What Is Sec 47 Investment Credit Recapture?

The investment tax credit is a federal incentive for businesses to invest in certain types of property, including expenditures for rehabilitating older buildings or installing renewable energy equipment. When a taxpayer claims this credit, they reduce their tax liability directly, making such investments more financially attractive. The credit is based on the assumption that the property will be used in the business for a required length of time.

When a business claims an investment credit, such as the rehabilitation credit under Internal Revenue Code Section 47, it is subject to investment credit recapture. The rules for this recapture are established under Internal Revenue Code Section 50. This provision requires a taxpayer to repay all or a portion of the tax credit if the property is sold or taken out of business use prematurely. The purpose is to ensure the tax benefit aligns with the intended long-term business use.

The principle of recapture is tied to the asset’s holding period. The law outlines a timeframe during which the property must be used in a qualifying manner to fully earn the credit. A disposition or change in use before the end of this period will trigger the recapture tax, preventing taxpayers from claiming a credit and then quickly selling the asset.

Events Triggering Recapture

The recapture of an investment credit is initiated by specific events that occur before the end of the property’s required holding period. The most common trigger is the disposition of the property, which includes an outright sale of the asset to another party. When the property is sold, it is no longer used by the taxpayer who claimed the credit, leading to a recapture of the unearned portion of the credit.

Another frequent trigger is the conversion of the property’s use. If a property that was used for business purposes is converted to personal use, it ceases to be qualifying investment credit property. For example, if a taxpayer claimed a rehabilitation credit for a building used in their trade and later converts it into their personal residence, this action would trigger the recapture rules. The property must be used in a trade or business for the entire holding period to avoid this outcome.

Gifting the property to another individual or entity is also considered a disposition that can trigger recapture. Even though no sale occurs, the transfer of ownership means the original taxpayer is no longer using the asset in their business. Similarly, if the property is physically moved outside of the United States for use, it may cease to qualify. Events like casualty or theft are also treated as dispositions, though specific rules may apply.

Recapture can also be triggered if a partner in a partnership that owns credited property sells their partnership interest. The same principle can apply to shareholders in certain corporations. These indirect dispositions are monitored to prevent taxpayers from avoiding recapture by transferring their interest in an entity rather than the property itself.

Calculating the Recapture Tax

The recapture amount is determined using a tiered percentage system based on a five-year holding period. The percentage of the credit that must be repaid decreases by 20% for each full year the property is held. If the property is held for five full years or more, no recapture is required.

The recapture percentages for early disposition are:

• 100% if held for less than one year.
• 80% if held for one year but less than two.
• 60% if held for two years but less than three.
• 40% if held for three years but less than four.
• 20% if held for four years but less than five.

To illustrate, consider a business that incurs $100,000 in qualified rehabilitation expenditures for a historic building and claims a 20% investment credit, resulting in a $20,000 tax credit. The building is placed in service on June 1, 2022. If the business sells the building on October 15, 2024, the holding period is more than two years but less than three. The applicable recapture percentage is 60%, and the recapture tax would be $12,000 ($20,000 x 60%), resulting in a tax increase for the 2024 tax year.

Required Information and Form Completion

To accurately calculate and report the recapture of an investment credit, a taxpayer must gather several specific pieces of information. This includes a clear description of the property, its physical characteristics, and its function within the business.

The taxpayer will need the exact date the property was originally placed in service, as this marks the beginning of the holding period. Also required is the original cost or other basis of the property that was used to calculate the investment credit. The specific type of investment credit, such as the rehabilitation or energy credit, must also be identified.

The total amount of the credit taken on a prior year’s tax return is needed. Finally, the taxpayer must have the precise date of the disposition or the event that caused the property to cease being qualifying. This date determines the actual holding period and the correct recapture percentage.

This information is used to complete IRS Form 4255, Recapture of Investment Credit. When filling out the form, the taxpayer will enter the property description, dates, and original cost. The form then requires the original credit amount and guides the user through determining the holding period and applying the correct recapture percentage.

Reporting and Filing Procedures

The completed Form 4255 must be attached to the taxpayer’s primary income tax return for the year in which the disposition occurred. For an individual, this would be Form 1040, while businesses may use Form 1120 for a corporation or Form 1065 for a partnership.

The total recapture tax calculated on Form 4255 is not paid separately but is integrated into the taxpayer’s overall tax liability for the year. The final recapture amount is transferred to a specific line on the main tax return, such as the “total tax” line, increasing the tax owed for that year.

This recaptured credit is treated as an adjustment to the current year’s tax, not a separate penalty. The return with the attached Form 4255 must be filed by the standard tax deadline, and the increased tax liability must be paid by the due date. Proper documentation should be retained in case the IRS has questions about the calculation.

Exceptions to the Recapture Rules

There are several exceptions where a disposition of property does not trigger investment credit recapture. One exception is for a transfer of property that occurs as a result of the taxpayer’s death. In this situation, the property is treated as if it had been held for its entire required holding period, and no recapture is necessary.

Another exception applies to transfers of property between spouses or former spouses if the transfer is incident to a divorce. The spouse who receives the property becomes responsible for any recapture if they later dispose of the property prematurely.

A mere change in the form of conducting a trade or business will not trigger recapture. For this to apply, the property must be retained in the same trade or business, and the taxpayer must retain a substantial interest in the new business entity. For example, if a sole proprietor incorporates their business and transfers the investment credit property to the new corporation, recapture is not required.

Certain tax-free corporate reorganizations or liquidations are also exempt from the recapture rules. When one corporation acquires the assets of another in a qualifying reorganization, the property can be transferred without triggering recapture. The acquiring corporation assumes responsibility for the property and any future recapture.