Virginia Land Preservation Tax Credits Continue to Provide Planning Opportunities for Clients
By: Keith Chase Troxell, J.D., LL.M.[i]
For over 15 years, Virginia taxpayers have been able to purchase Land Preservation Tax Credits at a discount in the marketplace to save on their Virginia income tax liability. However, despite the passage of time, some professionals are still unfamiliar with the program. In addition, questions remain as to the impact of the application of the credit against a purchaser’s Virginia taxable income and the corresponding tax treatment on the federal return.
Property owners that donate a conservation easement on their property and receive Virginia Land Preservation Tax Credits, are able to transfer (sell) their tax credits to other Virginia taxpayers. Credits may be purchased by any Virginia taxpayer during the year to which the credits will be applied.[ii]
Credits are bought and sold at a discount, enabling Virginia taxpayers the opportunity to purchase credits and apply the tax credit against their Virginia income tax liability at the full dollar amount on their Virginia income tax return. Currently, individuals may purchase up to $20,000 of tax credits per year, and couples may purchase up to $40,000.[iii]
A risk to the purchaser is that the credit could be adjusted by the Commonwealth or the IRS. As an example, a Virginia married couple would purchase $40,000 of tax credits before the end of 2018 for a purchase price of 89 cents per dollar of credit. The couple would then apply the credit at the face amount on their Virginia return and, in the process, save $4,400 dollars in Virginia state income tax.
For the purchaser of the tax credits, state income taxes paid with the use of a tax credit remain deductible under section 164 of the Internal Revenue Code for federal income tax purposes, subject to the limitations imposed on such deductions at the federal level.[iv]
Over the years, different approaches have evolved regarding the timing of the state income tax deduction and whether any gain is recognized at the federal level when the tax credit is applied on the Virginia income tax return.
Timing of the State Income Tax Deduction.
With regard to the timing of the state income tax deduction on the federal income tax return, two general approaches emerge, the first being that the deduction is proper in the year the credit is applied on the state return, and the second being that the deduction is proper in the year of purchase of the tax credit.
The Service has ruled that the buyer will receive the full benefit of the credit applied as a state income tax deduction on his or her federal income tax return in the year the credit is applied (as compared to when purchased).[v]
Based on these rulings, many Virginia tax practitioners take the state income tax deduction for clients in the tax year following the year of purchase.
However, other tax practitioners argue that the taxpayer should get the benefit of the deduction in the year they purchased the credit, rather than the following year when the credit is actually applied. There is support for this position in rulings issued by the Virginia Department of Taxation.[vi]
The Department has ruled that a taxpayer must purchase tax credits in the same taxable year for which the credit will be claimed. In these rulings, the Tax Commissioner stated “tax credits and payments are typically allowed as a credit against the tax liability in the taxable year they are earned or paid. It is clear that any credit transferred during a taxable year may be claimed as a credit on the tax return of the transferee in the taxable year that the transfer of the credit occurs.”
Under this approach, because the use of a tax credit is treated as a payment of tax for purposes of Virginia law, the payment of the state tax liability occurs in the taxable year the credit is transferred.[vii]
Stated differently, the deduction does not accrue at the time of sale, or at the time of application of the credit on the state return, but rather at the time and period for which the Tax Commissioner determines the payment was made.[viii]
Practitioners who are purchasing credits for clients who have substantial income in one year and typically lower income in other years should plan carefully here.
Gain on Application of the Tax Credit
The second issue with respect to the tax treatment of the state income tax credit on the federal income tax return is whether the purchaser has a gain on the application of the credit to satisfy the state liability based on the difference between the purchase price and the face amount of the credit. As with the timing issue, practitioners are taking different approaches on the federal return.
The IRS has indicated that the purchaser should include the difference between the “face amount” of the credit claimed and the purchase price (cost basis) as a gain on his or her federal income tax return.[ix]
More specifically, the IRS has stated that the taxpayer’s basis in the purchased state tax credit will be the cost of the credit. In the year or years the taxpayer applies the credit to satisfy the taxpayer’s state tax liability, the taxpayer will realize gain or loss equal to the difference, if any, between the basis of the credit and the amount of liability satisfied by the application of the credit.
