CEZC FAQ: Renewal Community Tax Incentive Questions
Commercial Revitalization Deduction (CRD) Questions
QUESTION 1: Can the CRD apply to construction that started before January 1, 2002?
ANSWER: Yes, provided an allocation was made to the building not later than December 31 of the calendar year in which the building was placed in service.
QUESTION 2: If a business constructed a building beginning in 2002 without getting certification first to receive the CRD, can it still get part of the deduction?
ANSWER: Yes, provided an allocation was made to the building not later than December 31 of the calendar year in which the building was placed in service.
QUESTION 3: Is the depreciation in the CRD based on straight-line accounting?
ANSWER: Yes. The deduction is allowed ratably over a 120-month period.
QUESTION 4: Can a business in the Renewal Community take both the CRD and the general credits available for the rehabilitation of historic buildings?
ANSWER: Yes. However, the expenditures used to figure the rehabilitation credit may not also be used to figure the CRD (IRS section 14001(b)(2)(B)(ii).
QUESTION 5: How does the CRD apply to mixed-use buildings? What is the amount of residential space that is allowed? Are there any other limits on the mix of uses?
ANSWER: The CRD applies to any nonresidential real property. Nonresidential real property is any real property other than (a) residential rental property or (b) property will a class life of less than 27.5 years. Residential rental property is a building or structure for which at least 80% of the gross rental income is rental income from dwelling units. Therefore, if less than 80% of a building’s gross rental income is rental income from dwelling units, the building would qualify for the CRD.
QUESTION 6: When an award is made for a project, is the total CR deduction amount for that project counted against the city’s available allocation for the year that it is awarded, regardless of its deduction method (50% in 1st year or 10% over 10 years), or is the amount of CR deduction for a project counted against the city’s total annual allocation depending on what the annual deduction for that project would be?
ANSWER: The amount of the award is counted against the available allocation for that year. The amount or method chosen by the business to claim the CRD has no effect on the amount of the allocation for any year.
QUESTION 7: Are awards made only after projects are placed into service so that actual costs are used, or can awards be made for proposed projects? If proposed projects are also eligible, how will any potential discrepancies between actual qualifying expenses versus estimated qualifying expenses be reconciled?
ANSWER: The allocations will be made according to the qualified allocation plan. There is no federal requirement that allocations be made based on either actual or estimated costs. However, once an allocation is made, there is no provision for “recapturing” any amount which the project is ultimately unable to use.
QUESTION 8: If an RC is not able to award the total of $12 million in deductions in any given year, is there a carry forward provision?
QUESTION 9: What type of forms/documentation are required to claim the deduction?
ANSWER: If the 50% deduction is claimed, it will be claimed under “other deductions” or “other expenses” on the taxpayer’s income tax return or business schedule (e.g., Schedule C). If amortization over a 120-month period is claimed, the deduction is claimed on line 42 of Form 4562 (for the first tax year) and also on the “other deductions” or “other expenses” line of the taxpayer’s income tax return or business schedule. For partners and S corporation shareholders, the deduction will be included in the net income or loss claimed in Part II of Schedule E (Form 1040). Form 8582 must also be used to claim the special $25,000 allowance if the CRD is from a passive rental real estate activity. The $25,000 allowance for the CRD applies to all taxpayers regardless of the AGI.
QUESTION 10: If a business has a net operating loss as a result of using this deduction, is it treated in the same manner as a net operating loss under the current tax code?
QUESTION 11: The CRD states that a company can exercise one of two options for taking accelerated deductions, (1) a 50% write off, or (2) a 100% write off of “all of its investment over a 10 year period.” Is the stipulation under (2) limited to the $10 million per project cap, or if a company had an expense of, for example, $38 million, could it write off (depreciate) this entire amount over a 10-year period?
ANSWER: No. Under either method, the company cannot take accelerated deductions in excess of the expenditure amount allocated to the building by the Commercial Revitalization Agency (or $10 million, if less). The remaining expenditures must be capitalized and depreciated under the applicable MACRS recovery period 9generally 39 years).
QUESTION 12: Does the tax code require Renewal Community states to adopt the CRD (and other Renewal Community incentives) for state tax purposes — so that when a business determines their federal taxable basis with use of RC deductions, that taxable basis is carried over to the state tax return? (This pertains to a state’s recognition of federal tax incentives for the state’s taxable basis.)
ANSWER: No. No provision of the Internal Revenue Code requires any state to follow federal income tax law for state purposes.
QUESTION 13: It is understood that, in most cases, a qualified allocation for the Commercial Revitalization Deduction must be made not later than the close of the calendar year in which a building is placed in service. What about early allocations? Is it possible to make a qualified allocation for a project that may not be placed into service until a future calendar year?
ANSWER: Yes. If an allocation is made prior to the date the building is placed in service, the building will qualify for the CRD provided it is placed in service by December 31, 2009. If a Renewal Community makes a CRD allocation during one year and then places a building in service in a later year, the allocation will count against the CRD amount available during the year of the allocation, not the later year when the building is placed in service.
