligible property if I.R.C. §381
(regarding carryovers in certain corporate acquisitions) applies to the
transfer.
(3) "Substantial
interest", defined. For purposes of this exception, a transferor (or in a case
where the transferor is a partnership, estate or trust, or S corporation, the
partner, beneficiary, or shareholder) is considered to have retained a
substantial interest in the trade or business if, after the change in form, the
transferor's interest in the trade or business is:
(A) substantial in relation to the total
income interest of all the owners; or
(B) equal to or greater than the transferor's
interest prior to the change in form. A taxpayer will not be considered to have
retained a substantial interest where the only basis for claiming substantial
interest is that the values of the interests exchanged are equal.
(A) Examples. Paragraph (3) is illustrated as
follows:
Example 1. A taxpayer owns a five percent
interest in a partnership. After an incorporation of the partnership, the
taxpayer retains at least a five percent interest in the corporation. In this
case, the taxpayer will be considered to have retained a substantial interest
in the business as of the date of the change in form.
Example 2. A taxpayer exchanges a 48 percent
partnership interest for a seven percent interest in a corporation (seven
percent of the outstanding stock), contending that the values of the interests
exchanged are equal. In this case, the taxpayer will not be considered to have
retained a substantial interest.
(B) The determination of whether a taxpayer
has retained a substantial interest in the trade or business is to be made
immediately after the change in the form of conducting the trade or business,
and after each time the taxpayer disposes of a portion of the taxpayer's
interest in the new enterprise.
(4) S Corporation. Neither an election to be
treated as an S corporation, nor a termination or loss of S corporation status
automatically triggers recapture. However, recapture may result if either of
the recapture events discussed in paragraph (5) occurs. In determining whether
a reduction in a shareholder's interest (for example, by a sale of stock) will
result in recapture, the 66 2/3 percent and 33 1/3 percent rules (as discussed
in section 18-235-110.7-15(f)) apply even if the corporation is no longer an S
corporation.
(5) Disposition or
cessation. Property ceases to be eligible property with respect to a transferor
(or in a case where the transferor is a partnership, estate or trust, or S
corporation, the partner, beneficiary, or shareholder), and the transferor must
make a recapture determination if during the recapture period:
(A) the transferee disposes of eligible
property (or if eligible property otherwise ceases to be eligible property in
the hands of the transferee);
(B)
the transferor (or in a case where the transferor is a partnership, estate or
trust, or S corporation, the partner, beneficiary, or shareholder) does not
retain a substantial interest in the trade or business directly or indirectly
(through ownership in other entities provided that the other entities' bases in
the interests are determined in whole or in part by reference to the bases of
the interests in the hands of the transferor).
(6) Recordkeeping. A taxpayer who seeks to
establish the taxpayer's interest in a trade or business under this subsection
must maintain adequate records to demonstrate the taxpayer's direct or indirect
interest, or both, in the trade or business after any transfer.
(e) Transfer between spouses or
incident to divorce.
(1) In general. A
transfer between spouses or incident to divorce is not considered to be a
disposition, subject to the recapture rule.
(2) Subsequent to a transfer between spouses
or incident to divorce, a disposition by the transferee during the recapture
period may result in recapture to the same extent as if the disposition had
been made by the transferor at that later date.
(3) Paragraphs (1) and (2) apply to transfers
made after December 31, 1987, in taxable years ending after December 31, 1987.
It does not apply to transfers under an instrument in effect before January 1,
1988.
(f) Property
destroyed by casualty. The recapture rule shall not apply to eligible property
which is disposed of or otherwise ceases to be eligible property with respect
to the taxpayer as a result of its destruction or damage by fire, storm,
shipwreck, or other casualty, or theft.
(g) Downward basis adjustment pursuant to
I.R.C. §754 (regarding manner of electing optional adjustment to basis of
partnership property). In the case of a partnership, a downward basis
adjustment pursuant to I.R.C. §754 is not subject to recapture because the
use of the property is not considered to be terminated for purposes of the
credit.
