Can a Virginia partner subtract the entire gain from selling a Historic Rehabilitation Tax Credit, or is the subtraction limited to net capital gain?

Plain-English summary

A general partner's partnership sold a Historic Rehabilitation Tax Credit in 2016, producing a short-term capital gain. The partner reported his share of that gain on his federal return (he also had a separate long-term capital loss that year) and, on his Virginia return, subtracted the full short-term gain. The Department reduced the subtraction to his "net capital gain" — i.e., it netted the short-term gain against the long-term loss — and assessed the difference. The partner appealed, arguing he could subtract the entire gain.

The Tax Commissioner agreed with the taxpayer and abated the assessment. Virginia Code § 58.1-339.2 F says that gain or income from the allocation of the Historic Rehabilitation Tax Credit is not taxable for Virginia income tax purposes and may be subtracted from federal adjusted gross income (FAGI). That statute limits the subtraction only "to the extent that the gain … is otherwise excluded, deducted or subtracted" in computing Virginia income tax. Because this credit gain was not otherwise excluded, deducted, or subtracted for individual income tax purposes, the ordinary "net capital gain" netting did not apply — the partner could subtract his share of the entire gain from the credit sale.

The determination reaches this by treating the partnership's gain as passing through with its character intact to the partner (Va. Code § 58.1-391 B; IRC § 702(b)), so the gain is the partner's credit-sale gain, fully covered by the § 58.1-339.2 F subtraction — even though subtraction statutes are otherwise strictly construed against the taxpayer.

What this means for you

Investors and partners who sell or are allocated Virginia tax credits

Gain from selling or being allocated the Historic Rehabilitation Tax Credit is not Virginia-taxable and can be subtracted from FAGI. Importantly, this ruling holds that the subtraction is not cut down to your "net capital gain" — so a separate capital loss elsewhere on your return does not shrink the credit-gain subtraction. If the Department has limited your subtraction to net capital gain, this determination is directly on point.

Partnerships and pass-through entities

Character flows through. A partnership's credit-sale gain keeps its identity as credit-allocation gain in the partner's hands (Va. Code § 58.1-391 B; IRC § 702(b)), which is what lets the § 58.1-339.2 F subtraction apply at the partner level.

Accountants and tax professionals

The key move is that § 58.1-339.2 F caps the subtraction only to the extent the gain is "otherwise excluded, deducted or subtracted." Since Historic Rehabilitation credit gain is not otherwise removed from individual income, the general net-capital-gain limitation doesn't bite. Watch the strict-construction backdrop (Howell's Motor Freight) — the taxpayer won here because the statute's own text, not an implied allowance, covered the full gain. See also P.D. 13-225.

Common questions

Q: Is gain from selling a Historic Rehabilitation Tax Credit taxable in Virginia?
A: No. Under Va. Code § 58.1-339.2 F, gain or income from the allocation of the credit is not taxable for Virginia income tax and may be subtracted from federal adjusted gross income.

Q: Is the subtraction limited to my net capital gain?
A: No. The Commissioner held that because the credit gain is not otherwise excluded, deducted, or subtracted for individual income tax purposes, the subtraction is not limited to net capital gain — the taxpayer could subtract his share of the entire gain.

Q: Does a separate capital loss reduce the credit-gain subtraction?
A: Not here. The Department had netted the short-term gain against a long-term loss to reach "net capital gain," but the Commissioner rejected that limitation for this credit gain and abated the assessment.

Q: How does this work when the credit is sold by a partnership?
A: The gain passes through to the partner with its character intact (Va. Code § 58.1-391 B; IRC § 702(b)), so the partner may take the § 58.1-339.2 F subtraction for his share of the gain.

Q: Can another taxpayer rely on this determination?
A: No. It resolves one taxpayer's appeal on its specific facts and the law in effect when issued. Confirm your own situation with a tax professional.

