PORTFOLIO

Rehabilitation Tax Credit and Low-Income Housing Tax Credit (Portfolio 584)

Tax Management Portfolio, Rehabilitation Tax Credit and Low-Income Housing Tax Credit, No. 584, provides an in-depth analysis of the tax credit for the rehabilitation of certified historic structures and buildings placed in service before 1936, as well as the credit enacted by the Tax Reform Act of 1986 for the acquisition, construction, and rehabilitation of low-income housing. A 20% credit is available for “qualified rehabilitation expenditures” incurred in connection with a certified historic structure, and a 10% credit may be taken for qualified rehabilitation expenditures incurred with respect to a building placed in service before 1936. To qualify for the credit, a qualified rehabilitated building must have been “substantially rehabilitated” and initially placed in service before the beginning of the rehabilitation. In addition, buildings qualifying for the 10% credit must meet an external wall requirement. A certified historic structure, while exempt from the external wall requirement, must either be listed in the National Register or located in a registered historic district. Part One of this portfolio discusses in detail the technical requirements for the rehabilitation credit, and also describes the process under which a certified historic structure obtains its certification.

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Tax Management Portfolio, Rehabilitation Tax Credit and Low-Income Housing Tax Credit, No. 584, provides an in-depth analysis of the tax credit for the rehabilitation of certified historic structures and buildings placed in service before 1936, as well as the credit enacted by the Tax Reform Act of 1986 for the acquisition, construction, and rehabilitation of low-income housing. A 20% credit is available for “qualified rehabilitation expenditures” incurred in connection with a certified historic structure, and a 10% credit may be taken for qualified rehabilitation expenditures incurred with respect to a building placed in service before 1936. To qualify for the credit, a qualified rehabilitated building must have been “substantially rehabilitated” and initially placed in service before the beginning of the rehabilitation. In addition, buildings qualifying for the 10% credit must meet an external wall requirement. A certified historic structure, while exempt from the external wall requirement, must either be listed in the National Register or located in a registered historic district. Part One of this portfolio discusses in detail the technical requirements for the rehabilitation credit, and also describes the process under which a certified historic structure obtains its certification.

The low-income housing credit is calculated on the basis of the cost of acquiring, constructing, and/or rehabilitating a building (“eligible basis”) which will provide low-income housing, and the number of qualifying housing units that low-income tenants occupy (“qualified basis”). The credit is claimed annually for 10 years, provided low-income use is maintained continuously throughout a 15-year “compliance period” and the taxpayer commits to maintaining the project as a low-income housing project for an “extended use” period, which can be an additional 15 years. The Revenue Reconciliation Act of 1993 extended the low-income housing credit indefinitely. To qualify for the low-income housing credit, the building must receive an allocation of credits from a designated state agency (or be financed with tax-exempt bonds that are subject to a state's “volume cap”) and at least 20% of the units in the project must be occupied by persons whose incomes are substantially below the local area median. In addition, rents paid by low-income tenants are restricted to 30% of the imputed income limitation for the unit, based upon the number of bedrooms. The many technical rules and compliance requirements that must be met in order to claim the low-income housing credit are analyzed in Part Two of this portfolio.


Limitations on the use of the rehabilitation and low-income housing credits, as well as guidelines applied by the IRS in auditing credit projects, are discussed in Part Three of this portfolio. These limitations include the at-risk and passive loss rules. Finally, planning opportunities using the rehabilitation and low-income housing credits, including use of the credits in tandem, are presented in Part Four.


