Sale of State Tax Credits Produces Capital Gains

Colorado allows its residents to claim a tax credit for conservation easement donations up to certain limits. Credits above the limit can be carried forward or sold to others. Does the sale of these credits produce capital gains or ordinary income?

According to the Tax Court, the tax treatment depends on the characterization of tax credits as a capital asset or noncapital asset. The tax law details various categories of assets that are not treated as capital assets; all other types of property are considered capital assets. Since tax credits are not part of any of the categories of noncapital assets, such as inventory, literary and musical compositions by the creators, and commodities derivative financial instruments held by commodities derivatives dealers, the tax credits are treated as capital assets. As such, the sale of tax credits results in capital gain (or loss).

Source: William M. McNeil et ux. v. Commissioner; T.C. Memo. 2011-109; Tempel, 136 TC No. 15 (2011)