After a corporation claims the investment tax credit and spins the property off to an LLC in a tax-free section 721 exchange, who keeps the credit and is it recaptured?

Plain-English summary

A New York film production company bought $1 million of qualifying video post-production equipment in 1993 and placed it in service for the year ended March 31, 1994, but did not claim the investment tax credit that year. On about April 1, 1994 it spun off the video division to a newly formed LLC (90% owned by the company, taxed as a partnership) in a tax-free section 721 exchange. Bruce Nadell asked who is entitled to the ITC -- the corporate taxpayer, the LLC, or the LLC's members.

The Department held:

• The corporate taxpayer must claim the credit for the first qualified-use year (year ended March 31, 1994), under 20 NYCRR 5-2.1.
• No recapture on the section 721 spin-off. A section 721 contribution that meets the "mere change in form" conditions is not a disposition (Rev. Rul. 86-23; 20 NYCRR 5-2.8). And because a corporate member of a partnership-LLC is treated like a corporate partner (and the property stays in qualified use by the LLC), the property continues in qualified use by the corporate taxpayer -- so no recapture is required under section 210.12(g).
• The LLC and its members cannot claim the ITC on this property. The LLC (a partnership) is not a taxpayer, so it cannot claim the credit; and the members cannot claim it because, under IRC section 723, the LLC took the property at the transferor's carryover basis, which is not a "purchase" under IRC section 179(d) as the credit requires.

What this means for you

A section 721 spin-off to an LLC is a mere change in form, not a disposition

Contributing ITC property to a partnership/LLC in a tax-free section 721 exchange that is a mere change in the form of the business does not trigger recapture, as long as the property stays in qualified use.

The corporate taxpayer keeps the credit it claimed

The company that originally bought and placed the property in service claims the credit and keeps it; reorganizing into an LLC it controls does not cost it the credit.

The LLC and its members cannot newly claim the credit on the same property

A partnership-LLC is not a taxpayer and cannot claim the ITC, and its members cannot claim it on contributed property because the LLC holds it at carryover basis, which is not a section 179(d) purchase.

Common questions

Q: Does spinning ITC property off to an LLC trigger recapture?
A: No, if it is a tax-free section 721 contribution that is a mere change in form and the property stays in qualified use.

Q: Who claims the credit?
A: The corporate taxpayer that bought the property and placed it in service claims it for the first qualified-use year, and keeps it.

Q: Can the LLC or its members claim the credit on the contributed property?
A: No. The LLC is a partnership (not a taxpayer), and the members cannot claim it because the LLC took the property at carryover basis, not by a section 179(d) purchase.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 210.12 / 210.12(g) (investment tax credit; recapture on disposition); 20 NYCRR 5-2.1, 5-2.2, 5-2.8 (claim year; qualified property; disposition / mere change in form)
- IRC section 721 (tax-free contribution to a partnership); section 723 (carryover basis); section 179(d) (purchase requirement); section 47 / Rev. Rul. 86-23
- John J. Eagan, TSB-A-87(9)C (corporate partner deemed to purchase partnership property); Department Memorandum TSB-M-94(6)I and (8)C (LLC classification)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1996.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a96_12c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-96 (12) C
Corporation Tax
May 2, 1996

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C950223A

On February 23, 1995, a Petition for Advisory Opinion was received from Bruce Nadell, 156
W. 56th Street, 4th Floor, New York, New York 10019.
The issue raised by Petitioner, Bruce Nadell, is whether the corporate taxpayer, the limited
liability company ("LLC") or the member owners of the LLC are entitled to claim the investment tax
credit under section 210.12 of Article 9-A of the Tax Law based on a set of facts.
Petitioner submits the following facts as the basis for this Advisory Opinion.
The corporate taxpayer is a New York film production company with a March 31 taxable
year end. In 1993, the corporate taxpayer started a new division devoted to video-tape post
production. On October 1, 1993, the corporate taxpayer purchased, for its new division, one
million dollars worth of new state-of-the-art equipment to be used in video-tape post production. The
corporate taxpayer put the equipment in use in the taxable year ended March 31, 1994. The corporate
taxpayer did not claim the investment tax credit in taxable year ended March 31, 1994.
On or about April 1, 1994, the corporate taxpayer spun-off its new videotape division to a
newly formed LLC in a tax-free exchange under section 721 of the Internal Revenue Code ("IRC").
The LLC was formed in New Jersey, but operates exclusively in New York. The corporate
taxpayer retained a 90% ownership interest in the LLC.
Section 721(a) of the IRC provides that "[n]o gain or loss shall be recognized to a partnership
or to any of its partners in the case of a contribution of property to the partnership in exchange for
an interest in the partnership."
Section 723 of the IRC provides, in part, that "the basis of property contributed to a
partnership by a partner shall be the adjusted basis of such property to the contributing partner at the
time of the contribution .... "
Section 210.12 of the Tax Law allows an investment tax credit against the tax imposed under
Article 9-A of the Tax Law. For taxable years beginning after 1990, section 210.12 allows an
investment tax credit equal to five percent with respect to the first $350 million of the investment
credit base and four percent with respect to the investment credit base in excess of $350 million. The
investment credit base is the cost or other basis for Federal income tax purposes