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AUTHORS

FORREST DAVID MILDER
Forrest David Milder, S.B., Massachusetts Institute of Technology (1973) (Phi Beta Kappa); S.M., Massachusetts Institute of Technology (1974); J.D., Harvard Law School (1977); LL.M. (Taxation), Boston University (1983); admitted to bar, Massachusetts; member, Tax Section, American Bar Association, Boston Bar Association (Chairman, Internet and Computer Assisted Tax Practice Committee, former Chairman, Section of Law Office Management and Professionalism); member, National Association of Bond Lawyers; Boston University School of Law, Instructor of Legal Research and Writing; Lecturer, Federal Tax Institute, Massachusetts Continuing Legal Education, Massachusetts Association of Public Accountants, Northwest Center for Professional Education; Contributor on tax matters to The Wall Street Journal, Boston Globe, Massachusetts Banker and Tradesman, The Matrimonial Strategist, Massachusetts Lawyer's Weekly, and Writer's Digest; author of “Disposition of Personal Residence” (The Best of MCLE, August 1991). Contributed Chapter “Federal Income Taxation of Asset Securitization Transactions” to Securitization: Asset–Backed and Mortgage–Backed Securities (Michie 1994).

RONALD S. BOROD
Ronald S. Borod, B.A., Princeton University (1963) (Magna Cum Laude, Phi Beta Kappa); J.D., Harvard Law School (1966); LL.M. (Taxation), New York University (1967); admitted to bar, Massachusetts and Tennessee; member, Tax and Urban Law, Sections, American Bar Association; member, Massachusetts Bar Association, Boston Bar Association, Tennessee Bar Association, Memphis Bar Association; member, National Association of Bond Lawyers; contributor of articles to New York University and Memphis State University Law Reviews; contributed chapters on “At Risk Limitation on Losses” and “Rehabilitation Expenditures for Historic Structures” in Federal Tax Deductions (Warren, Gorham & Lamont 1983); contributor of articles to Tax Management Real Estate Journal; contributed chapter on “Syndicating REO and Troubled Loan Assets From the Lender's and Buyer's Perspective” to The Workout Game — Managing Nonperforming Real Estate Assets (Executive Enterprises and Land Development Institute 1987); editor of Securitization: Asset–Backed and Mortgage–Backed Securities (Michie 1991, Revised 1994 and 1995); Adjunct Professor of Law, Boston University School of Law; member, Tax Management Advisory Board on U.S. Income.

