 |
| Real Estate and Business Transactions, Tax Credit Investments and General Tax: Recent Developments |
| |
Highlights of 2004 Changes in Low Income Housing Finance Law
|
| |
6/10/2005
Authors: David E. Raderman, Jessica B. Lang
|
 |
 |
|
Dave Raderman |
|
|
 |
|
Jessica Lang |
|
|
The low-income tax credit industry saw several notable changes in laws in 2004. We briefly describe them below.
I. Federal Highlights
HUD Notice Reducing Funding for Existing Section 8 Housing Choice Vouchers
In Notice PIH 2004-7, issued on April 22, 2004, the Department of Housing and Urban Development (“HUD”) modified its method of calculating Section 8 voucher renewal funding to public housing finance agencies (“PHAs”). Before the notice was issued, voucher funding was based on the number of units reserved for HUD by the PHA as of the end of the prior year and the per-unit costs were based on the most recent HUD-approved year-end settlement, see 24 CFR 982.102(c)(1), (e)(1). Under the new notice, funding is based on the number of units reserved for HUD by the PHA as of August 1, 2003 and the per-unit cost will be based on the per-unit costs as of August 1, 2003. This new method of calculating Section 8 vouchers, which essentially freezes vouchers at the levels provided to PHAs in August 1, 2003, subject to an annual adjustment for inflation, is retroactive to January 1, 2004.
After controversy erupted regarding the notice, legislation was introduced in both houses in the previous Congress to restore the former practice of renewing vouchers based on the public housing finance agency’s actual per-unit costs in the prior quarter, adjusted by inflation for the intervening months. See H.R. 4263; S. 2467. This legislation was sent to committee and no further action was taken. In the interim, according to a study by the Center on Budget and Policy Priorities, the National Low Income Housing Coalition and the Council of Large Public Housing Authorities, the policy change is causing widespread reductions in rental assistance. See “Local Consequences of HUD’s Fiscal Year 2004 Voucher Funding Policy,” Center for Budget and Policy Priorities, July 15, 2004.
New Rules for Eligibility for 130% Basis Boost When Building Is Located in a Difficult Development Area or Qualified Census Trust
HUD has relaxed its requirements regarding when a building must be located in a difficult development area (“DDA”) or a qualified census tract (“QCT”) to receive the 130% increase in eligible basis under Section 42(d)(5)(C) of the Code. The original notice announcing 2004 DDAs and QCTs, 68 FR 70982 (Dec. 19, 2003), required the project to be in a DDA or QCT as of the date of the credit allocation, or, in the case of a tax-exempt bond financed building, on the earlier of the date of issuance of the bonds or the date that the building is placed in service in order to qualify for the 130% increase in eligible basis under Section 42(d)(5)(C). Under the amended notice, 69 FR 63551 (Nov. 2, 2004), the project must be in a DDA or QCT as of the date on which the application for tax credits or tax-exempt bond financing was filed. 69 FR 63551 (Nov. 2, 2004). This change would permit a project located in an area that has ceased to be DDA or QCT after the tax credit application was filed to qualify for the 130% basis.
New Requirements for Extended Use Agreements
On July 29, 2004, the IRS issued Rev. Rul. 2004-82. Among other clarifications in the ruling, the IRS stated that extended use agreements must prohibit evictions and increases in gross rent described in Section 42(h)(6)(E)(ii)(I) and (II) throughout the entire extended use period. Before Rev. Rul 2004-82 was issued, practitioners and state housing finance agencies believed that extended use agreements need only prohibit such evictions and gross rent increases for the three-year “opt-out” period at the end of the tax credit period. In contrast, the new ruling provides that these tenant protections must be in place for the entire extended use period. Because the revenue ruling represents a departure from conventional understanding of the requirements of Section 42(h)(6)(E)(ii)(I) and (II), the IRS ordered state housing finance agencies to review all extended use agreements approved since 1989 by December 31, 2004, which then have one year to amend all non-complying extended use agreements to include the prohibition on evictions and increases in gross rent throughout the extended use period. After that point, if an existing or newly-executed extended use agreement does not comply with Rev. Rul. 2004-82, the building cannot receive tax credits for the current year and any prior years.
For information about the effect of the Ruling in Maryland, see the discussion below under Extended Low Income Housing Covenants.
Tax Credit Application Fees Are Not Includable in Eligible Basis
Also in Rev. Rul. 2004-82, the IRS stated that application fees and allocation fees paid to the state housing credit agency are not includable in the eligible basis of the project. The IRS reasoned that the fees are not capitalizable into the adjusted basis of the building under Section 263 and 263A. However, the IRS noted that all or a portion of the fees may be required to be capitalized as amounts paid to create an intangible asset, and that the remaining portion of the fees not so capitalized may be deductible under Section 162 or 212.
When A New Unit Is Included in Applicable Fraction
Rev. Rul. 2004-82 also clarified the treatment of a formerly vacant unit in a newly construction building when the initial tenant moved into the unit on the last day of the month. The unit is treated as a low-income unit and included in the numerator and denominator of the applicable fraction for that month as provided in Section 42(f)(2)(A)(i) as long as (1) the tenant resides in the unit on the last day of the month and (2) the building was placed in service for a full month.
