In a private letter ruling (PLR 201440013), the IRS allowed individual shareholders of an S corporation to increase their basis in the stock of the S corporation to the extent the taxpayers were allocated a share of certain low-income housing awards received by an underlying partnership from the state.
The S corporation and a third-party developer were partners in a partnership that developed, financed, constructed, owned and operated a low-income rental apartment complex, enabling the partnership to take a Section 42 low-income housing tax credit. In 2009, Congress enacted section 1602 of the American Recovery and Reinvestment Tax Act of 2009, to allow certain taxpayers to receive a cash award in lieu of the tax credit under Section 42. In the tax years in question, the partnership elected to receive the award.
Notice 2010-18 states that such awards can be excluded from the gross income of recipients, are exempt from taxation and don’t reduce the tax basis of a qualified low-income building. Section 702 says that each partner will take into account his or her distributive share of the partnership’s items of income, gain, loss, deduction or credit, including tax-exempt income. Similarly, Section 1366 states that each shareholder in an S corporation will take into account the shareholder’s pro-rata share of the S corporation’s items of income, gain, loss, deduction or credit, including tax-exempt income. Section 1367(a)(1) provides that the basis of each shareholder’s stock in an S corporation will be increased by the shareholder’s pro-rata share of the S corporation’s tax-exempt income. Section 1368(e)(1)(A), however, provides that an S corporation’s accumulated adjustments account (AAA) won’t be increased for tax-exempt income.
The IRS ruled the award was tax-exempt income. As a result, the S corporation was allocated its pro-rata share of the partnership’s award, which was allocated to the taxpayers based on their respective ownership in the S corporation. Correspondingly, the taxpayers could increase their respective tax basis in the S corporation stock to the extent of their allocable share of the award. The S corporation itself, however, wasn’t permitted to increase its AAA because of the award.