TABLE OF CONTENTS

Detailed Analysis

Introduction to the Role of Tax Credits in Financing Real Estate Projects

Introduction

I. The Rehabilitation Tax Credit

II. The Low–Income Housing Tax Credit

Part One: The Rehabilitation Tax Credit

1:I. History of the Rehabilitation Tax Credit

1:II. Overview of Former Code Provisions

Introductory Material

A. Former Section 191 (as in Effect Immediately Prior to ERTA)

1. In General

2. Eligible Costs Under Former Section 191

B. Pre–ERTA Section 48(g)

1. In General

2. Definitions

3. Requirement That Rehabilitation Be “Substantial”

C. Post–ERTA/Pre–1986 TRA Section 48(g)

1:III. Summary of the Current Rehabilitation Tax Credit

A. Two–Tier Credit

B. Definitions

1. Certified Historic Structure

2. Qualified Rehabilitated Building

3. Rehabilitation

1:IV. “Qualified Rehabilitated Building” Defined

A. Must Be a “Building”

B. Building Must Be “Substantially Rehabilitated”

1. Meaning of “Substantially Rehabilitated” Under Prior Law

2. The Mathematical Test

3. Permitting the Taxpayer to Select the 24–Month Period

4. Inclusion of Expenditures Outside the Measuring Period

5. Rehabilitation of Major Portion of a Building Under Prior Law

6. Special Rule for Phased Rehabilitation over 60 Months

7. Portions of Building that Do Not Pass Age Requirements

8. Partnership Adjustments

9. Aggregation of Adjusted Basis

10. Including Lessees' and Others' Capital Expenditures

C. Retention of Walls and Relocation

1. Pre–1986 TRA Rules

2. 1986 TRA Changes

3. Shared Walls

4. Other Rules Regarding External Walls

5. Examples of the External Wall Rules

6. Relocation

1:V. Overview of Qualified Rehabilitation Expenditures

A. General

1. Personal Property Ineligible

2. Effect of Nonrecognition Rules

3. Straight–Line Method of Depreciation

4. Personal Use Property

B. Acquisition Cost Excluded

1. General Rule

2. Proportionate Treatment for Condominium Owner

3. Rules for Transferees

4. Placed in Service Considerations

C. Enlargement Expenditures Excluded

D. Demolition

E. Certain Expenditures Excluded Unless Rehabilitation Certified

1. General Rule

2. Ten Percent Credit Not Available for Certified Historic Buildings

F. Treatment of Lessees

1. Importance of Remaining Term of Lease

2. General Requirements of Prior Law

3. Amendments Made by the 1986 TRA

4. Requirement that Expenditures Exceed Basis

G. Expenditures Must Be Incurred and Properly Chargeable to Capital Account

1. Chargeable to Capital Account

2. Kinds of Fees Permitted by the Regulations

3. Incurred on Accrual Basis

H. “Placed in Service” Requirement

1. Importance of Timing

2. Pre–1990 RRA Rule for Sale–Leasebacks

1:VI. “Certified Historic Structure” Defined

Introductory Material

A. Listed in National Register

B. Located in Registered Historic District and Certified to Be of Historic Significance to the District

1. Certification of Statutes

2. Certification of Districts

3. Certifying Structures Within Registered Historic Districts Part 1 Certification

1:VII. “Certified Rehabilitation” Defined

A. Overview

B. Certifying the Rehabilitation - Part 2 Certification

C. Standards for Rehabilitation

D. Comparing the Department of Interior and IRS Definitions of Rehabilitation

1:VIII. Disqualified Uses

A. In General

B. Property Used for Lodging

1. In General

2. Exception for Certified Historic Structures

C. Property Used by Exempt Organizations or Governmental Units or Foreign Persons or Entities and Tax–Exempt Use Property