Some practitioners, however, just limit the state income tax deduction on the federal return to the cost basis in the credit. The approach here is that since the purchaser has recently purchased the credit, there should be no gain on application of the tax credit as the fair market value of the credit (the property used to satisfy the liability) equals the basis of the recently purchased credit. The IRS has stated that use of the tax credit is treated as a transfer of property to the state.[x]
Accordingly, the amount of the state tax payment should be based on the fair market value of the property transferred to the state, which in the case of a recently purchased credit, would be the purchase price. The use, by the IRS, of the face amount of the tax credit as the amount realized may be incorrect, as: (1) the face amount of the tax credit does not reflect the fair market value of the property used to satisfy the liability; and (2) the reduction in state income tax liability on account of the use of the tax credit is not an accession to wealth. Under this approach, the taxpayer would merely deduct the amount that they paid for the tax credits on Schedule A as this is the fair market value of the tax credit.[xi]
As an example, assume a taxpayer purchases $10,000 of tax credits for 89 cents for each dollar of credit and applies those credits on their Virginia return. Under the IRS position, the taxpayer would claim the full $10,000 as a deduction on Schedule A on their federal return, and report a capital gain of $1,100 on Schedule D of the return. It is also important to note that even if there is gain recognition at the federal level, the buyer would be able to further reduce their Virginia taxable income due to the inclusion.[xii]
Under the alternative approach discussed above, the taxpayer would claim a Schedule A deduction of $8,900, and no gain on Schedule D.[xiii]
Virginia Land Preservation Tax Credits provide the opportunity for Virginia taxpayers to save on their Virginia income taxes, while supporting a worthy state program of land conservation. The purchase of such credits provide interesting planning opportunities for tax practitioners and their clients. In addition, the purchase of tax credits may enable a taxpayer to avoid a Virginia underpayment penalty, where the taxpayer has insufficient estimated tax payments or withholding for the yea.[xiv]
Keith C. Troxell is a member of Virginia Easement Exchange, L.L.C. (www.virginiataxcredit.com
) and has brokered tax credits for landowners to Virginia taxpayers since 2003.
Rulings of the Tax Commissioner, P.D. 03-12 (February 27, 2003) and P.D. 03-13 (March 4, 2003).
Ruling of the Tax Commissioner, P.D. 05-136 (August 10, 2005). Each member of a consolidated group filing a consolidated return may purchase up to $20,000 of tax credit and claim such credit on the consolidated return. See
Ruling of the Tax Commissioner, P.D. 07-131 (August 17, 2007). Excess credit purchased may be carried forward. Va. Code Ann. § 58.1-512(D)(5)(b). See also
Ruling of the Tax Commissioner, P.D. 04-119 (September 15, 2004); and Virginia Attorney General’s Opinion, P.D. 02-094 (November 19, 2002).
PLR 200126005 (June 29, 2001).
Chief Counsel Advisory 200238041 (July 24, 2002), Chief Counsel Advisory 200704028 (January 26, 2007), Chief Counsel Advisory 200704030 (January 26, 2007).
Rulings of the Tax Commissioner, P.D. 03-12 (February 27, 2003) and P.D. 03-13 (March 4, 2003).
[vii] See Mitchell v. Commissioner
, T.C. Memo. 1983-155 (“A taxpayer on the cash basis may deduct state and local income taxes only during the year in which such taxes are paid to the taxing authority.”) and Rev. Rul. 71-190, 1971-1 C.B. 70 (advance tax payments of state income taxes made pursuant to specific provisions of state law authorizing such payments, constituted deductible items).
TAM 9303003 (October 6, 1992) and Rulings of the Tax Commissioner, P.D. 03-12 (February 27, 2003) and P.D. 03-13 (March 4, 2003). See also
Form 760 and Form 760C and the instructions.
Chief Counsel Advisory 200238041 (July 24, 2002); Chief Counsel Advisory 200704028 (January 26, 2007), and Chief Counsel Advisory 200704030 (January 26, 2007). These rulings cited Rev. Rul. 86-117, 1986-2 C. B. 157 as support for the position.
Rev. Rul. 86-117, 1986-2 C. B. 157.
Rev. Rul. 79-315, 1972-2 C.B. 27 (Holding (3) Iowa tax rebate used to reduce income tax was not income and is not deductible), Tempel v. Commissioner
, 136 T.C. 341, 350 (2011) (“a reduction in a tax liability is not an accession to wealth. Consequently, a taxpayer who has more section 164 deductions has not received any income.”), and Snyder v. United States
, 894 F.2d 1337 (6th Cir. 1990) (reduction in state taxes is not “income” from the state). Of course, these cases and rulings apply to the original issuance and use of the credit by the initial holder, and not a subsequent transferee. It is also important to note that even if there is gain recognition at the federal level, the buyer would be able to further reduce their Virginia taxable income due to the inclusion. Va. Code Ann. § 58.1-513(E).
Va. Code Ann. § 58.1-513(E).
This simplified example does not consider AMT
Form 760 and Form 760C and the instructions, wherein the application of the tax credit on the return is treated as a payment by the Virginia Department of Taxation for the year purchased.and SALT limitation issues.