United States

New regulations clarify income inclusion for ITC transfer to lessee

Regulation requires partners, not partnership, to report income inclusion


On July 21, 2016, the Treasury Department released temporary and proposed regulations to section 50, Temp. Reg. section 1.50-1T (the ‘temporary regulations’). The temporary regulations provide clarity on the income inclusion rule for property subject to the investment tax credit (ITC) in certain leasing structures. The ITC lease pass-through structure allow for the lessor of ITC property to make an election to treat the lessee as the owner of the credit property for ITC purposes. Making such an election allows the lessee to acquire the ITC benefits of ownership at fair market value. Accordingly, the normal rules related to the basis adjustment to the ITC property are suspended and an alternative income inclusion method is applied.

The basis in ITC property is, normally, reduced by the value of the credit received; unless, the property is eligible energy property whose basis is only reduced by 50 percent. The income inclusion method is used when the election is made to treat the leasee as the owner of ITC property. The income inclusion method is unique because it requires the ultimate credit claimant to include into income the amount of the negative basis adjustment normally received by the owner of an ITC property. The income inclusion occurs at the shortest life of the available depreciable asset eligible for the credit. Example 2 of the new temporary regulations provides a mathematical explanation of this concept:

“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).”

X is the lessee and, therefore, receives the full value of the credit because of Y’s election. In place of reducing Y’s basis in the ITC property, X instead, takes into income the 50 percent of the credit value over the appropriate life. This provides X, the ultimate credit claimant, with income over five years. The income inclusion is a straight-line calendar year calculation and does not follow the MACRS methodology. The inclusion of income may be accelerated at the time of disposition of either the interest in the leasee entity or upon the disposition of the ITC property.

The inclusion of income and credit calculation occur at the ultimate credit claimant level. The ultimate credit claimant is the tax reporting entity that will offset tax with the credit generated. Accordingly, the calculation of income inclusion occurs at the partner, member or shareholder level in the case of lessee entities that are partnerships or S corporations. When modeling ITC lease structures to determine the after-tax net present value of discounted cash flows for pass-through structures, it is important to realize that the computations do not increase basis in the ownership interest or capital accounts. The income inclusion in subsequent years does not follow allocations under section 704 accounting and is not considered a partnership attribute for the computation of capital account maintenance under Reg. section 1.704-1(b)(2)(iv). To properly identify the impact that the temporary regulations will have on taxpayer benefits, models must account for the income inclusion during required quarterly estimated payments for each stakeholder. Luckily, the new temporary regulations only apply to property placed in service on or after Sept. 19, 2016, and taxpayers entering into a credit lease transaction should contact their tax advisors to understand all the implications to their model or structure prior to finalizing the deal.


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