If a partnership added back bonus depreciation on Virginia returns for years before I sold my partnership interest, can I subtract the resulting basis difference when I sell?

Plain-English summary

Virginia "conforms" to federal law for individual income tax by starting with federal adjusted gross income (FAGI) and only deviating where the Virginia code says so -- one such deviation is "fixed date conformity" (FDC), which for years disallowed the federal bonus depreciation deduction under IRC § 168(k). Because of that mismatch, businesses (including partnerships) had to ADD BACK bonus depreciation on their Virginia returns each year, then later take offsetting SUBTRACTIONS as the disallowed depreciation caught up. A husband was a partner in a partnership that had been making these FDC additions and subtractions every year since 2009; when he sold his partnership interest to the other partners in 2017, the running total of additions still exceeded the total of subtractions at that point.

The couple claimed a subtraction on their 2017 return for that leftover excess, framing it as a long-term capital gain subtraction. The Department disagreed with that specific framing -- the taxpayers weren't selling stock in a "qualified business" eligible for the capital-gain subtraction they'd claimed, and they ultimately conceded that point. But the Department recognized a different, correct basis for essentially the same relief: because the partnership had been required to add back bonus depreciation for Virginia purposes over the years, the husband's BASIS in his partnership interest was higher for Virginia tax purposes than for federal tax purposes at the time of sale -- meaning his true Virginia gain on the sale was actually LOWER than his federal gain. The existing 2017 instructions for corporate and pass-through entity returns (Forms 500/502) already provided for this kind of basis-difference adjustment when an asset with FDC history is sold, but those instructions didn't explicitly address individual returns, since FDC bonus depreciation issues are normally a business-only concern. Because this individual's situation arose directly from a partnership interest sale carrying that same basis mismatch, the Department extended the same adjustment to him -- sending the case back to the audit staff to compute the correct subtraction amount and issue a refund.

What this means for you

Partners selling an interest in a partnership with a history of bonus depreciation add-backs

If the partnership has been making Virginia fixed-date-conformity additions/subtractions for bonus depreciation over the years, your Virginia basis in the partnership interest likely differs from your federal basis. On sale, you may be entitled to a basis-difference subtraction even though the standard individual-return instructions don't spell this scenario out -- don't assume it's unavailable just because Form 760's instructions are silent on it.

Accountants and tax professionals

When a client with FDC history sells a partnership interest (or any asset that received federal bonus depreciation while carrying Virginia FDC adjustments), compute the federal-vs-Virginia basis difference using the same method described in the Form 500/502 instructions, even for an individual return -- this ruling confirms the Department will apply that same logic to individuals in analogous circumstances.

Anyone confusing a basis-adjustment subtraction with the qualified-business capital-gain subtraction

These are different provisions. The taxpayers here initially claimed the wrong one (the qualified-business capital-gain subtraction, which requires the sale of stock in a qualifying business) and had to concede that point, but still recovered relief under the correct, distinct basis-adjustment theory.

Common questions

Q: Do the Form 500/502 bonus-depreciation basis adjustment instructions apply to individual taxpayers?
A: The instructions are written for corporations and pass-through entities, but this ruling confirms the Department will apply the same basis-adjustment logic to an individual whose situation (here, a partnership interest sale) creates the same federal/Virginia basis mismatch.

Q: What if I claimed the wrong subtraction on my Virginia return for a partnership interest sale?
A: As in this case, conceding an incorrect claim (the qualified-business capital-gain subtraction) doesn't necessarily forfeit relief -- the correct, distinct basis-adjustment subtraction may still be available and was granted here.

Q: How is the basis-adjustment amount calculated?
A: As the difference between the federal and Virginia basis of the asset at the time of sale -- if the federal basis is lower (producing a bigger federal gain), that difference becomes a Virginia subtraction.

Q: Since Virginia's IRC conformity date, does bonus depreciation still require FDC additions/subtractions?
A: This ruling addresses the 2017 tax year specifically, when Virginia continued to disallow bonus depreciation under IRC § 168(k); check current-year Virginia Tax Bulletins for the applicable conformity date and any bonus-depreciation carve-outs before relying on this analysis for a different year.

