Could a beneficiary use historic rehabilitation credits allocated to trusts that had matured before the credit distribution?

Subject

Historic Rehabilitation Credit, Transfer from Trust

Plain-English summary

Virginia allowed a taxpayer to use historic rehabilitation tax credits allocated to two trusts after both trusts had matured and the taxpayer had full control of their principal and income.

Under IRC § 678(a), a beneficiary with sole power over trust principal or income is treated as the trust's owner. The Department concluded that once the taxpayer met the trusts' age requirements, the trusts were disregarded grantor trusts and their tax items accrued to him.

The taxpayer could therefore use the trust-allocated credit against his 2014 Virginia income tax liability. The auditor was directed to adjust the credit and issue any appropriate refund, and unused credit could be carried through the 2017 tax year.

What this means for you

The timing of trust maturity and credit allocation mattered. The ruling did not approve a free-standing transfer between separate taxpayers; it treated the beneficiary as owner of matured, disregarded trusts when the credit was distributed.

Citations and references

• Va. Code § 58.1-339.2 — historic rehabilitation credit and carryover.
• IRC § 678(a) — beneficiary treated as owner when holding sole power over trust principal or income.
• Va. Code §§ 58.1-1821 and 58.1-1824 — appeal and protective refund claim.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-207

Original ruling text

December 18, 2017

Re: § 58.1-1824 Application: Individual Income Tax

Dear *:

This will reply to your letter in which * (the “Taxpayer”) requests a refund of individual income tax paid for the taxable year ended December 31, 2014. I apologize for the delay in responding to your request.

FACTS

* (VALLC) was formed to rehabilitate a building in Virginia. VALLC claimed a Virginia Rehabilitation Historic tax credit (the “Credit”) for the 2008 taxable year. The Credit was then passed through to VALLC's members. The members of VALLC included the Taxpayer and two trusts benefitting the Taxpayer. One trust matured at age 21 and the other at age 35, giving the Taxpayer full control over the trusts’ principal and income. Both trusts had fully matured prior to the pass through of the Credit.

The Taxpayer claimed the Credit on his 2008 through 2014 individual income tax returns. He used all of the Credit granted directly to him and utilized a portion of the Credit issued to the trusts to offset a portion of his 2014 tax liability. After review, the Department disallowed the Taxpayer's use of the Credit from the trusts on the basis that the Credit is nontransferable. An assessment was issued to the Taxpayer for the 2014 taxable year.

The Taxpayer paid the assessment and appealed, contending he could claim the Credit derived from the Trusts because it passed through to him. He also contends that he claimed the Credit on his federal return, which was not challenged by the Internal Revenue Service (IRS).

DETERMINATION

Protective Claim

Pursuant to the authority granted the Department under Va. Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Va. Code § 58.1­1821. As permitted by statute, the Taxpayer's request has been treated as an appeal under Va. Code § 58.1-1821.

Historic Rehabilitation Tax Credit

Under Va. Code § 58.1-339.2, any individual, trust, estate, or corporation is entitled to the Credit equal to 25% of eligible expenses. Credits granted to partnerships are allocated to the partners either in proportion to their ownership interest or as agreed. The credit may be carried over for up to 10 taxable years.

The Taxpayer contends that the Credit allocated to the trusts passed to him in 2008 once the trusts terminated due to the age requirement being met. He asserts that the Credit was reported on a federal form K-1 and not challenged by the IRS.

Under Internal Revenue Code (IRC) § 678(a), a beneficiary of a trust would be treated as the owner of the trust if that person has the sole power to use the principal or income from the trust. Therefore, when a beneficiary meets the age requirement of a trust, the trust becomes a grantor trust and is disregarded for federal income tax purposes. All items of income, loss and deduction then accrue to the beneficiary. In this case, the Credit allocated to the trusts could be claimed by the Taxpayer because he turned 35 prior to the distribution of the Credit. Any remaining Credit not used to offset the Taxpayer's 2014 tax liability could be carried over until the 2017 taxable year.

Based on the facts presented, the Taxpayer was entitled to use the Credit distributed to the trusts to offset his 2014 Virginia income tax liability. As such, the case will be remanded to the auditor to adjust the Credit in accordance with this determination and a refund will be issued, as appropriate. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/731.B