Rulings of the Tax Commissioner

May 22, 2024

Re: § 58.1-1821 Application: Individual Income Tax
    
Dear *****: 

This will respond to your letter in which you seek correction of an assessment of individual income tax issued to ***** and ***** (the “Taxpayers”) for the taxable year ended December 31, 2022.

FACTS

The Taxpayers, Virginia residents, sold a rental property located in another state during the taxable year at issue. They included the gain on the sale, a portion of which was attributable to recaptured depreciation under Internal Revenue Code (IRC) § 1250, in their federal adjusted gross income (FAGI). The Taxpayers subtracted the portion of recaptured depreciation attributable to deductions taken during the six years when they were not residing in Virginia. The Department disallowed the subtraction, which resulted in an assessment being issued. The Taxpayers filed an application for correction of the assessment, contending that they should be allowed to subtract the recaptured amounts to the extent that they did not previously receive any benefit from the depreciation deductions for Virginia income tax purposes.

DETERMINATION

Conformity

Virginia Code § 58.1-301 provides, with certain exceptions, that the terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the IRC unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia. For individual income tax purposes, Virginia conforms to federal law, in that it starts the computation of Virginia taxable income (VTI) with FAGI, with certain exceptions. Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia. 

It is well established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn v. Graves, 300 U.S. 308, 312-313, 57 S. Ct. 466, 467 (1937), the United States Supreme Court explained “[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized.”

Subtraction of Depreciation Recapture

The Department addressed a similar issue in Public Document (P.D.) 98-158 (10/20/1998). In that determination, the Department held that an owner of a pass-through entity that sold a rental property was not eligible to subtract IRC § 1250 depreciation recapture attributable to deductions taken while the taxpayer was not a Virginia resident. See also P.D. 95-109 (5/9/1995), P.D. 95-254 (9/22/1995), and P.D. 04-31 (7/12/2004). 

Because the depreciation recapture was included as income in FAGI, it must be included in the computation of VTI as a result of Virginia’s conformity to the IRC. Virginia law does provide for certain subtractions and deductions from FAGI. Neither Virginia Code § 58.1-322.02 nor § 58.1-322.03, however, provides a subtraction or deduction for IRC § 1250 depreciation recapture attributable to periods of nonresidency. As such, the subtraction was properly denied. 

Credit for Taxes Paid to Another State 

Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia returns for income taxes paid to another state provided the income is either earned or business income or gain from the sale of a capital asset. 

Virginia law does not necessarily allow a taxpayer to claim a credit for the total amount of tax paid to another state. Rather, the credit is limited to the lesser of the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. See P.D. 97-301 (7/7/1997). The limitation is computed by multiplying the individual’s Virginia tax liability by a fraction, the numerator of which is the income upon which the other state’s tax is imposed, and the denominator of which is Virginia taxable income. 

The Taxpayers did not indicate whether they were required to pay income tax to the state where the property was located for the taxable year at issue. If they did, however, they likely would be entitled to claim a credit for any such taxes paid on the sale of the property to the extent permitted by Virginia Code § 58.1-332.

CONCLUSION

For the reasons stated above, the denial of the subtraction was correct and is upheld. If the Taxpayers are entitled to a credit for income tax paid to the state in which the property was located, they may file an amended 2022 Virginia resident income tax return to claim the credit to the extent permitted by Virginia Code § 58.1-332. The credit may be granted so long as the amended return is filed within the time prescribed under Virginia Code §58.1-1823. The Taxpayers should also attach a copy of the 2022 return they filed with the other state. The return will be reviewed and processed, and the assessment will be adjusted as warranted. Otherwise, the Department’s records indicate that the assessment has been paid and no further action is required. 

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at (804) *****.

Sincerely,

James J. Alex
Tax Commissioner
Commonwealth of Virginia

AR/4704.X