Publication 954 (1/2004), Tax Incentives for Distressed Communities

IRS Resources

Publication 954 - Main Contents

Table of Contents

Table 1. Tax Incentives for Distressed Communities

Type of Benefit	Empowerment Zones (EZs)	Enterprise Communities (ECs)	Renewal Communities (RCs)
Credits
EZ Employment Credit	X
RC Employment Credit			X
Work Opportunity Credit	X	X	X
Welfare-to-Work Credit	X	X	X
Indian Employment Credit	X	X	X
New Markets Credit	X	X	X
Deductions
Increased Section 179 Deduction	X		X
Commercial Revitalization Deduction			X
Depreciation of Property Used on Indian Reservations	X	X	X
Bond Financing
Enterprise Zone Facility Bonds	X	X
Qualified Zone Academy Bonds (QZABs)	X	X	X
Capital Gains
Capital Gain Exclusion for RC and DC Zone Assets			X ^*
Rollover of Gain from Sale of EZ Assets	X
Increased Exclusion of Gain From Qualified Small Business Stock	X
* Also applicable to District of Columbia Enterprise Zone.

Empowerment Zones

This section describes the areas that have been designated empowerment zones and explains the tax benefits available to businesses in those zones.

Designated Zones

The following paragraphs describe current designations of empowerment zones. The empowerment zone designations will generally remain in effect until the end of 2009.

Urban areas. Parts of the following urban areas are empowerment zones. You can find out if your business or an employee's residence is located within an urban empowerment zone by using the RC/EZ/EC Address Locator at www.hud.gov/crlocator or by calling 1-800-998-9999.

Pulaski County, AR
Tucson, AZ
Fresno, CA
Los Angeles, CA (city and county)
Santa Ana, CA
New Haven, CT
Jacksonville, FL
Miami/Dade County, FL
Chicago, IL
Gary/Hammond/East Chicago, IN
Boston, MA
Baltimore, MD
Detroit, MI
Minneapolis, MN
St. Louis, MO/East St. Louis, IL
Cumberland County, NJ
New York, NY
Syracuse, NY
Yonkers, NY
Cincinnati, OH
Cleveland, OH
Columbus, OH
Oklahoma City, OK
Philadelphia, PA/Camden, NJ
Columbia/Sumter, SC
Knoxville, TN
El Paso, TX
San Antonio, TX
Norfolk/Portsmouth, VA
Huntington, WV/Ironton, OH

Washington, DC. Under section 1400, parts of Washington, DC, are treated as an empowerment zone. For details, use the RC/EZ/EC Address Locator at www.hud.gov/crlocator or see Notice 98-57, on page 9 of Internal Revenue Bulletin 1998-47 at www.irs.gov/pub/irs-irbs/irb98-47.pdf.

Rural areas. Parts of the following rural areas are empowerment zones. You can find out if your business is located within a rural empowerment zone by using the RC/EZ/EC Address Locator at www.hud.gov/crlocator or by calling 1-800-645-4712.

Desert Communities, CA (part of Riverside County)
Southwest Georgia United, GA (part of Crisp County and all of Dooly County)
Southernmost Illinois Delta, IL (parts of Alexander and Johnson Counties and all of Pulaski County)
Kentucky Highlands, KY (part of Wayne County and all of Clinton and Jackson Counties)
Aroostook County, ME (part of Aroostook County)
Mid-Delta, MS (parts of Bolivar, Holmes, Humphreys, Leflore, Sunflower, and Washington Counties)
Griggs-Steele, ND (part of Griggs County and all of Steele County)
Oglala Sioux Tribe, SD (part of Jackson County and all of Bennett and Shannon Counties)
Middle Rio Grande FUTURO Communities, TX (parts of Dimmit, Maverick, Uvalde, and Zavala Counties)
Rio Grande Valley, TX (parts of Cameron, Hidalgo, Starr, and Willacy Counties)

Empowerment Zone Employment Credit

The empowerment zone employment credit provides businesses with an incentive to hire individuals who both live and work in an empowerment zone. (An exception applies to the Washington, DC empowerment zone. Individuals who work in the Washington, DC empowerment zone may live anywhere in the District of Columbia.) You can claim the credit if you pay or incur “qualified zone wages” to a “qualified zone employee.”

