Question

Paul Chaing acquires a qualifying historic structure for $350,000 (excluding the cost of the land) and plans to substantially rehabilitate the structure. He is planning to spend either $320,000 or $380,000 on rehabilitation expenditures.

Complete the letter to Paul and the memo for the tax research files that outlines the following for the two alternative expenditures.

The computation that determines the rehabilitation expenditures tax credit available.

The effect of the credit on Paul's adjusted basis in the property.

The cash-flow differences as a result of the tax consequences related to his expenditure choice.

Dear Mr. Chaing:

This letter is in response to your questions concerning the availability of the rehabilitation tax credit for expenditures that you plan to incur in the rehabilitation of your qualifying historic structure and their impact on the cost recovery basis of the structure. It is our understanding that you purchased the qualifying historic structure for $350,000 and that you intend to incur rehabilitation expenditures of either $320,000 or $380,000.

For the credit to be available, the law requires that a taxpayer substantially rehabilitate the structure. If you incurred rehabilitation expenditures of $320,000, the credit would not be avalible nd the cost recovery basis of the structure would be $___________.

By incurring $380,000 on rehabilitation expenditures, the credit would be available and the cost recovery basis of the structure would be $___________.

Because the rehabilitation tax credit is available if you choose the renovation plan costing $380,000. ou need to consider carefully the impact the credit will have on your short-term cash-flow position. Based solely on current cash flow due to the cost of the two projects and the potential tax credit, you would enefit by selecting the more expensive renovation project. The net cash flow gain would be $__________

Of course, other considerations, including the reduced depreciation deduction associated with the credit, may impact your decision, but the benefit of the tax credit is indisputable.

PLEASE HELP FILL IN THE BLANKS. THANKS IN ADVANCE!

Answer 1

The tax law requires that in order for the credit to be available, a taxpayer must substantially rehabilitate the structure. In this case, the requirement calls for you to expend more than $350,000 on rehabilitation charges. Therefore, if you incur rehabilitation expenditures of $320,000, the credit is not available and the depreciable basis of the structure would be $670,000 [$350,000 (original cost) + $320,000 (capital improvements)].

By incurring $380,000 on rehabilitation expenditures, a credit of $76,000 ($380,000 X 20%) would be available. However, the depreciable basis of the property would be reduced to the extent of the available credit. Therefore, the depreciable basis of the building would be $654,000 [$350,000 (original cost) + $380,000 (capital improvements) – $76,000 (amount of credit)].