Foreclosure ATG - Chapter 10 - Rehabilitation Credit and IRC §469
Publication Date - February 2015
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
IRC §47 allows a tax credit for the rehabilitation of a qualified building as defined in IRC §47(c). The rehabilitation credit applies to costs that are incurred for rehabilitation and reconstruction of certain buildings. In the case of a building other than a certified historic structure, a building is not a qualified rehabilitated building unless the building was first placed in service before 1936. Rehabilitation includes renovation, restoration, and reconstruction. It does not include enlargement or new construction. The certified historic credit is co-administered with the National Park Service and the State Historic Preservation Office.
The credit is an investment tax credit and is:
- 10% of the qualified rehabilitation expenditures with respect to any qualified rehabilitation building other than a certified historic structure and
- 20% with respect to the qualified rehabilitation of a certified historic structure.
The credit is temporarily increased for property located in specific disaster areas:
- For pre-1936 buildings (other than certified historic structures), the credit percentage is increased from 10% to 13%.
- For certified historic structures, the credit percentage is increased from 20% to 26%.
If the rehabilitation credit is generated by a rental activity, IRC §469(i) generally limits the deduction to the tax equivalent of $25,000 ($7,000 in the 28% bracket). Furthermore, while the active participation standard is not required for the rehabilitation credit, it is phased out beginning at modified AGI of $200,000. Generally, no rehabilitation credit may be deducted if the taxpayer's modified AGI exceeds $250,000.
A rehabilitation credit may be generated by a business in which the taxpayer materially participates (works on a regular, continuous, and substantial basis). If the credit is generated by a business (not a rental activity) in which the taxpayer works, it is not limited by the passive loss rules under section 469.
Under IRC §469(c)(7), beginning in 1994, a qualifying real estate professional may be able to deduct his entire rehabilitation credit if he/she materially participates in the rental activity generating the credit. The rehabilitation credit is reflected on Form 8582CR which is carried to Form 3468 which is carried to Form 3800 which is ultimately carried to Form 1040 under other credits.
If the credit is generated by a rental activity or by a business in which the taxpayer does not materially participate, losses are limited under section 469(i) to the tax equivalent of $25,000.
It is important to note that a taxpayer cannot deduct a credit of $25,000, but instead is allowed the tax equivalent of $25,000 for the rehabilitation credit. Thus, for example, a taxpayer in the 28% bracket could deduct a credit of up to $7,000.
There have been substantial examination issues where taxpayers failed to limit the rehabilitation credit to the tax equivalent of $25,000 or failed to consider the modified AGI limitations. Rehabilitation credits disallowed must be carried forward. Credits suspended due to the passive loss provisions also must be carried forward and they cannot be carried back per IRC §469(b).
- Check Form 8582CR for any passive credits that exceed $9,900 (the total passive credit allowable for a taxpayer in the 39.6% bracket). If there is no Form 8582CR, it is an indicator that the taxpayer ignored the passive limitations.
- If adjusted gross income exceeds $250,000, no rehabilitation credit is deductible (unless the taxpayer has passive income which is relatively rare).
- Scrutinize carefully, any large amounts of passive income on Form 8582CR line 6 to verify that the character is truly passive.
For additional information and audit techniques on the rehabilitation credit and PAL refer to:
- Rehabilitation Credit MSSP Guide (PDF)
- Rehabilitation Tax Credit Real Estate Tax Tips
- Passive Activity Loss Audit Technique Guide