The credit is 20% of the qualified zone wages paid or incurred during a calendar year. The amount of qualified zone wages you can use to figure the credit cannot be more than $15,000 for each employee for each calendar year. As a result, the credit can be as much as $3,000 (20% of $15,000) per qualified zone employee each year.

Qualified zone employee. A qualified zone employee is any employee who meets both of the following tests.

The employee performs substantially all of his or her services for you within an empowerment zone and in your trade or business.
While performing those services, the employee's main home is within that empowerment zone (for services performed within the DC Zone, the employee's main home may be anywhere within the District of Columbia).

Both full-time and part-time employees may qualify.

Substantially all services performed within the zone. You can use the pay-period method or the calendar-year method to determine the period of time the employee has performed services in the zone. For details, see section 1.1396–1 of the regulations.

Nonqualified employees. The following individuals are not qualified zone employees. For more details, see the Form 8844 instructions.

An individual you employ for less than 90 calendar days. However, this 90-day requirement does not apply in either of the following situations.
1. You terminate the employee because of misconduct as determined under the state unemployment compensation law that applies.
2. The employee becomes disabled before the 90th day. However, if the disability ends before the 90th day, you must offer to reemploy the former employee.
Certain related taxpayers.
Certain dependents.
Any 5% owner.
An individual you employ at any:
1. Private or commercial golf course,
2. Country club,
3. Massage parlor,
4. Hot tub facility,
5. Suntan facility,
6. Racetrack, or other facility used for gambling, or
7. Store whose principal business is the sale of alcoholic beverages for off-premise consumption.
Any individual you employ in a farming trade or business if, at the close of the tax year, the sum of the following amounts is more than $500,000.
1. The larger of the unadjusted bases or fair market value of the farm assets you own.
2. The value of the farm assets you lease.

Qualified zone wages. Qualified zone wages are any wages you pay or incur for services performed by an employee while the employee is a qualified zone employee (defined earlier). Wages are generally defined as wages (excluding tips) subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit.

Also treat as qualified zone wages certain training and education expenses you pay or incur on behalf of a qualified zone employee.

Effect of welfare-to-work, work opportunity, or New York Liberty Zone business employee credit. Qualified zone wages do not include any amount you take into account in figuring the welfare-to-work credit, the work opportunity credit, or the New York Liberty Zone business employee credit. In addition, you must reduce the $15,000 maximum qualified zone wages for each qualified zone employee by the amount of wages you use to figure any of those credits for that employee.

Fiscal year taxpayers. If you use a fiscal tax year, the amount of qualified zone wages you use to figure the credit is the amount paid or incurred during the calendar year that ends during your tax year.

Example.

Your tax year begins on February 1 and ends on January 31 of the next year. You use the cash method of accounting and have one employee, whom you hired in March 2003 and pay $1,000 a month. You paid that employee qualified zone wages of $10,000 in calendar year 2003 and $1,000 in January 2004. When you figure your credit for the tax year ending January 31, 2004, you use the $10,000 paid in 2003 but cannot use the $1,000 paid in January 2004. That amount will be used to figure the credit on your next tax return.

Claiming the credit. Use Form 8844 to claim this credit. Although the empowerment zone employment credit is a component of the general business credit, a special tax liability limit applies to this credit. Therefore, you figure the credit separately and never carry it to Form 3800, General Business Credit.

Effect on salary and wage deduction. In general, you must reduce the deduction on your income tax return for salaries and wages and certain education and training costs by the amount of your current year empowerment zone employment credit (before applying the tax liability limit).

More information. For more information about the empowerment zone employment credit, see Form 8844.