Tax-Exempt Bond Financed-Project Compliance with Set-Aside Requirements
The IRS has clarified that the set-aside requirements of Section 142(d)(1)(A) or (d)(1)(B), which require a specified percentage of units be leased to low-income tenants, apply to the number of units actually available for lease, not the total units in the project when it is completed or rehabilitated. Rev. Proc. 2004-39 (Jul. 1, 2004). The IRS’ stated purpose for issuing the Revenue Procedure to address uncertainty regarding how the set-aside rules should be applied. Formerly, some practitioners believed that all units needed to be rented to low-income tenants until the appropriate percentage (20% or 40%) of the total number of units were rented to low-income tenants. The IRS clarified that after the date on which at least ten percent (10%) of the total units are occupied, or, for an acquisition of an existing project, the later of the date on which the project is acquired or the date of issuance of the bonds, only a proportionate share of the units then-available for occupancy (excluding units that are scheduled to be renovated) need be leased to low-income tenants. The Revenue Procedure also provides that for bond-financed projects, units empty as of the later of the date the bonds were issued and the project was acquired will not be included in the set-aside calculation.
708(b)(1)(B) Termination of Taxpayer Partnership Is Not Taken Into Account for Ten Year Hold Rule
In a ruling released this month, the IRS stated that three carryover basis transactions causing technical terminations of the taxpayer partnership should not be taken into account for purposes of the ten-year hold rule of Section 42(d)(2)(B)(ii). PLR 200502019 (Jan. 14, 2005). In the first transaction, a corporation (“Corporation”) foreclosed on a note issued by the 99% limited partner of the taxpayer partnership (“Taxpayer”) and took possession of the 99% limited partner interest in Taxpayer in satisfaction of the note. Immediately thereafter, Corporation sold and assigned the limited partner interest to one of its shareholders (“Shareholder”). As a result of a later bankruptcy settlement between Corporation and Shareholder’s estate, Shareholder’s estate transferred to the 99% limited partner interest in Taxpayer back to a second-tier limited liability company wholly owned by Corporation.
The IRS ruled that although both the transfer of the limited partner interest in Taxpayer to Corporation and the sale of the interest by Corporation to Shareholder resulted in technical terminations of Taxpayer under Section 708(b)(1)(B), the transactions are not taken into account for Section 42(d)(2)(B)(ii) because they were carryover basis transactions in spite of the fact that the Taxpayer had a section 754 election in effect. Similarly, the IRS ruled that the transfer from Shareholder’s estate to the second-tier limited liability company owned by Corporation resulted in a technical termination of Taxpayer, but was not taken into account for the ten year hold rule because it was a carryover basis transaction.
Legislative Action
There were several bills introduced in the last session of Congress that, if enacted, would have affected the low-income housing tax credit program.
The Community Restoration and Revitalization Act, H.R. 5378, was intended to encourage projects receiving both historic tax credits and low-income tax credits by increasing the low-income housing tax credit applicable percentages for such projects by 125%. The increase in applicable percentages would counteract the rule in Section 50(c) requiring the basis of historic tax credit project be reduced by the historic tax credits, which greatly reduces eligible basis for low-income tax credits purposes, and consequently discourages development of projects with both types of credits.
The Affordable Housing Preservation Act of 2004, S. 2692, would set up a matching grant program for states and localities to ensure that affordable housing was preserved in areas where residents face difficulty in finding adequate, available, and decent housing if they were displaced from their current housing.
Another bill introduced in Congress would remove the recapture bond requirements for a building that is “reasonably expected . . . to continue to be operated as a qualified low-income building for the remaining compliance period with respect to such building.” HR. 3610; S. 2689. The bill also would extend the statute of limitations for recapture for three years after the end of the compliance period to allow for recapture against the seller in the event the property falls out of compliance. Owners of buildings who had already posted a bond to avoid recapture would have been able to elect out of the recapture bond requirement.
II. Maryland Highlights
The Maryland Department of Housing and Community Development (“DHCD”) addressed several issues in 2004 in connection with its administration of the low-income housing tax credit program in Maryland and anticipates some additional changes in 2005 to its Qualified Allocation Plan and the Multifamily Rental Financing Program Guide
Rate Lock Program
Developers are now permitted to lock-in interest rates in the Multifamily Bond Program. Permitting the developer to lock the interest rate in advance of closing allows a developer to control interest rate risk. In this program, the developer is permitted to lock the Community Development Administration published interest rate 30 to 90 days before closing on the financing. The developer must execute a rate lock agreement and pay a rate lock fee.
