Sales of IRA Tax Credits Entail Special Tax Accounting Considerations

Taxpayers either purchasing or selling certain federal income tax credits under the Inflation Reduction Act of 2022 (IRA) should be aware of specific tax accounting rules governing the treatment of amounts paid or received for those credits. These special rules are provided in Section 6418 of the Internal Revenue Code, as well as in final Treasury regulations published in the Federal Register on April 30, 2024 (T.D. 9993, 89 Fed. Reg. 34770).

Taxpayers and tax advisers unaware of the new rules might overlook them and mistakenly apply the more familiar general rules instead, potentially resulting in sellers overstating their taxable income and purchasers claiming impermissible deductions.

The special tax accounting rules apply in preparing federal income tax returns of taxpayers engaging in qualifying transfers of eligible credits in 2023 or later years.

Eligible Credits

The new tax accounting rules apply to qualifying sales of “eligible credits,” which Section 6418(f)(1) defines as the following tax credits:

• The portion of the credit for alternative fuel vehicle refueling property allowed under Section 30C that is treated as a credit listed in Section 38(b);
• The renewable electricity production credit determined under Section 45(a);
• The credit for carbon oxide sequestration determined under Section 45Q(a);
• The zero-emission nuclear power production credit determined under Section 45U(a);
• The clean hydrogen production credit determined under Section 45V(a);
• The advanced manufacturing production credit determined under Section 45X(a);
• The clean electricity production credit determined under Section 45Y(a);
• The clean fuel production credit determined under Section 45Z(a);
• The energy credit determined under Section 48;
• The qualifying advanced energy project credit determined under Section 48C; and
• The clean electricity investment credit determined under Section 48E.

Section 6418 allows taxpayers to elect to transfer eligible credits to an unrelated person (but an eligible credit can only be transferred one time). Specific requirements and procedures apply in making such an election.

Special Tax Accounting Requirements

Qualifying transfers of eligible credits are subject to specific tax accounting rules that differ from tax accounting principles generally applicable to the sale or exchange of property.

Section 6418(b) provides that with respect to consideration paid for the transfer of an eligible credit, that amount:

• Must be “paid in cash”;
• Is not includible in the seller’s gross income; and
• Is not deductible by the purchaser of the eligible credit.

The final regulations clarify that a purchaser may not make payment earlier than the first day of the seller’s tax year during which the credit is determined. Payments cannot be made for credits that will be determined in subsequent years.

In the case of eligible credits determined with respect to any facility or property held directly by a partnership or S corporation, if the partnership or S corporation makes a qualifying election to transfer an eligible credit:

• Any amount received as consideration for the transfer of the credit is treated as tax-exempt income for purposes of Section 705 (dealing with the basis of a partner’s interest in a partnership) and Section 1366 (dealing with pass-through of items to S corporation shareholders); and
• A partner’s distributive share of the tax-exempt income must be based on the partner’s distributive share of the otherwise eligible credit for each taxable year.

Just as the seller would not have realized income had it used the eligible credit to reduce its own federal tax liability rather than selling the credit, the final regulations provide a step-in-the-shoes rule for the eligible credit’s purchaser. The purchaser will not realize income upon its use of the credit to reduce its federal tax liability, even if the tax savings exceed the consideration paid to acquire the eligible credit.

For any eligible credit (or portion of an eligible credit) that the taxpayer elects to transfer in accordance with Section 6418, the purchaser takes the credit into account in its first taxable year ending with, or after, the seller’s taxable year with respect to which the credit was determined.  

Public comments on the proposed regulations published in the Federal Register on June 21, 2023, raised concerns regarding this rule if either the seller or purchaser uses a 52-53-week taxable year. Commenters were concerned that a purchaser using a 52–53-week taxable year might have to wait until its following taxable year to take into account an eligible credit that was transferred by a seller using a calendar year. A similar delay could result if the seller uses a 52–53-week taxable year ending in January and the purchaser has a taxable year ending on December 31.

The final regulations address this concern by providing a special rule for taxpayers using a 52–53-week taxable year. Under that rule, for purposes of determining the taxable year in which an eligible credit is taken into account, a 52–53-week taxable year of either the seller or the purchaser is deemed to end on or close on the last day of the calendar month nearest to the last day of the 52–53-week taxable year.

Open Issues

Although the basic tax accounting requirements are facially straightforward, the preamble to the proposed regulations posited numerous ancillary issues that the final regulations do not address. The preamble to the final regulations instead indicates that the government plans to issue separate guidance on at least some of these open issues.

The open accounting method questions include:

• The federal income tax treatment of transaction costs incurred by either the purchaser or the seller of eligible credits;
• Whether a purchaser may deduct a loss if the amount paid to acquire the eligible credit exceeds the amount of the eligible credit that the purchaser can ultimately claim;
• Whether amounts for which a deduction is disallowed instead may be capitalized and added to the basis of the eligible credits acquired by the purchaser;
• Whether the seller may either currently deduct, or alternatively reduce its amount realized on the sale of eligible credits by, the amount of selling expenses incurred in the transaction;
• Whether the sales proceeds must be treated as a class of “tax-exempt income” to which Section 265 applies to preclude a deduction for expenditures incurred in connection with those untaxed amounts, including amounts treated as tax exempt income for purposes of Sections 705 and 1366.

Although this issue is not addressed by Section 6418 or the final regulations, taxpayers filing state returns in jurisdictions that do not conform to federal tax law or that do not have “rolling conformity” will need to determine the tax treatment of eligible credit transfers under the tax law of those jurisdictions. For example, although Section 6418 does not require sellers of eligible credits to include the sales proceeds in gross income for federal tax purposes, the result might differ in states that do not conform to the Internal Revenue Code.

Basis Adjustment Rules

Under Section 6418 and the final regulations, if a Section 48 energy credit, Section 48C qualifying advanced energy project credit, or a Section 48E clean electricity investment credit is transferred, the basis reduction rules of Section 50(c) apply to the applicable investment credit property as if the transferred eligible credit was allowed to the seller, rather than to the purchaser. Section 50(c) generally provides that if a credit is determined with respect to any property, the basis of the property is reduced by the amount of the credit (subject to certain recapture rules).

The basis adjustment will affect the computation of the seller’s available cost recovery deductions for the investment property with respect to which the transferred credits arose, and so must be considered in preparing the returns of taxpayers engaged in the sale of eligible credits.

Applicability Dates

Section 6418 applies to taxable years beginning after December 31, 2022. Sellers must elect to transfer all or a portion of an eligible credit on the seller’s original return for the taxable year for which the credit is determined by the due date of that return (including extensions), but not earlier than February 13, 2023.

The final regulations are applicable for taxable years ending on or after April 30, 2024, the date on which the final regulations were published in the Federal Register. Taxpayers may apply the final regulations to taxable years ending prior to that date but must apply them in their entirety if they choose to do so.

Insight

Payments made or received outside of the specific requirements of Section 6418 and the final regulations remain subject to general tax accounting principles (such as the requirement to treat proceeds from the sale or exchange of property as taxable income, as well as the applicable rules for either capitalizing or deducting related expenditures).

Thus, understanding the detailed requirements of Section 6418 and the facts of a given transaction is essential in identifying the correct tax accounting rules governing that transaction.

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