Rev. Rul. 88-96

1988-2 C.B. 27, 1988-47 I.R.B. 4.

                       Internal Revenue Service

                                 Revenue Ruling

        INVESTMENT CREDIT; RECAPTURE; TERMINATION OF REGULAR PERCENTAGE

                          Published: November 21, 1988

SECTION 47. - CERTAIN DISPOSITIONS, ETC., OF SECTION 38 PROPERTY, 26 CFR 1.47-3: Exceptions to the application of section 1.47-1

(Also Section 49.)

  Investment credit; recapture; termination of regular percentage. Section 1.47-3(h)(1)(i) of the regulations does not apply to prevent recapture of investment credit under section 47(a) of the Code when a taxpayer disposes of section 38 property and replaces such property after December 31, 1985, with property similar or related in service or use to the property disposed of.

  A taxpayer disposed of section 38 property that qualified for the regular percentage of the investment tax credit (ITC). The taxpayer replaced the property within six months with property similar or related in service or use. (The Service indicated that the replacement occurred after December 31, 1985.) Under section 49(a), as added by the 1986 Act, the regular percentage of the ITC does not apply to the replacement property.

  ISSUE. At issue is whether regulation section 1.47-3(h)(1)(i) applies to prevent recapture of the ITC under section 47(a).

  HOLDING. The Service has held that, in the above circumstances, regulation section 1.47-3(h)(1)(i) does not apply to prevent recapture of ITC under section 47(a).

  ANALYSIS. The issue in this ruling surrounded the effective dates of various amendments to the Code section (sections 47 and 49) involving the ITC. Regulation section 1.47-3(h)(1)(i), the Service noted, provides for a reduction in ITC recapture when section 38 property is disposed of and replaced with property that is similar or related in service or use, and such replacement property 'would be section 38 property but for the application of section 49.' New section 49(a), as added to the Code by the 1986 Act, repealed the regular ITC for property placed in service after December 31, 1985.

  However, the Service said that, when regulation section 1.47- 3(h)(1)(i) refers to section 49, 'the reference is solely to former section 49,' since the regulation was promulgated while a 1969 version of section 49 was in effect; former section 49 was repealed by the Revenue Act of 1978, effective for tax years ending after December 31, 1978. Furthermore, the regulation's underlying statute, section 47, was repealed by the Revenue Act of 1971. The upshot of these enactments and repeals, the Service concluded, is that regulation section 1.47-3(h)(1)(i) does not apply to tax years after December 31, 1978. Therefore, a disposal of section 38 property, followed by a replacement occurring after December 31, 1985, does not gain the benefit of the ITC recapture reduction provided for in the regulation.

                                     ISSUE

  If a taxpayer disposes of section 38 property that qualified for the regular percentage of the investment credit and replaces that property within 6 months with property similar or related in service or use to the property disposed of, but, pursuant to section 49(a) of the Internal Revenue Code, the regular percentage of the investment credit does not apply to the replacement property, does section 1.47- 3(h)(1)(i) of the Income Tax Regulations apply to prevent recapture of investment credit under section 47(a)?

                                LAW AND ANALYSIS

  Section 1.47-3(h)(1)(i) of the regulations provides, in part, that, if section 38 property is disposed of and replaced with property that is similar or related in service or use (for purposes of section 1033 of the Code and regulations thereunder), and such replacement property 'would be section 38 property but for the application of section 49,' the investment credit recapture 'shall be reduced (but not below zero) by the credit that would be allowed for the qualified investment of the replacement property (determined as if such property were section 38 property).'

  Section 1.47-3(h)(1)(i) of the regulations interprets former section 47(a)(5) of the Code, which provided that in any case in which section 38 property was disposed of and, within 6 months after the date of such disposition, property that 'would (have been) section 38 property but for section 49' was placed in service 'to replace' the property disposed of, the increase under section 47(a)(1) was not greater than the increase that would have resulted if the qualified investment of the replacement property (determined as if such property were section 38 property) had been substituted for the property disposed of. Section 1.47-3(h)(1)(i) elaborates on the exception to investment credit recapture in former section 47(a)(5) by adding the requirement that the replacement property be similar or related in service or use to the property disposed of.

  Former section 49(a) of the Code, which was added by section 703(a) of the Tax Reform Act of 1969 (1969 Act), 1969-3 C.B. 111, repealed the investment credit by excluding property constructed, reconstructed, erected, or acquired (other than pre-termination property) after April 18, 1969, from the definition of section 38 property. Section 312(c)(1) and (d) of the Revenue Act of 1978 (1978 Act), 1978-3 C.B. 60, repealed former section 49, effective for tax years ending after December 31, 1978.

  New section 49(a) was added to the Code by section 211 of the Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. 83. With certain transitional exceptions, new section 49(a) repeals the regular investment credit for property placed in service after December 31, 1985. The repeal does not exclude property from the definition of section 38 property, but rather makes the regular percentage of the investment credit inapplicable to such property.

  Former section 47(a)(5) of the Code was added by section 703(c)(1) of the 1969 Act, 1969-3 C.B. 115. Section 1.47-3(h)(1)(i) of the regulations was promulgated on June 9, 1971. Thus, when section 1.47-3(h)(1)(i) of the regulations refers to section 49, the reference is solely to former section 49 (and not to new section 49).

  Former section 47(a)(5) of the Code was repealed, with an exception not relevant here, by section 107(b)(1) of the Revenue Act of 1971, 1972-1 C.B. 443, 449. Because former section 47(a)(5) of the Code was the statutory basis for section 1.47-3(h)(1)(i) of the regulations and because former section 47(a)(5) cannot apply for tax years after December 31, 1978, section 1.47- 3(h)(1)(i) does not apply to tax years after December 31, 1978.

                                    HOLDING

  If a taxpayer disposes of section 38 property that qualified for investment credit and replaces that property within 6 months with property similar or related in service or use to the property disposed of, but, pursuant to section 49(a) of the Code, the regular percentage of the investment credit does not apply to the replacement property, section 1.47-3(h)(1)(i) of the regulations does not prevent recapture of investment credit under section 47(a).

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Paul F. Handleman of the Office of Assistant Chief Counsel (Passthroughs and Special Industries.) For further information regarding this revenue ruling contact Mr. Handleman on (202) 566-4121 (not a toll-free call).

Rev. Rul. 88-96, 1988-2 C.B. 27, 1988-47 I.R.B. 4.