Increased Section 179 Deduction

Section 179 of the Internal Revenue Code allows you to choose to deduct all or part of the cost of certain qualifying property in the year you place it in service. You can do this instead of recovering the cost by taking depreciation deductions over a specified recovery period. There are limits, however, on the amount you can deduct in a tax year.

You may be able to claim an increased section 179 deduction if your business qualifies as an “enterprise zone business.” The increase can be as much as $35,000. This increased section 179 deduction applies to “qualified zone property” you place in service in an empowerment zone.

Enterprise zone business. For the increased section 179 deduction, a corporation, partnership, or sole proprietorship is an enterprise zone business if all the following statements are true for the tax year.

Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within an empowerment zone. (This rule does not apply to a sole proprietorship.)
At least 50% of its total gross income is from the active conduct of a qualified business within a zone.
A substantial part of the use of its tangible property is within a zone.
A substantial part of its intangible property is used in the active conduct of the business.
A substantial part of the employees' services are performed within a zone.
At least 35% of the employees are residents of an empowerment zone. (This rule does not apply to businesses in the DC Zone.)
Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
2. Collectibles not held primarily for sale to customers.

For a sole proprietorship, the term “employee” in (5) and (6) includes the proprietor.

Qualified business. A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in an empowerment zone is a qualified business only if the property is not residential rental property and at least 50% of the gross rental income from the property is from enterprise zone businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to enterprise zone businesses or zone residents.

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Qualified zone property. For the increased section 179 deduction, qualified zone property is any depreciable tangible property if all the following are true.

You acquired the property after the zone designation took effect.
You did not acquire the property from a related person or member of a controlled group of which you are a member.
Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
You were the first person to use the property in an empowerment zone.
At least 85% of the property's use is in an empowerment zone and in the active conduct of a qualified trade or business in the zone.

Buildings are qualified zone property, but they do not qualify for the section 179 deduction. Used property may be qualified zone property if it has not previously been used within an empowerment zone.

Special rule for substantially renovated property. Property will be treated as having met requirements (1) and (4) if you substantially renovate the property. You substantially renovate property if, during any 24-month period beginning after the zone designation took effect, your additions to the property's basis are more than the greater of the following amounts.

100% of the adjusted basis of the property at the beginning of the 24-month period.
$5,000.

Section 179 deduction limits. There are limits on the amount you can deduct under section 179. The following sections explain how these limits are increased for certain qualified zone property placed in service by an enterprise zone business.

Maximum dollar limit. The total cost of section 179 property that you can deduct for a tax year generally cannot be more than the maximum section 179 dollar limit. However, if you place section 179 property that is qualified zone property in service during the year, this maximum dollar limit is increased by the smaller of the following amounts.

The cost of that property.
$35,000.

The following table shows these maximum dollar limits.

Table 2. Maximum Dollar Limits

		Maximum
	Maximum	Dollar Limit
For Tax Years	Section 179	With Qualified
Beginning In:	Dollar Limit	Zone Property
2002	$ 24,000	$ 59,000
2003	100,000	135,000
2004	102,000 ^*	137,000 ^*
2005	Inflation Adjusted	Inflation Adjusted
*Inflation-adjusted amount for 2004

For 2005, the total amount you can elect to deduct under section 179 will be increased to reflect an adjustment for inflation. The inflation-adjusted amount for 2004 is $102,000 (rounded to the nearest multiple of $1,000).

These maximum dollar limits are reduced if you go over the investment limit (discussed next) in any tax year.

Investment limit. For each dollar of your business cost over the threshold amount ($400,000 for 2003) for section 179 property placed in service in a tax year, reduce the maximum dollar limit by $1 (but not below zero). However, count only one-half of the cost of section 179 property that is also qualified zone property when figuring the investment limit.

Reduced dollar limit for cost exceeding the threshold amount. If the cost of your qualifying section 179 property placed in service in 2003 is over $400,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $400,000. If the cost of your section 179 property placed in service during 2003 is $500,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $500,000.