1. Introduction and History

2. Current Law

3. Exception for Certain Long Term Leases

4. Disqualified Leases and Tax–Exempt Use Property

5. Tax-Exempt Use Expenditures Included for Some Purposes

1:IX. Pass-Through Election by Lessor

Introductory Material

A. Election Only for “New” 38 Property

B. Allowable Depreciation Rule

C. Possibility That Exempt Organization Could Pass Through the Credit

1. General Rule

2. Eligibility for Depreciation

1:X. Progress Expenditures

A. Overview

B. Self-Rehabilitated Buildings

C. Non-Self-Rehabilitated Buildings

D. When Is the Credit Attributable to Progress Expenditures Available?

E. Election to Use Progress Expenditures

1:XI. Effect of Rehabilitation Credit on Basis

A. Before TEFRA

B. Changes Made by TEFRA

C. 1986 TRA Changes

D. Effect of Basis Reduction on Depreciation Recapture

1:XII. Claiming the Credit on IRS Form 3468

A. General

B. The Part 2 Final Certification for Historic Rehabilitations

C. Pre-2002 30-Month Rule

D. Progress Expenditures

1:XIII. Tax Credit Recapture

A. Overview

B. Disposition of Partnership Interests

1:XIV. Transitional Rules and Effective Dates

Part Two: The Low–Income Housing Tax Credit

2:I. Background and Overview

Introductory Material

A. Congressional Objectives

B. Overview of the LIHC

C. Allocation of the Credit by States

D. Overview of the Tests Which Must Be Passed to Qualify for the LIHC

E. Rate of the Credit

F. Exceptions to the General Rules

1. Below Market Federal Loans

2. Tax–Exempt Financing

3. Federal Grants

4. Increase in Credit for Certain Locales

G. Illustration

2:II. Qualified Projects and Qualified Buildings

A. Qualified Low–Income Housing Projects

1. Definition of Residential Rental Property

2. Functionally Related and Subordinate Facilities

3. Amenities

4. Mixed–Use Facilities

5. Multiple Building and Scattered Site Projects

6. Use by the General Public

7. Unit Used by Resident Manager or Security Officer

8. SRO Housing

9. Tenants' Payments Applied to Purchase Price

B. Qualified Low–Income Buildings

1. General Definition

2. Building Cannot Receive Moderate Rehabilitation Assistance

3. Cooperative Ownership

4. Effect of Right of First Refusal

5. Owner–Occupied Buildings

6. Nontransient Use

7. Prohibited Facilities

8. Suitable for Occupancy

C. Overview of “Placed in Service” and Start of the Credit Period

2:III. Volume Caps and LIHC Allocation

Introductory Material

A. Allocation Amounts

1. In General

2. Allocations

a. General

b. The Unused Carryforward Component

c. The Population Component

d. The Returned Credit Component

(1) In General

(2) Notifying the IRS of Returned Credits

e. The National Pool Component

(1) In General

(2) Qualified State

(3) Unanticipated Returns of Credits

(4) Three-Month Rule

(5) Requests from the National Pool

f. Stacking Rules

B. Allocation Set-Asides for Nonprofit-Sponsored Projects

1. In General

2. Rules Applicable to the Nonprofit Set-Aside

C. LIHCs Derived from Tax-Exempt Financing

1. General Rule

2. Volume Cap and Other Requirements

3. Project Must Comply with Qualified Allocation Plan

D. Housing Credit Agencies

1. In General

2. Qualified Allocation Plans

a. In General

b. Housing Priorities Selection Criteria

c. Reasonableness of Costs

3. Limit on Credit Allocated

E. Making LIHC Allocations

1. Commitment to Make a Credit Allocation

2. Standard Allocations

a. Allocation Made by Issuance of Form 8609

b. No Need for State Agency to Investigate the Building Before Completing Part I of Form 8609

3. Overview of Carryover Allocations

a. Requirements for Qualification

b. Temporary Relief from 10% Test and Two-Year Rule

4. Application of the 10% Test for Carryover Allocations

a. General

b. Determining Basis

c. Accounting Method

d. Inclusion of Application and Monitoring Fees in Carryover Basis

e. Verification by Agency

5. Form of Carryover Allocation

6. Allocation of Additional Credits

7. Unused Credits

F. Additional Rules Related to Allocations

G. Extended Low-Income Housing Commitment

1. Requirement of the Agreement

2. Terminating the Extended Use Period Early

H. Allocation of Credits on a Project Basis

I. Correction of Administrative Errors and Omissions

1. Definition of Administrative Error or Omission

2. When is Prior Approval Needed?

3. Form of Request for IRS Approval

4. Automatic Approval for Certain Corrections

2:IV. Low-Income Housing Grant

2:V. LIHC Percentages

Introductory Material

A. 1987 Buildings

B. Post-1987 Buildings

1. The 70% and 30% Credits

2. How the Credit Percentages are Calculated

3. Determining the Applicable Percentage

4. Making a Binding Agreement to Elect the Percentage

5. Electing the Percentage

6. Illustrations of Electing a Credit Percentage

C. Treatment of Federal Subsidies

1. Grants

a. Adverse Rules Apply to Federal (But Not State or Local) Grants

b. Grants Derived from Federal Funds

c. Exceptions for Natural Disaster

d. Grants Received Prior to Compliance Period

2. Federally Subsidized Loans

a. General Rules

b. Loans Derived from Federal Funds

c. Attribution of Federal Funds to Entire Project

d. Getting the 70% Credit on Projects That Have Federally Subsidized Loans

3. Exceptions to Federally Subsidized Loan Rules With Respect to Buildings Placed in Service On or Before July 30, 2008

a. Construction Financing

b. Community Development Block Grant Funds

c. HOME Funds and Native American Housing Assistance

d. Affordable Housing Program Funds

e. Oil Stripper Settlement Funds

f. Exceptions for Natural Disaster

2:VI. Calculating the LIHC

Introductory Material

A. Eligible Basis

1. New Construction

2. Acquisition of Used Buildings and the 10-Year Rule

a. General Rules

b. Waiver of the 10-Year Holding Period

(1) Buildings Place in Service On or Before July 30, 2008

(2) Buildings Placed in Service After July 30, 2008

c. Transfer of Property with Carryover Basis

d. Other Exceptions to the 10-Year Rule

3. Rehabilitations

a. Pre-1990

b. Post-1989 and Pre-July 31, 2008

c. Post-July 30, 2008

d. Exception for Acquisition from Governmental Units

e. Definition of Rehabilitation Expenditures

f. Illustration of Calculations

g. Transferees

h. Groups of Units

B. Adjustments to Eligible Basis

1. Adjustments for Other Rehabilitation Incentives

2. Difficult Development Areas, Qualified Census Tracts, and Certain Buildings Designated by a State Housing Credit Agency

