Opinion ID: 199081
Heading Depth: 2
Heading Rank: 3

Heading: The Rehabilitation Tax Credits.

Text: 45 Last -- but not least -- the taxpayers claim that they were entitled to use their rehabilitation tax credits on their 1993 and 1994 returns regardless of the reclassification of their rental income. In order to address this claim, we first supply some background. 46 At the pertinent time, the law provided for tax credits as an incentive for undertaking a qualified rehabilitation of an historic structure. See 26 U.S.C. §§ 38(b), 46 (1), 47. To qualify for such credits, a taxpayer had to meet certain standards propounded by the Secretary of the Interior. See 36 C.F.R. § 67. Congress placed the rehabilitation tax credit provision in subpart D of part IV of subchapter A of chapter 1 of subtitle A of the Internal Revenue Code. 3 As such, the provision comes within the purview of the statute restricting the use of passive activity credits in any tax year to 47 the amount (if any) by which -- (A) the sum of the credits from all passive activities allowable for the taxable year under -- (i) subpart D of part IV of subchapter A . . . exceeds (B) the regular tax liability of the taxpayer for the taxable year allocable to all passive activities. 48 26 U.S.C. § 469(d)(2). 49 With this background in mind, we return to the case at bar. Here, the taxpayers earned rehabilitation tax credits while refurbishing the Kunhardt Mill. Nevertheless, the Commissioner scotched the use of these credits for the tax years in question. The Tax Court upheld this determination. See Sidell, 78 T.C. Memo. 1999-301, at 28. The taxpayers brand this disallowance as contrary to both the plain language of the enabling statute and the tenor of the congressional policy underlying it. We disagree. 50 To be sure, the applicable statute, as the taxpayers suggest, imposes only two pertinent preconditions to the use of rehabilitation tax credits. The first is that the credits arise out of the qualified rehabilitation of a certified historic structure (and, thus, be allowable under subpart D of part IV of subchapter A). See 26 U.S.C. § 469(d)(2)(A)(i). The taxpayers plainly satisfy this requirement. 51 The battleground here is the second condition -- a condition which requires that the tax liability that the credit-holder seeks to offset be allocable to [his] passive activities. Id. § 469(2)(B). The taxpayers posit that since only the income from a property is classified as nonpassive under the self-rental rule, their rental activities remain passive and, therefore, the tax liability incurred anent those activities is eligible to be offset by rehabilitation tax credits. See, e.g., Appellant's Reply Brief at 30 (maintaining that although the rental income received from KGR has been recharacterized as nonpassive under the self-rental rule, the rental income will generate a tax liability, and therefore, the taxpayers will have a tax liability allocable to their passive activities). 52 This argument is no more than a clever exercise in semantics -- and one that reads the rehabilitation tax credit provision with much too sanguine an outlook. In the Tax Reform Act of 1986, Congress aspired to close precisely the kind of tax loophole that the taxpayers here seek to exploit. See, e.g., House Conf. Rep. 99-841, at 147, reprinted in 1986 U.S.C.C.A.N. 4075, 4235 (explaining that the underlying purpose of the passive loss provision [is to prevent] the sheltering of positive income sources through the use of tax losses derived from passive business activities). When Congress refined the rehabilitation tax credit four years latter, it aspired to grant a carefully circumscribed incentive for the restoration of historic structures -- but there are no signs that it meant to blunt the thrust of its earlier handiwork. If allowed to prevail, the taxpayers' reading of the rehabilitation tax credit provision would undermine the overarching intent of Congress. 53 To be specific, the Secretary's regulations classify rent paid by closely-held C corporations to their proprietors as nonpassive income for a reason: so that the latter cannot manipulate the corporation's revenues to take advantage of the benefits that attach to the classification of income as passive. Free use of rehabilitation tax credits comprises one of those benefits. Thus, as more fully explained by the Tax Court, the Sidells' credits were not available for use in 1993 and 1994 because they exceeded their passive tax liability for those years. See Sidell, 78 T.C. Memo. 1999-301, at 27-28. 54 The sockdolager rests in the regulations. While both the 1988 and 1989 temporary regulations contained sunset provisions, the Secretary went out of his way to preserve Temp. Treas. Reg. § 1.469-3T in T.D. 8417, Limitation on Passive Activity Losses and Credits -- Technical Amendments to Regulations, 57 Fed. Reg. 20,747 (May 15, 1992). That preserved regulation, which comprises a part of the transition rules, makes it very clear that a taxpayer who earns rehabilitation tax credits must have net passive income in order to employ those credits in a given year. See Temp. Treas. Reg. § 1.469-3T(g) (Examples (3) and (4)). Since the taxpayers in this case do not have any net passive income for the years in question -- what they had reported as passive income has now been reclassified by the Commissioner, see supra -- they are not eligible to use their rehabilitation tax credits for those years. 55 Contrary to the taxpayers' importunings, this result does not defeat the purpose of the rehabilitation tax credit law. The law still provides a meaningful incentive. Indeed, the taxpayers, notwithstanding the reclassification of the Kunhardt Mill rental income, have at least three remaining avenues for taking advantage of the credits in later tax years. First, they may carry over any unused credits indefinitely until such time as they have passive income to offset against these credits. See 26 U.S.C. § 469(b); see also St. Charles Inv. Co. v. Commissioner, 110 T.C. 46, 56 (1998). Second, upon sale or disposition of the rehabilitated property, the taxpayers can use any suspended credits against passive income from the same activity, then against net passive income from other activities, and finally, as a nonpassive loss. See 26 U.S.C. § 469(g); St. Charles, 110 T.C. at 49. Third, the taxpayers at the time of disposition might be able to employ unused credits to adjust their basis in the property. See 26 U.S.C. § 469(j)(9). Viewed from this perspective, the Commissioner's disallowance of the rehabilitation tax credits for 1993 and 1994 does not contravene Congress's discernible intent.