For 2005, the threshold amount used to figure any reduction in the dollar limit will be increased to reflect an adjustment for inflation. The inflation-adjusted amount for 2004 is $410,000 (rounded to the nearest multiple of $10,000).

Example.

In 2003, your enterprise zone business placed in service section 179 property that is qualified zone property costing $820,000. Because all of this property is qualified zone property, only $410,000 (one-half of its cost) is used to figure the investment limit. Because $410,000 is $10,000 more than $400,000, you must reduce the maximum dollar limit by $10,000. Your maximum dollar limit for 2003 is $135,000. You can claim a section 179 deduction of $125,000 ($135,000 – $10,000) for 2003 (if your taxable income from trades or businesses is at least $125,000).

Recapture. The recapture rules of section 179 apply when qualified zone property is no longer used in an empowerment zone by an enterprise zone business.

More information. For more information about the section 179 deduction and the increased section 179 deduction (including the section 179 deduction for off-the-shelf computer software that is placed in service in 2003), see chapter 2 of Publication 946. Also, see sections 1397A, 1397C, and 1397D of the Internal Revenue Code.

Rollover of Gain From Sale of Empowerment Zone Assets

If you sold a qualified empowerment zone asset that you held for more than one year, you may be able to elect to postpone part or all of the gain that you would otherwise include on Schedule D. If you make the election, the gain on the sale generally is recognized only to the extent, if any that the amount realized on the sale exceeds the cost of qualified empowerment zone assets (replacement property) you purchased during the 60-day period beginning on the date of the sale. The following rules apply.

No portion of the cost of the replacement property may be taken into account to the extent the cost is taken into account to exclude gain on a different empowerment zone asset.
The replacement property must qualify as an empowerment zone asset with respect to the same empowerment zone as the asset sold.
You must reduce the basis of the replacement property by the amount of postponed gain.
This election does not apply to any gain (a) treated as ordinary income or (b) attributable to real property, or an intangible asset, which is not an integral part of an enterprise zone business.
The District of Columbia enterprise zone is not treated as an empowerment zone for this purpose.
The election is irrevocable without IRS consent.

Qualified empowerment zone asset. The following are qualified empowerment zone assets.

• Tangible property, if

You acquired the property after December 21, 2000,
The original use of the property in the empowerment zone began with you, and
Substantially all of the use of the property, during substantially all of the time that you held it, was in your enterprise zone business; and

• Stock in a domestic corporation or a capital or profits
interest in a domestic partnership, if:

You acquired the stock or partnership interest after December 21, 2000, solely in exchange for cash, from the corporation at its original issue (directly or through an underwriter) or from the partnership;
The business was an enterprise zone business (or a new business being organized as an enterprise zone business) as of the time you acquired the stock or partnership interest; and
The business qualified as an enterprise zone business during substantially all of the time during which you held the stock or partnership interest.

How to report. Report the entire gain realized from the sale, as you otherwise would, without regard to the election. On Schedule D, line 8, enter “Section 1397B Rollover” in column (a) and enter as a loss in column (f) (and for 2003 only, in column (g) for sales after May 5, 2003) the amount of gain included on Schedule D that is not recognized. (If you report the sale directly on Schedule D, line 8, use the line directly below the line on which you reported the sale.)

More information. For more information about rollover of gain from empowerment zone assets, see section 1397B of the Internal Revenue Code.

Increased Exclusion of Gain From Qualified Small Business Stock

Taxpayers other than corporations generally can exclude from income 50% of their gain from the sale or trade of qualified small business stock held more than 5 years. If the stock is in a corporation that qualifies as an enterprise zone business (defined earlier under Increased Section 179 Deduction) during substantially all of the time you hold the stock, you can exclude 60% of your gain.

To claim this increased exclusion, you must have acquired the stock after December 21, 2000. Gain from periods after 2014 will not qualify for the increased exclusion.