Wage Credit, Section 179 Deduction and Zero Capital Gains Questions
QUESTION 1: Can a business benefiting from the Renewal Community tax credits available in Burlington transfer those credits to another business entity, i.e., a flow-through entity?
ANSWER: No. There is no provision in the Internal Revenue code that allows one entity to transfer an unused RC employment credit to another entity.
QUESTION 2: With respect to the employment tax credit, can an employer count the time an employee is on a tour boat in Lake Champlain that starts and stops its tours in the Renewal Community?
ANSWER: To qualify for the credit, substantially all of the services performed by the employee for the employer must be performed within the Renewal Community. Any services that are performed outside of the Renewal Community’s geographic boundaries would not count under this test.
QUESTION 3: Can real estate professionals qualify as Renewal Community Businesses?
ANSWER: Yes, provided the property owned by the real estate professional is not residential rental property and at least 50% of the gross rental income from the lessees is from Renewal Community businesses. Note that property is residential real estate only if at least 80% of the gross rental income from the property is from dwelling units.
QUESTION 4: Can a bank, located in a Renewal Community with more than 35% of it’s employees being in the RC and doing more than 50% of its business in the RC, meet the definition of an RC business? This question arises since the provision stating that less than 5% of the aggregate adjusted bases of the property of the business be attributable to “non qualified financial property” is unclear. What type of business is this provision referring to?
ANSWER: No, unless less than 5% of the bank’s average aggregate unadjusted bases are attributable to nonqualified financial property. Nonqualified financial property includes debt and other similar property (other than accounts or notes receivable from sales or services). There is no explanation in the Congressional Committee Reports as to the types of businesses targeted by this provision.
QUESTION 5: A company is located in a Renewal Community and leases employees from a third party employer (which is located outside the RC). The company pays the third party employer a fee that includes gross wages, payroll taxes and administrative fees. These leased employees are residents of the RC and work 100% of their available time at the company. Who can take advantage of the RC Employment Credit – the company or the third party employer?
ANSWER: Only the employer for Federal employment tax purposes is eligible for the credit. See IRS Publication 15-A for more information on the treatment of leased employees for employment tax purposes.
QUESTION 6: Can an employer receive the RC Employment Credit for an employee who lives in one Renewal Community and works in another?
ANSWER: No. Wages must be paid to a qualified zone employee to qualify for the credit. To be a “qualified zone employee,” the employee must live in the same Empowerment Zone or Renewal Community in which substantially all of the services are performed for the employer. (IRC section 1396(d)(1)).
QUESTION 7: To qualify as an Empowerment Zone or Renewal Community business, based on the percentage requirements, can investments and employees be in multiple designated RCs or EZs?
ANSWER: Yes, except that the tests for Empowerment Zones and Renewal Communities must be figured separately (i.e., you can aggregate RCs with other RCs, but not with Empowerment Zones, and vice versa). (IRC sections 1397C and 1400G).
QUESTION 8: In what manner can national or international conglomerates participate in this program if they have a plant or plants located in the Renewal Community?
ANSWER: To qualify as a Renewal Community business, a large business can set up a separate legal entity (e.g., a subsidiary or partnership). Activities of legally separate (even if related) parties are not aggregated for purposes of determining whether an entity qualifies as an Enterprise Zone [or Renewal Community] business. (P.L. 103-66, House Committee Report).
And, of course, the RC wage credit is available for employees who live and work in the Renewal Community, regardless of whether the employer qualifies as a “Renewal Community business.”
QUESTION 9: With respect to the RC Employment Credit, is the 90-day period calculated based on the calendar, or on days worked?
ANSWER: The 90-day test is based on calendar days, not days worked.
QUESTION 10: Do you count family members as employees in determining if the business is considered a Renewal Community Business? For example, if a business located in the Renewal Community has ten employees, four of whom are family members who live in the RC, how many employees need to live in the RC in order to be considered a Renewal Community Business? Would it be 35% of 10 employees or 35% of 6 employees? If the answer is a fraction, do you round up or down to determine the correct number of employees?
ANSWER: Yes, employees who are also family members count for purposes of the 35% test. So, in the example, you would base the test on 10 employees. You would not round at all. At least 35% of the employees must be residents of a Renewal Community. For any percentage less than 35%, the employer would fall below the 35% threshold and would fail to meet the test.
QUESTION 11: Are tips considered Qualified Wages in order to determine the Renewal Community Employment Credit?
ANSWER: No. Wages are defined in IRC section 1397 by reference to IRC section 51, which in turn defines them by reference to IRC section 3306(b). Because tips are counted as wages under IRC section 3306(s), not IRC section 3306(b), tips do not count as wages for figuring the Renewal Community employment credit.
QUESTION 12: The 0% capital gains benefit is available to “Renewal Community businesses”. What happens if, during the 5-year period that the asset must be held, the status of the business changes? For example, a business buys a building 1/1/2002 and meets the RC Business definition during 2002, 2003, 2004, but doesn’t meet the definition in 2005 and 2006. The business sells the property in 2007 after holding it five years. Does the business still get the 0% capital gains tax rate on the profits?