3. Federally Subsidized Grants and Loans

4. Comparable Quality of Low-Income and Other Units

5. Unit Occupied by Manager

6. Other Adjustments to Eligible Basis

C. Calculating Qualified Basis

1. Fraction Tests Based on Floor Area or Number of Units

2. Vacated Units

3. Increases in Qualified Basis

D. Proration of LIHC in First Year Claimed

E. Filings to Claim the Credit

F. Example

G. Accelerated Credit Election

2:VII. Low-Income Use Requirements

Introductory Material

A. Requirements for Low-Income Units

B. Required Incomes for Low-Income Units

1. In General

2. Changes in Tenant or Median Income

3. Irrevocable Set-Aside

4. Projects with Buildings Placed in Service on Different Dates

C. Application of the Rent Restriction Rules

1. Imputed Income Limitation Based on Number of Bedrooms

2. Utilities

3. Rent Subsidies

4. Support Services

D. 10-Year LIHC Period, 15-Year Compliance Period, and the Extended Commitment Period

1. Electing the First Year of the Credit Period

2. Maintaining Low-Income Occupancy Throughout the Compliance Period

3. Extended Low-Income Housing Commitment

2:VIII. Monitoring Low-Income Housing Projects

A. Overview

1. History of Compliance Monitoring Regulations

2. Maintaining Records for Audit Purposes

3. Effective Dates

4. Waivers of Compliance Monitoring

B. Recordkeeping and Record Retention Provisions

1. Requirements

2. How Long Must Records Be Retained?

C. Certification and Review Provisions

1. Certification

2. Waiver of Annual Certification

3. Required Review by Agency

4. Frequency and Form of Certification

5. Exception for Certain Buildings

6. Agency Reports of Compliance Monitoring Activities

7. Emergency Housing Relief

D. Inspection Provision

E. Notification of Noncompliance

F. Delegation of Compliance Monitoring Functions

G. Liability for Noncompliance

H. Fees for Monitoring Expenses

2:IX. Transfers, Recapture and Posting Bond

A. Transferees

B. Recapture in General

1. Recapture Percentages

2. Illustration of Recapture

3. Other Rules Applicable to Recapture

4. No Recapture in Certain Situations

5. Disaster Exceptions from Recapture

C. Special Rule for Large Partnerships

D. Casualty Losses

E. Posting Bonds

1. Dispositions of Interests in Buildings On or Before July 30, 2008

2. Dispositions of Interests in Buildings After July 30, 2008

Part Three: Rules and Limitations Applicable to Both Rehabilitation and Low-Income Housing Credits