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of qualified tangible personal property and other tangible property, including buildings and structural
components of buildings.
Section 5-2.1 of the Business Corporation Franchise Tax Regulations ("Article 9-A
Regulations") provides that the taxpayer must claim the investment tax credit for the first taxable
year in which the property becomes qualified property.
Under section 210.12(b) of the Tax Law and section 5-2.2 of the Article 9-A Regulations,
the term "qualified property" means tangible personal property and other tangible property, including
buildings and structural components of buildings, which:
(1)

is acquired, constructed, reconstructed or erected by the taxpayer after
December 31, 1968;

(2)

is depreciable pursuant to section 167 of the Internal Revenue Code;

(3)

has a useful life of four years or more;

(4)

is acquired by the taxpayer by purchase as defined in section 179(d) of the
Internal Revenue Code;

(5)

has a situs in New York State; and

(6)

is principally used by the taxpayer in the production of goods by
manufacturing, processing, assembling, refining, mining, extracting, farming,
agriculture, horticulture, floriculture, viticulture or commercial fishing.

Section 210.12(g) of the Tax Law and section 5-2.8(a) of the Article 9-A Regulations provide
that if property on which investment tax credit has been claimed is disposed of or ceases to be in
qualified use prior to the end of its useful life, the difference between the credit taken and the credit
allowed for actual use must be added back to the tax otherwise due in the year of disposition or
disqualification.
Section 5-2.8(c) of the Article 9-A Regulations provides that a disposition of qualified
property includes:
(1)

a sale of the property;

(2)

a liquidation other than as part of a statutory merger or consolidation;

(3)

a legal dissolution of the taxpayer;

(4)

a trade-in of the property;

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(5)

a gift of the property;

(6)

transfer upon foreclosure of a security interest in the property;

(7)

retirement of the property before expiration of its useful life;

(8)

condemnation of the property;

(9)

loss of the property due to fire, theft, storm or other casualty; and

(10)

transfer of the property to a corporation not taxable under article 9-A.

However, the term "disposition" is not defined for purposes of section 210.12(g) of the Tax
Law or section 5-2.8 of the Article 9-A Regulations.
Section 1-2.1 of the Article 9-A Regulations provides that, unless a different meaning is
clearly required, any term used in the Article 9-A Regulations shall presumably have the same
meaning as when used in a comparable context in the IRC and the corresponding regulations. The
language of section 210.12(g) of the Tax Law is parallel to that contained in section 47 of the IRC
prior to the enactment of the Revenue Reconciliation Act of 1990. Therefore, when determining
whether a transaction is a disposition requiring recapture of investment tax credit for purposes of
section 212.12(g) of the Tax Law and section 5-2.8 of the Article 9-A Regulations, it is appropriate
to apply precedent set under the IRC for Federal income tax purposes.
Section 47 of the IRC, (prior to the enactment of the Revenue Reconciliation Act of 1990
applicable to property placed in service after December 31, 1990), provides for a recomputation of
the investment credit allowed by section 38 of the IRC when qualified property is disposed of or
ceases to be section 38 property. In general, property will be considered disposed of whenever it
is sold, exchanged, transferred, distributed, involuntarily converted, or disposed of by gift. (See, S
Rep No 1881, 87th Cong, 2nd Sess 149 (1962), 1962-3 CB 707, 852-853.) However, not all
dispositions result in recapture for Federal income tax purposes.
Section 1.47-3(f)(1) of the Federal Income Tax Regulations provides that the provisions of
section 47 of the IRC relating to disposition do not apply to "section 38 property which is disposed
of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the
estimated useful life which was taken into account in computing the taxpayer's qualified investment
by reason of a mere change in the form of conducting the trade or business in which such section 38
property is used provided that [certain] conditions ... are satisfied." The conditions are as follows:
(1)

the section 38 property is retained as section 38 property in the same trade or
business;

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(2)

the transferor of the section 38 property retains a substantial interest in such
trade or business;

(3)

substantially all the assets (whether or not section 38 property) necessary to
operate the trade or business are transferred to the transferee to whom the
section 38 property is transferred; and

(4)

the basis of the section 38 property in the hands of the transferee is
determined in whole or in part by reference to the basis of the section 38
property in the hands of the transferor.