Citations and references

• Va. Code § 58.1-301 (Virginia conformity to Internal Revenue Code terminology)
• IRC § 168(k) (federal bonus depreciation)
• Virginia Tax Bulletin 18-1 (2/26/2018) (2017 fixed date conformity update and bonus depreciation instructions)

Subject

Federal Adjusted Gross Income: Fixed Date Conformity - Bonus Depreciation, Gain on Sale of Partnership Interest

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-39

Original ruling text

April 12, 2023

Re: § 58.1-1821 Appeal: Individual Income Tax

Dear *:

This will respond to your letter in which you seek a refund of the individual income tax paid by * (the “Taxpayers”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayers, a husband and wife, filed a joint Virginia individual income tax return for the 2017 taxable year. The husband was a partner in a partnership that placed equipment in service in 2009. Fixed date conformity (FDC) additions and subtractions for bonus depreciation were claimed each year from 2009 through 2017 by the partnership and were passed through to the Taxpayers in accordance with the husband’s partnership interest. The husband sold his partnership interest to the remaining partners in 2017. At the time of the sale, the total of the additions from the bonus depreciation exceeded the total of the subtractions.

The Taxpayers claimed a long-term capital gain subtraction on their 2017 Virginia individual income tax return for the amount that the bonus depreciation additions exceeded the subtractions at the time of the partnership interest sale. Under review, the Department disallowed the subtraction on the basis that the Taxpayers did not show that the sale was of stock in a qualified business. In addition, the Department recognized that the Taxpayers had a balance of FDC additions at the time of the sale, but concluded that the Taxpayers could not subtract them on their Virginia return.

The Taxpayers paid the assessment and appealed. The Taxpayers concede that they were not eligible to claim a subtraction for long-term capital gain attributable to a qualified business. They contend, however, that they were entitled to claim a subtraction for the amount that the bonus depreciation additions exceeded the subtractions at the time of the sale of the partnership interest.

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 federal adjusted gross income (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 .

In 2003, Virginia began conforming to the IRC as of a specific or fixed date. Since then, the General Assembly has enacted legislation to move the date of conformity forward each year. Effective for taxable years beginning on and after January 1, 2016, Virginia’s conformity date was advanced from December 31, 2016, to December 31, 2017 with limited exceptions. See Virginia Tax Bulletin (VTB) 18-1 (2/26/2018). For the taxable year at issue, Virginia continued to prohibit bonus depreciation allowed for certain assets under IRC § 168(k). VTB 18-1 instructs taxpayers to consult the instructions for the appropriate 2017 Virginia income tax form about how to make adjustments related to bonus depreciation.

The instructions for the 2017 Virginia returns for corporations (Form 500) and pass-through entities (Form 502) provide that:

If an asset was disposed of in 2017 and such asset received the special 30% or 50% bonus depreciation deduction for federal purposes in any of the years 2001 through 2017, and a gain or loss was recognized for federal purposes, then the gain or loss must be recomputed as if such asset did not receive the special 30% or 50% bonus depreciation deduction for federal purposes in any of the years 2001 through 2017. The adjustment will be the difference in the federal and Virginia basis of the asset when sold. If the federal basis of the asset is lower than the Virginia basis (resulting in a greater gain for federal purposes), then the difference between the two bases is included as a subtraction on the Virginia return.

As FDC adjustments related to bonus depreciation apply only to businesses, this provision was not included in the instructions for individual returns. Nevertheless, this issue arises from partnership transactions so taxpayers will be allowed an adjustment for the disposition of assets that have different bases for federal and Virginia income tax purposes as the result of FDC adjustments as described in the above instructions from Forms 500 and 502.

Because the Taxpayer was required to report FDC additions for Virginia income tax purposes to offset the federal bonus depreciation deductions that were not allowed in the computation of his Virginia taxable income, his basis in the partnership interest was higher for Virginia income tax purposes than it was for federal income tax purposes. Thus, the gain would have been less for Virginia income tax purposes. Because the computation of VTI begins with FAGI, unless the Taxpayer is allowed a subtraction in order to correctly reduce the gain to account for the basis difference, his Virginia income tax liability for the transaction would not properly reflect his different Virginia basis in the partnership interest.

Accordingly, the case will be returned to the audit staff to allow the appropriate subtraction amount, adjust the assessment, and issue a refund as warranted. If the audit staff requires more information from the Taxpayer in order to determine the amount, the Taxpayer must provide the information within the time allotted.

The Code of Virginia sections and Tax Bulletin 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/3879.B

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