3:I. At–Risk Limitations

Introductory Material

A. Overview of the At–Risk Rules

B. Rehabilitation Tax Credit

1. General Rule for Nonrecourse Financing

2. Definitions

3. Comparison to 465

C. Low–Income Housing Credit

1. Related Persons Can Make Loans

2. The 80% Limit Does Not Apply

3. Exception for Loans from Nonprofit Organizations

4. Application of the Rules to Loans from Nonprofits

3:II. Limitation Based on Amount of Tax

3:III. Passive Activity Limitations

Introductory Material

A. General Rules

B. Application to Certain Corporations

C. Real Estate Activities

1. $25,000 Deduction Equivalent

2. Special Rule for Rehabilitations and Low-Income Housing

3. Phase-Out of the $25,000 Rule

4. Carryforward of Credits

5. Rental Real Estate Activities

3:IV. Credits Not Available Against Alternative Minimum Tax

3:V. Allocation of Credits Among Partners

A. Overview

B. Rehabilitation Tax Credit

1. Introduction

2. Allocation of Rehabilitation Tax Credit Among Partners

C. Substantial Economic Effect

D. Allocation of Low-Income Housing Tax Credits

3:VI. Activities Not Engaged in for Profit

A. In General

B. Low-Income Housing Tax Credits

C. Rehabilitation Tax Credit

3:VII. Development Fees

A. In General

B. Inclusion of Development Fees

1. The Amount of the Development Fee and How It Was to Be Paid

2. How the Development Fee Amount Was Determined

3. Who the Developer Is

4. Underlying Transactions and Entities Connected to the Development Fee

5. Development Fee Mechanism

3:VIII. Other Issues Related to Audits of Tax Credit Projects

A. Coordination with National Park Service

B. Other Items That Are Closely Scrutinized by the IRS

1. Syndication Costs

2. Organizational Costs

3. Acquisition Costs

4. Rent Up/Lease Costs

5. Rental Management

C. Materials Reviewed by the Auditor

D. Sample Auditor's Report

Part Four: Planning Rehabilitation and Low-Income Housing Transactions

4:I. Combining the Rehabilitation Credit with a Facade Easement Donation

4:II. Avoiding Passive Loss Rules by Making a 50(d) Election

4:III. Public Offerings of Rehabilitation and Low-Income Housing Credits

4:IV. Combining the Rehabilitation Credit with the Low-Income Housing Credit


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Listing of Online Resources for Historic Places Registration and Rehabilitation

Worksheet 2 Calendar Year 2009 Resident Population Estimates for States, the District of Columbia, and U.S. Possessions (Notice 2009-21)

Worksheet 3 [Reserved]

Worksheet 4 [Reserved]

Worksheet 5 [Reserved]

Worksheet 6 [Reserved]

Worksheet 7 [Reserved]

Worksheet 8 [Reserved]

Worksheet 9 [Reserved]

Worksheet 10 Department of Interior Regulations Concerning Historic Preservation Certification, 55 Fed. Reg. 6764 (Feb. 26, 1990)

Worksheet 11 Summary of Rehabilitation Tax Credit and Low–Income Housing Tax Credit Elections

Worksheet 12 Glossary of Terms Relevant to Low–Income Housing.

Worksheet 13 H.R. Rep. No. 795, 100th Cong., 2d Sess. (excerpt) (1988) (House Report on the Technical and Miscellaneous Revenue Act of 1988, P.L. 100–647).

Worksheet 14 Conditional Reservation for Low–Income Housing Tax Credits.

Worksheet 15 Carryover Allocation Tax Opinion.

Worksheet 16 Low–Income Housing Credit Allocations Activity by States (Prepared by the National Council of State Housing Agencies)

Worksheet 17 Calendar Year 2006 Resident Population Estimates for States, Puerto Rico, and Insular Areas of the United States, including GO Zone Population Estimates (Notice 2006-22, Notice 2006-21)

Worksheet 18 Calendar Year 2007 Resident Population Estimates for States, the District of Columbia, and U.S. Possessions (Notice 2007-23)

Worksheet 19 Calendar Year 2008 Resident Population Estimates for States, the District of Columbia, and U.S. Possessions (Notice 2008-22)

Worksheet 20 List of Low–Income Housing Tax Credit Allocating Agencies (Source: National Council of State Housing Agencies)

Worksheet 21 Sample Financial Forecast for Low–Income Housing Project.

Worksheet 22 Letter from the SEC to the Emerging Issues Task Force of the Financial Accounting Standards Board Regarding the Proper Accounting Treatment of Investments in Affordable Housing Projects.

Worksheet 23 Computation of Low–Income Housing (LIH) Credit - Example

Worksheet 24 Low–Income Housing Tax Credit Carryover Allocation.

Worksheet 25 Sample Public Offering Material.

Worksheet 26 Sample Tax Opinion for Privately Placed Low-Income Housing Partnership with Corporate Investor

Worksheet 27 IRS Memo Outlining Criteria for Low-Income Housing Tax Credit Limited Partnerships

Bibliography

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Statutes:

Regulations:

Prop. Regs.:

Treasury Rulings:

Cases:

UNOFFICIAL

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