I paid D.C.'s Unincorporated Business Franchise Tax on gain from selling my rental property -- can I credit that against my Virginia income tax?

Plain-English summary

A married couple filed a 2018 Virginia resident return claiming a credit for the District of Columbia's Unincorporated Business Franchise Tax (UBFT), which they'd paid on gain from selling rental real estate. The Department disallowed the credit and assessed additional tax; the couple appealed, arguing the credit should apply because the underlying income was gain from selling a capital asset -- a category Virginia's out-of-state credit statute explicitly covers.

The Department explained this claim fails on two separate, independent grounds, either one of which would be enough on its own. First, Virginia has consistently held for over a decade that the D.C. UBFT simply doesn't qualify for the out-of-state credit at all, no matter what kind of income triggered it. That's because Virginia's credit only applies to a genuine "income tax" as defined by Va. Code § 58.1-332.2 -- a tax that taxes all of a resident's income, similar to Virginia's own income tax. Taxes labeled as a franchise or license tax that don't tax all of a person's income don't qualify, even if they're partly measured by income; the UBFT, along with taxes like the Texas Margin Tax and Ohio's Commercial Activity Tax, are named examples of taxes that fall into this excluded category.

Second, even setting the UBFT issue aside entirely, the specific income here -- gain from selling rental real estate -- isn't a "capital asset" gain in the first place under the tax code definition Virginia's credit statute relies on (IRC § 1221). Rental real estate used in a trade or business is instead governed by a different tax code provision (IRC § 1231) covering business-use property, which Virginia's credit statute specifically excludes from the capital-asset gain category eligible for the credit. So even if the couple had paid a qualifying "income tax" to D.C., this particular type of gain wouldn't have been eligible for the credit anyway. With both independent grounds against them, the disallowance and assessment were upheld.

What this means for you

Anyone who paid D.C.'s Unincorporated Business Franchise Tax and hopes to credit it against Virginia tax

Don't count on it, regardless of what income the D.C. tax was based on. Virginia has repeatedly and consistently ruled that the UBFT categorically doesn't qualify for the out-of-state credit, because it's a franchise-style tax that doesn't tax all of a person's income the way a true income tax does.

Landlords or investors selling rental real estate held in a business

Be aware that gain from selling rental real estate used in a trade or business is treated as IRC § 1231 property, not a "capital asset" under IRC § 1221 -- and Virginia's out-of-state tax credit statute specifically excludes trade-or-business property from its capital-asset gain category, separate from any issue with the type of tax paid.

Taxpayers weighing whether another state's business-style tax will qualify for Virginia's credit

Check whether the tax is styled as a franchise, license, or similar business-entity tax rather than a general individual income tax -- Virginia's credit statute (Va. Code § 58.1-332.2) specifically lists categories like this (naming the D.C. UBFT, Texas Margin Tax, and Ohio Commercial Activity Tax as examples) that don't qualify even though they may be partly measured by income.

Common questions

Q: Does it matter what kind of income the D.C. UBFT was based on?
A: No -- the Department has ruled repeatedly that the UBFT never qualifies for Virginia's out-of-state credit, regardless of the underlying income, because it's classified as a franchise-style tax rather than a true income tax under Va. Code § 58.1-332.2.

Q: Is gain from selling rental property a "capital asset" gain for purposes of Virginia's tax credit?
A: No -- rental real estate used in a trade or business is treated as IRC § 1231 property, not a capital asset under IRC § 1221, and Virginia's credit statute specifically excludes property used in a trade or business from the capital-asset gain category that can qualify for the credit.

Q: What other taxes are specifically called out as not qualifying for Virginia's out-of-state credit?
A: Besides the D.C. UBFT, the Department has identified the Texas Margin Tax and the Ohio Commercial Activity Tax as examples of taxes that don't qualify, because they're franchise/license-style taxes that don't tax all of a person's income.

Citations and references

• Va. Code § 58.1-332(A) (credit for income tax paid to another state on earned/business income or capital-asset gain)
• Va. Code § 58.1-332.2 (definition of "income tax" for credit purposes; identifies excluded franchise/license-style taxes)
• IRC § 1221 (capital asset definition)
• IRC § 1231 (property used in a trade or business)
• P.D. 11-92 (6/2/2011), P.D. 15-89 (4/28/2015), P.D. 18-166 (9/26/2018), P.D. 19-107 (9/18/2019) (D.C. UBFT does not qualify for the out-of-state credit)
• P.D. 12-108 (7/1/2012) (Texas Margin Tax and Ohio Commercial Activity Tax likewise don't qualify)

Subject

Credit: Tax Paid to Another State - District of Columbia; Capital Asset

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-138

Original ruling text

September 20, 2022

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income assessment issued to * and *** (the “Taxpayers”) for the taxable year ended December 31, 2018.

FACTS

The Taxpayers filed a Virginia resident income tax return for the 2018 taxable year claiming a credit for Unincorporated Business Franchise Tax (UBFT) paid to the District of Columbia. Under review, the Department disallowed the credit and issued an assessment. The Taxpayers appeal, contending the tax paid qualifies for Virginia’s credit for taxes paid to other states because it was a tax paid on capital gain from the sale of a capital asset.

DETERMINATION

Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either “earned or business income or . . . gain on the sale of a capital asset (within the meaning of § 1221 of the Internal Revenue Code), not including an asset used in a trade or business.”

The Department has consistently ruled that tax paid pursuant to the UBFT does not qualify for the out-of-state tax credit. See Public Document (P.D.) 11-92 (6/2/2011), P.D. 15-89 (4/28/2015), P.D. 18-166 (9/26/2018), and P.D. 19-107 (9/18/2019). In addition, Virginia Code § 58.1-332.2 defines an “income tax” as a term of art that refers to a specific type of tax levied on all of a resident’s earned and unearned income, and all income of nonresidents from sources within the jurisdiction, which is similar to the income tax that Virginia imposes on resident and nonresident individuals. Virginia Code § 58.1-332.2 B includes examples of taxes that do not qualify for the credit, even though they may be measured, in part, by income. Taxes do not qualify if (i) they are labeled as a franchise or license tax, and (ii) they do not tax all income of the individual. Examples of taxes that do not qualify for the credit pursuant to Virginia Code § 58.1-332.2 include the UBFT, the Texas Margin Tax, and the Ohio Commercial Activity Tax. See P.D. 12-108 (7/1/2012).

The Taxpayers assert that, because the income reported on their UBFT return was gain derived from the sale of a capital asset, it qualifies for the out-of-state tax credit even though it was reported on a UBFT return. The capital gain at issue was derived from the sale of rental real estate owned by the Taxpayers. Rental real estate is not a capital asset under IRC § 1221; rather, it is property used in a trade or business as defined in IRC § 1231. In addition, the clear language of Virginia Code § 58.1-332.2 A excludes from the out of state credit taxes paid that are attributable to the sale of an asset used in a trade or business. Therefore, the Department’s disallowance of the credit is upheld.

The Taxpayers will receive an updated bill that will include accrued interest to date. The Taxpayers should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collection actions.

The Code of Virginia sections and public documents 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/4116.X

Related Documents

11-92

12-108

15-89

18-166

19-107