The requirement that the corporation must qualify as an enterprise zone business during substantially all of the time you hold the stock will still be met if the corporation ceased to qualify after the 5-year period beginning on the date you acquired the stock. However, the gain that qualifies for the 60% exclusion cannot be more than the gain you would have had if you had sold the stock on the date the corporation ceased to qualify.

If you sell the stock after 2009, disregard the end of the empowerment zone designation on December 31, 2009, in determining whether the corporation qualified as an enterprise zone business during substantially all of the time you held the stock.

For more information about this exclusion, including a definition of qualified small business stock, see chapter 4 of Publication 550, Investment Income and Expenses.

Renewal Communities

This section describes the areas that have been designated renewal communities and explains the tax benefits available to businesses in those renewal communities.

Designated Renewal Communities

The Secretary of Housing and Urban Development (HUD) has designated the parts of the following areas as renewal communities. The designation will generally remain in effect until December 31, 2009. The designation may be revoked if the state or local government modifies the boundaries of the area or does not keep certain commitments.

You can find out if a business or an employee's residence is located within a renewal community by using the RC/EZ/EC Address Locator at www.hud.gov/crlocator or by calling HUD at 1-800-998-9999.

Greene-Sumter County, AL
Mobile County, AL
Southern Alabama
Los Angeles, CA
Orange Grove, CA
Parlier, CA
San Diego, CA
San Francisco, CA
Atlanta, GA
Chicago, IL
Eastern KY
Central Louisiana
New Orleans, LA
Northern Louisiana
Ouachita Parish, LA
Lawrence, MA
Lowell, MA
Detroit, MI
Flint, MI
West Central Mississippi
Turtle Mountain Band of Chippewa, ND
Camden, NJ
Newark, NJ
Buffalo-Lackawanna, NY
Jamestown, NY
Niagara Falls, NY
Rochester, NY
Schenectady, NY
Hamilton, OH
Youngstown, OH
Philadelphia, PA
Charleston, SC
Chattanooga, TN
Memphis, TN
Corpus Christi, TX
El Paso County, TX
Burlington, VT
Tacoma, WA
Yakima, WA
Milwaukee, WI

Renewal Community Employment Credit

The renewal community employment credit provides businesses with an incentive to hire individuals who both live and work in a renewal community. You can claim the credit if you pay or incur “qualified wages” to a “qualified employee.” The credit is for wages paid or incurred after 2001.

The credit is 15% of the qualified wages paid or incurred during a calendar year. The amount of qualified wages you can use to figure the credit cannot be more than $10,000 for each employee for each calendar year. As a result, the credit can be as much as $1,500 (15% of $10,000) per qualified employee each year.

Qualified employee. A qualified employee is any employee who meets both of the following tests.

The employee performs substantially all of his or her services for you within a renewal community and in your trade or business.
While performing those services, the employee's main home is within that renewal community.

Both full-time and part-time employees may qualify.

Substantially all services performed within the renewal community. You can use the pay-period method or the calendar-year method to determine the period of time the employee has performed services in the renewal community. For details, see section 1.1396–1 of the regulations.

Nonqualified employees. Certain individuals cannot be qualified employees. For a list of those individuals, see Nonqualified employees under Empowerment Zone Employment Credit, earlier.

Qualified wages. Qualified wages are any wages you pay or incur for services performed by an employee while the employee is a qualified employee (defined earlier). Wages are generally defined as wages (excluding tips) subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit.

Also treat as qualified wages certain training and education expenses you pay or incur on behalf of a qualified employee.

Effect of welfare-to-work or work opportunity credit. Qualified wages do not include any amount you take into account in figuring the welfare-to-work credit or the work opportunity credit. In addition, you must reduce the $10,000 maximum qualified wages for each qualified employee by the amount of wages you use to figure either of those credits for that employee.

