Allocations Must Follow Depreciation Deductions
The IRS recently issued circular chief counsel advisory (CCA) 2008812023, requiring that tax credits be allocated in accordance with depreciation deductions. The coordinated allocation should occur wherever a partnership agreement provides for special allocations of depreciation that differ from the general allocation of partnership items, says Barry Jacobs, editor of Housing & Development Reporter.
The IRS's chief counsel advisory concerned a limited liability company (LLC) composed of a managing and a non-managing member who owned and operated a tax credit site. The LLC, which was a partnership for tax purposes, had an operating agreement providing for special allocations prior to the percentage division of taxable income and loss between the managing and non-managing members.
According to one special allocation in the LLC agreement, if losses otherwise attributable to the non-managing member resulted in a deficit to the capital account, those losses were allocated instead to the managing member, Jacobs says. As a result of this special allocation, it was possible for the LLC to reduce within two years' time all nonrecourse deductions, including depreciation, to the non-managing member.
The IRS advisory supports the LLC's resolution. The advisory explains that according to IRC §704(a), the partnership agreement determines each partner's distributive share of income, gain, loss, deduction, or credit. And according to IRC §704(b), the partner's interest in the partnership determines the partner's distributive share if the partnership agreement does not provide for the distributive share or if the allocation of an item lacks substantial economic effect.
The advisory further explains that according to IRS Regulations Section 1.704-1(b)(4)(ii), allocations of tax credits are not reflected in adjustments to partners' capital accounts. Consequently, credit allocations have no economic effect under IRS Regulations Section 1.704(b)(2)(ii), says the advisory. Therefore, tax credits must be allocated in accordance with the partners' interest in the partnership, the advisory concludes.
In addition, if a partnership expenditure that funds a tax credit also results in a valid allocation of partnership loss or deduction for the same taxable year, the partners' interests in the partnership with respect to the credit are proportionate to their “respective distributive shares of the loss or deduction,” Jacobs says. For that reason, the credit allocations must follow the special allocations of depreciation when the latter differ from the general allocations specified in the operating agreement.
Barry Jacobs: Editor, Housing & Development Reporter; 1146 9th St. NW, Ste. 710, Washington, DC 20036; (202) 973-7710; firstname.lastname@example.org.