It has been determined that where the conditions set forth in section 1.473(f)(1) of the Federal
Income Tax Regulations are met, a transaction qualifying for nonrecognition treatment under section
721 of the IRC constitutes a mere change in the form of conducting the trade or business and
recapture of investment credit under section 47 of the IRC is not required. (See, Rev Rul 8623, 1986­
1 CB 5.)
Accordingly, pursuant to section 5-2.1 of the Article 9-A Regulations, if all of the conditions
set forth in section 5-2.2 of the Article 9-A Regulations have been met, a taxpayer must claim the
investment tax credit for the first taxable year in which the property becomes qualified property.
In this case, if all of the conditions of section 5-2.2 of the Article 9-A Regulations are met,
the corporate taxpayer must claim the investment tax credit for the qualifying property purchased
on October 1, 1993, on its franchise tax report for fiscal year ended March 31, 1994. The corporate
taxpayer spun-off its new video-tape division to a newly formed LLC in a tax-free exchange under
section 721 of the IRC on or about April 1, 1994. For Federal income tax purposes, this transaction,
pursuant to Revenue Ruling 86-23 (1986-1 CB 5), would be a mere change in the form of conducting
the trade or business and the corporate taxpayer would not be required to recapture the investment
credit taken on the section 38 property that was transferred.
Therefore, pursuant to section 5-2.8(c) of the Article 9-A Regulations, this transaction is not
considered a "disposition" as contemplated in section 210.12(g) of the Tax Law. Where there is no
disposition of qualified property, a recapture of investment tax credit is not required provided that
the property continues in qualified use for its entire life or for more than 12 consecutive years.
In John J. Eaqan. Norris. McLaughlin & Marcus, Adv Op St Tax Comm, April 29, 1987,
TSB-A-87(9)C, it was held that where a partnership purchases tangible personal property that is
principally used by the partnership and that meets all of the requirements for qualifying for the
investment tax credit, a corporate partner of the partnership is allowed an investment tax credit,
pursuant to section 210.12(a) of the Tax Law, for its allocable share of the cost or other basis of such
qualifying tangible personal property.

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Section 2 of the Tax Law provides the definition of certain terms used in the Tax Law, and
was amended by Chapter 576 of the Laws of 1994 which added the following:
5. The term "limited liability company" means a domestic limited liability company
or a foreign limited liability company, as defined in section one hundred two of the
limited liability company law.
6. "Partnership and partner," unless the context requires otherwise, shall include, but
shall not be limited to, a limited liability company and a member thereof,
respectively.
Section 208.1 of the Tax Law provides that the term "corporation" includes an association
within the meaning of section 7701(a)(3) of the IRC, including an LLC.
Accordingly, an LLC that is treated as a corporation for Federal income tax purposes is
treated as a corporation for New York State tax purposes. An LLC that is treated as a partnership for
Federal income tax purposes, is treated as a partnership for New York State tax purposes. (See,
Department of Taxation and Finance Memorandum, TSB-M-94(6)I and (8)C, October 25, 1994.)
Since an LLC that is treated as a partnership for Federal income tax purposes is treated as a
partnership for New York State tax purposes, it is consistent to treat a corporate member of an LLC
like a corporate partner of a partnership. That is, where a corporate partner of a partnership is
allowed to claim an investment tax credit on qualifying property that is principally used by the
partnership, a corporate member of an LLC is allowed to claim an investment tax credit on
qualifying property that is principally used by the LLC. Further, as long as the tangible personal
property continues to be in qualified use by the LLC, the property continues to be in qualified use
by a corporate member of the LLC.
In this case, when the corporate taxpayer spun-off its new video-tape division to a newly
formed LLC in a tax-free exchange under section 721 of the IRC and the property continues in
qualified use by the LLC, the property continues to be in qualified use by the corporate taxpayer
pursuant to section 1-2.1 of the Article 9-A Regulations. Therefore, a recapture of the investment
tax credit claimed by the corporate taxpayer in the first year the equipment was in qualified use, that
is, for taxable year ended March 31, 1994, is not required by section 210.12(g) of the Tax Law and
section 5-2.8(a) of the Article 9-A Regulations.
It should be noted that, since the LLC in this case is treated as a partnership and is not a
taxpayer, the LLC is not entitled to claim an investment tax credit. Further, the members of the
LLC cannot claim an investment tax credit on the qualifying property purchased by the corporate
taxpayer on October 1, 1993 and spun-off to the LLC. The reason is that, pursuant to section 723
of the IRC, the LLC takes over the qualifying property at the adjusted basis of the

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transferor, and, therefore, the transfer does not qualify as a purchase pursuant to section 179(d) of
the IRC as required in section 210.12(b) of the Tax Law and section 5-2.2 of the Article 9-A
Regulations.

DATED: May 2, 1996

NOTE:

/s/
DORIS S. BAUMAN
Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.