Fiscal year taxpayers. If you use a fiscal tax year, the amount of qualified wages you use to figure the credit is the amount paid or incurred during the calendar year that ends during the tax year.

Example.

Your tax year begins on February 1 and ends on January 31 of the next year. You use the cash method of accounting and have one employee, whom you hired in March 2003 and pay $500 a month. You pay that employee qualified wages of $5,000 in calendar year 2003 and $500 in January 2004. When you figure your credit for the tax year ending January 31, 2004, you use the $5,000 paid in 2003 but cannot use the $500 paid in January 2004. That amount will be used to figure the credit on your next tax return.

Claiming the credit. Use Form 8844 to claim this credit. Although the renewal community employment credit is a component of the general business credit, a special tax liability limit applies to this credit. Therefore, you figure the credit separately and never carry it to Form 8300, General Business Credit.

Effect on salary and wage deduction. In general, you must reduce the deductions on your income tax return for salaries and wages and certain education and training costs by the amount of your current year renewal community employment credit (before applying the tax liability limit).

Increased Section 179 Deduction

You may be able to claim an increased section 179 deduction if your business qualifies as a renewal community business. The increase can be as much as $35,000. This increased section 179 deduction applies to “qualified renewal property” you acquire after 2001 and before 2010 and place in service in a renewal community.

Renewal community business. For the increased section 179 deduction, a corporation, partnership, or sole proprietorship is a renewal community business if all the following statements are true for the tax year.

Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within a renewal community. (This rule does not apply to a sole proprietorship.)
At least 50% of its total gross income is from the active conduct of a qualified business within a renewal community.
A substantial part of the use of its tangible property is within a renewal community.
A substantial part of its intangible property is used in the active conduct of the business.
A substantial part of the employees' services are performed within a renewal community.
At least 35% of the employees are residents of a renewal community.
Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
2. Collectibles not held primarily for sale to customers.

For a sole proprietorship the term “employee” in (5) and (6) includes the proprietor.

Qualified business. A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in a renewal community is a qualified business only if the property is not residential rental property (defined under Commercial Revitalization Deduction, later) and at least 50% of the gross rental income from the property is from renewal community businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to renewal community businesses or community residents.

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Qualified renewal property. This is any depreciable tangible property if all the following are true.

You acquired the property after the renewal community designation is in effect.
You did not acquire the property from a related person or member of a controlled group of which you are a member.
Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
You were the first person to use the property in a renewal community.
At least 85% of the property's use is in a renewal community and in the active conduct of a qualified trade or business in the community.

Buildings are qualified renewal property, but they do not qualify for the section 179 deduction. Used property may be qualified renewal property if it has not previously been used within a renewal community.

More information. See the earlier discussion of the increased 179 deduction under Empowerment Zones for a special rule for renovated property, the section 179 deduction limits, and the recapture rules, all of which also apply in renewal communities. That earlier discussion also tells where to get additional information about the section 179 deduction.

Commercial Revitalization Deduction

You can elect to treat qualified revitalization expenditures chargeable to a capital account for any qualified revitalization building in either of the following ways:

Deduct half of the expenditures for the tax year the building is placed in service, or
Amortize all the expenditures over a 120-month period beginning with the month the building is placed in service.

If you elect to take this deduction, you cannot take a depreciation deduction for the same expenditures. Claiming this deduction enables you to recover half (or all) of your qualified revitalization expenditures over a shorter period of time than depreciation. The commercial revitalization deduction is also allowed for both regular tax and alternative minimum tax purposes.

The election must be made by the due date (including extensions) of your return for the tax year the building is placed in service. If you timely filed your return without making the election, you can still make the election by filing an amended return within 6 months of the due date (excluding extensions). Enter “Filed pursuant to section 301.9100-2” on the amended return. Once made, the election may be revoked only with IRS consent. To do so, you must submit a request for a letter ruling under the provisions of Rev. Proc. 2004-1 (or its successor). See Rev. Proc. 2004-1 on page 1 of Internal Revenue Bulletin 2004-1 at www.irs.gov/pub/irs-irbs/irb04-01.pdf.