Citations and references

Statutes:

• Va. Code § 58.1-1821 (application to the Tax Commissioner for correction of an assessment)
• Va. Code § 58.1-301 (Virginia conforms to the IRC; income starts from federal adjusted gross income)
• Va. Code § 58.1-339.2 F (gain from allocation of the Historic Rehabilitation Tax Credit is not taxable and may be subtracted from FAGI)
• Va. Code § 58.1-322.02 (Virginia individual income tax subtractions, limited to amounts included in FAGI)
• Va. Code § 58.1-391 B (pass-through items keep the same character for the owner as for federal purposes)
• IRC § 702(b) (character of partnership items determined as if realized directly by the partner)
• IRC § 1222(3); IRC § 61(a)(3) (long-term capital gain defined; capital gains included in gross income)

Case and guidance:

• Howell's Motor Freight, Inc. v. Virginia Dep't of Taxation (Roanoke Cir. Ct. 1983) (subtractions strictly construed against the taxpayer)
• P.D. 13-225 (12/17/2013) (subtraction of Historic Rehabilitation Tax Credit gain)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-77

Original ruling text

May 5, 2020

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the “Taxpayer”) for the taxable year ended December 31, 2016.

FACTS

The Taxpayer was a general partner in a partnership. In 2016, the partnership realized a short-term capital gain from the sale of a Historic Rehabilitation Tax Credit (the “Credit”). The Taxpayer reported his partnership share of the short-term capital gain on his 2016 federal individual income tax return. He also reported a long-term capital loss on the same return.

The Taxpayer subtracted his share of the short-term capital gain on his Virginia individual income tax return. The Department reviewed the return and adjusted the subtraction to equal the Taxpayer’s net capital gain. The Taxpayer appealed, contending that he is entitled to claim the entire short-term capital gain as a subtraction since it was included is his 2016 federal taxable income.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, that the terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) with FAGI. Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia .

Virginia generally conforms to the federal treatment of partnerships. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners. Under IRC § 702(b), “The character of any item of income, gain, loss, deduction, or credit included in a partner’s distributive share ... shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership.” In addition, each item of pass-through entity income, gain, loss or deduction has the same character for an owner for Virginia income tax purposes as for federal income tax purposes. See Virginia Code § 58.1-391 B.

Pursuant to IRC § 1222(3), a long-term capital gain is defined as gain from the sale or exchange of a capital asset held for more than one year. A short term capital gain is a gain from the sale or exchange of a capital asset held for less than one year. A net capital gain is the excess of a taxpayer’s net long term capital gain for the taxable year over the net short-term capital loss for the same year. Net capital gains are reported as taxable income as part of a taxpayer’s FAGI. See IRC § 61(a)(3). The Department limited the subtraction to the net capital gain reported on Schedule D of the Taxpayer’s federal return.

Virginia Code § 58.1-339.2 F provides that gain or income under federal law from the allocation of the Credit is not taxable gain or income for purposes of Virginia income tax. Therefore, such a gain or income may be subtracted from FAGI when computing Virginia taxable income. See Public Document (P.D.) 13-225 (12/17/2013).

By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell’s Motor Freight, Inc., et al. v. Virginia Dep’t of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983) .

Virginia subtractions under Virginia Code § 58.1-322.02 are limited to the extent included in FAGI. Virginia Code § 58.1-339.2 F limits the subtraction or deduction to the extent that the gain or deduction is otherwise excluded, deducted or subtracted in computing Virginia individual, trust, estate or corporate income tax. In this case, the taxable gain or income from the allocation of the Credit is not otherwise excluded, deducted or subtracted for individual income tax purposes. As such, the amount of the Credit that may be subtracted from FAGI pursuant to Virginia Code § 58.1-339.2 F is not limited to the net capital gain reported in FAGI.

Therefore, the Taxpayer was entitled to subtract his share of the entire gain realized by the partnership from the sale of the Credit and the amount of the subtraction allowed has been adjusted and the assessment issued for the taxable year ended December 31, 2016 has been abated.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. 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/3265.B

Related Documents

13-225