ANSWER: No. To qualify for the capital gain exclusion, substantially all of the use of the property during substantially all of the taxpayer’s holding period must have been in a Renewal Community business. Although “substantially all” is not defined in the Code for this purpose, it seems clear that qualifying as an RC business for only 3 of 5 years would not be considered “substantially all” of the taxpayer’s holding period.
QUESTION 13: What about a scenario where the business meets the criteria for a Renewal Community business in 2002 and ’03, doesn’t meet it in ’04, but regains the status for ’05 and ’06, and sell in ’07 while it still meets the criteria. Does the business get the 0% capital gains tax rate on the profits?
ANSWER: To qualify for the capital gain exclusion, substantially all of the use of the property during substantially all of the taxpayer’s holding period must have been in a Renewal Community business. Because “substantially all” is not defined in the Code for this purpose, it is unclear if qualifying as an RC business in 4 of 5 years would be considered “substantially all” of the taxpayer’s holding period.
QUESTION 14: Based on the 1990 Census Tract data, one major employer’s address is located in the Renewal Community. The firm has several adjacent buildings connected by pedestrian walkways that are physically located outside the RC, simply by the demarcation lines of the census tract. If all the connected buildings have one central address, however, that is located in the RC, can all the buildings be considered to be inside the RC?
ANSWER: Under IRC section 1397C(f), if a business uses real property located both within and outside an RC, and the amount of the real property located within the RC is “substantial” when compared to amount of the real property located outside the RC and contiguous to the real property within the RC, the contiguous property is treated as being within the RC. However, this rule applies only for purposes of defining a “Renewal Community business.” For any other purpose, the taxpayer can get an answer by submitting a private letter ruling request to the IRS.
QUESTION 15: If the tax year for a business is other than the calendar year, when would the business claim the Renewal Community wage credits? For example, if the business’s fiscal year runs from October 1, 2001 through September 30, 2002, should it claim all credits earned during this period when it files its 2002 tax return or should it claim the October – December 2001 credits in its 2001 tax return and then claim the January – September 2002 credits in its 2002 tax return?
ANSWER: The credit is based on the qualified wages paid or incurred during the CALENDAR YEAR that ENDS DURING the taxpayer’s FISCAL YEAR.
EXAMPLE: For a taxpayer with a fiscal year ending on September 30, the credit for CALENDAR YEAR 2002 wages is claimed on Form 8844 for the FISCAL YEAR that begins October 1, 2002 and ends on September 30, 2003. That’s because December 31, 2002 falls within the fiscal year ending September 30, 2003.
Therefore, for the wages paid or incurred from January 1 – December 31, 2001 (Renewal Community/Empowerment Zone employment credit only), the credit would be claimed on the return for the fiscal year that begins on October 1, 2001, and ends on September 30, 2002. For the wages paid or incurred from January 1 – December 31, 2002, the credit would be claimed on the return for the fiscal year that begins on October 1, 2002, and ends on September 30, 2003. Therefore, even though the taxpayer’s DEDUCTION is for fiscal year wages, the CREDIT is for calendar year wages.
NOTE: This rule applies ONLY to the Empowerment Zone and Renewal Community employment credit. The work opportunity credit, welfare-to-work credit, and Indian employment credit all use FISCAL YEAR wages.
QUESTION 16: Can a building construction site in a Renewal Community qualify for Renewal Community employment credits?
ANSWER: The RC employment credit is available for any employee that performs substantially all of its services during the period in the RC and also lives in the RC. The IRS has interpreted the language “the period” to include pay periods. So if an employee is working at a construction site for substantially all of specified pay periods, the wages paid during those pay periods would be qualified wages eligible for the 15% credit up to $10,000 per year in wages. The employee must live the in the RC that same time period.
QUESTION 17: To qualify for the zero-percent capital gains rate, what percentage of a business’s gross income must come from the active conduct of business within the Renewal Community, is it 50% or 80%?
ANSWER: The 80% rule is an Enterprise Zone benefit that applies only to businesses operating in the District of Columbia. For Renewal Community businesses, at least 50% of gross income must come from the active conduct of business within the RC. That does not mean that the customers or products of the business must come from the RC; it means that the business must perform its business in the RC. For the purposes of determining what is gross income, this income would be the same figure that a business would use for other federal tax purposes.
QUESTION 18: Are the employers and employees that use the Renewal Community and Empowerment Zone tax incentives required to be residents of the United States?
ANSWER: For purposes of figuring the RC and EZ credits and deductions, neither the owner nor the employees are required to be U.S. citizens.
QUESTION 19: When will the IRS tax forms be ready for Renewal Communities that use the available tax incentives?
ANSWER: Some – such as IRS Form 8844 to report the wage credit – are already available. The IRS is developing additional forms and plans to release them in the fall of 2002.