Qualified revitalization building. This is a building and its structural components that you place in service in a renewal community before 2010. If the building is new, the original use of the building must begin with you. If the building is not new, you must substantially rehabilitate the building and then place it in service.

Substantially rehabilitated building. You substantially rehabilitate a building if, during any 24-month period, your qualified rehabilitation expenditures are more than the greater of the following amounts.

The adjusted basis of the building at the beginning of the 24-month period, or at the beginning of your holding period for the building, whichever is later.
$5,000.

Qualified revitalization expenditure. This is a capital expenditure for depreciable property that is:

Nonresidential real property, or
Section 1250 property that is functionally related and subordinate to nonresidential real property. Section 1250 property is depreciable real property that is not and never has been section 1245 property. Section 1245 property is defined in Publication 544, Sales and Other Dispositions of Assets.

The total amount of qualified revitalization expenditures for any qualified revitalization building cannot be more than the smaller of:

$10 million, or
The commercial revitalization expenditure amount allocated to the building by the commercial revitalization agency for the state in which the building is located.

Nonresidential real property. This is section 1250 property that is not residential rental property or property with a class life of less than 27.5 years. Residential rental property is any building or structure if 80% or more of the gross rental income from it is rental income from dwelling units.

Expenditures that do not qualify. The following do not count as revitalization expenditures.

The cost of acquiring a building that you substantially rehabilitate, to the extent that cost is more than 30% of the total qualified revitalization expenses for the building (not counting the cost of the building itself).
Expenditures you use to figure any allowable credit (such as the rehabilitation credit).

Allocation of revitalization expenditure amounts. Each state authorizes an agency to act as the community revitalization agency. For a renewal community located within an Indian Reservation, the reservation governing body (as determined by the Department of the Interior) is treated as a state for this purpose. A commercial revitalization agency may make the following types of allocations for each qualified revitalization building.

An allocation made during the calendar year in which a qualified revitalization building is placed in service.
A binding commitment to make an allocation of a specified dollar amount to a qualified revitalization building during the calendar year in which the building is placed in service. A binding commitment is not, in and of itself, an allocation.
A carryover allocation for a single-building project or a multi-building project.

You must place the building in service by the close of the second calendar year following the calendar year during which the allocation is made and
Your basis in the project of which the building is a part (as of the later of the date that is 6 months after the date the allocation was made or the end of the calendar year during which the allocation was made) must be more than 10% of your reasonably expected basis in the project (land and depreciable property) as of the end of the second calendar year following the calendar year during which the allocation was made. Under an exception that applies for allocations made after June 30, 2002, and before January 1, 2003, you had until December 31, 2003, to meet this test.

Dollar ceiling. Each state is allowed to allocate up to $12 million of commercial revitalization expenditure amounts to each renewal community located within the state for calendar years 2002 through 2009. For calendar years after 2002, the $12 million ceiling for a renewal community may not be allocated, in whole or in part, to any other renewal community. For a special rule that applies for 2002, see section 8.02 of Rev. Proc. 2003-38 on page 1020 of Internal Revenue Bulletin 2003-24 at www.irs.gov/pub/irs-irbs/irb03-24.pdf. Allocations for buildings placed in service during the allocation year and carryover allocations both reduce the $12 million ceiling for the calendar year during which the allocation is made. A binding commitment does not reduce the $12 million ceiling until the year in which the actual allocation is made.

Carryforward. If a commercial revitalization agency does not allocate all of the commercial revitalization expenditure ceiling for a renewal community for any calendar year after 2002, the unused ceiling amount may not be carried forward to another year. For a special rule that applies for 2002, see section 8.01 of Rev. Proc. 2003-38 on page 1020 of Internal Revenue Bulletin 2003-24 at www.irs.gov/pub/irs-irbs/irb03-24.pdf.

All