Extended Low Income Housing Covenants
DHCD undertook an internal review of all existing extended low income housing covenants because of the clarification in IRS Rev. Rul. 2004-82 that extended use agreements must prohibit evictions and increases in gross rent described in Section 42(h)(6)(E)(ii)(I) and (II) throughout the entire extended use period. DHCD concluded that all existing extended low income housing covenants comply with the Ruling insofar as the covenants state generally that the property owner will comply with all federal laws. It is DHCD’s position that this statement is sufficient, and shortly all Maryland property owners with an extended low income housing covenant in place will receive a letter from DHCD to this effect. In the letter, however, DHCD will advise the property owner that DHCD will amend the extended low income housing covenant if the property owner wishes.
DHCD also reviewed the current form of extended low income housing covenant it uses for new financings. DHCD came to the same conclusion that the form adheres to the Ruling by stating that the property owner will comply with all federal laws. However, the National Conference of State Housing Agencies (“NCSHA”) is reviewing this issue as well and is communicating with the Service. DHCD expects that NCSHA will issue guidance to the states, and at that point, depending on NCSHA’s conclusions, DHCD may consider changing its form.
For information about the Ruling generally, see the discussion above under New Requirements for Extended Use Agreements
Proposed Changes to the 2005 Qualified Allocation Plan and Multifamily Rental Financing Program Guide
DHCD is considering numerous changes to the 2005 Qualified Allocation Plan (the “Plan) and Multifamily Rental Financing Program Guide (the “Guide”). The following is a list of changes that are under consideration appearing in the current proposed drafts of the Plan and the Guide. A public comment period will follow before the Plan is finalized.
The following are proposed significant changes:
1. Limitations on disbursement of developer’s fees and use of deferred fees (see Section 2.4.7);
2. New threshold criteria including:
- A history or pattern of serious and uncorrected health and safety violations on Tax Credit assisted properties (see Section 3.2.3 in the Guide);
- Standards for applications involving scattered site properties (see Section 3.4.5);
- Increased Maximum Construction Costs per Gross Square Foot (see Section 3.7.5); and
- Mandatory high-speed internet access for all units in the project (see Section 3.7.7);
3. Adding outstanding uncorrected IRS Form 8823’s for various management deficiencies as a potential deduction from the Development Team score for owners or managers (see Section 4.1.2.1);
4. Revised minimum reserve for replacement deposit limits and increased per unit annual operating cost limits (see Section 4.1.2.2);
5. Incorporate the IRS definition of Qualified Nonprofit and inclusion of Public Housing Authorities as eligible for full scoring under the criterion (see Section 4.1.4);
6. Revised definition of and requirements for revitalization plans (see Section 4.2.1);
7. Revised preference for People with Disabilities to focus on individuals living on SSI (see Section 4.2.4);
8. Revised criteria for market studies and specifying penetration rate below 10% (see Section 4.3.1);
9. Excluding operating subsidies raised from project resources from consideration as a long term subsidy (see Section 4.5.3); and
10. Requiring a 90 day advance submission for waiver requests involving construction cost limits (see Section 5.0, Waivers).
Compliance Issues
After a closing on a project, developers of low income tax credit housing in Maryland often face difficult challenges in assuring that the physical building and the tenant income certifications comply with applicable low income tax credit regulations. In Maryland, as with several other states, compliance audits are performed by one organization, Spectrum Enterprises, for all projects in the state. We spoke with a representative from Spectrum about recurrent problem areas Spectrum’s property compliance officers encounter.
A major violation found in more than half the properties Spectrum reviews is that the building’s emergency lights do not operate correctly. Property managers tend to check these lights using the “test” button on the light, but often overlook whether the lights function if power is shut off to the emergency light circuit or to the building. This problem can usually be corrected by examining the wiring to the lights and making sure they were installed correctly. Occasionally, however, the correction is time consuming. A frequently found minor violation is that smoke alarms in a building’s public area and in the apartments are not functional or have been disabled. Often this is corrected as easily as by installing a battery (which has often been removed). Other minor violations that Spectrum sees with some frequency are leaking faucets and toilets. In general, although many of these problems can be addressed easily, active property management and inspection of the apartment units before Spectrum’s on site visit, notice of which Spectrum sends in advance to the property manager, can often lead to these problems being addressed before the inspection occurs.
In reviewing the tenant income certification files, another major violation Spectrum frequently encounters is a failure to obtain complete income information. Even if it is occasionally difficult for tenants whose wages may depend on tips or incentives, it is still important that there are no blanks left on the tenant income verification forms. Spectrum recognizes that tenants and property managers may find such paperwork tedious, and has some flexibility in how such forms are completed. But, blanks on the forms cannot be left unfilled. Another frequent area of non compliance is found in reviewing tenant income re-certifications. Re-certification must be completed annually in advance of the anniversary of the tenants’ move in date. This means beginning the re-certification process usually two to three months before the anniversary date. Finally, it is important that there are no administrative or typographical errors on a project’s form 8609. On at least a few occasions, especially for projects with year end construction completion dates, Spectrum has encountered a form 8609 which claims for tax credits in the year the building is completed, even though it is not rented until the following year. For example, a building is completed in 2003, and the first tenants occupy it in January 2004. This project’s form 8609 should claim for 2004 credits, and checking the box for 2003 credits is a mistake.
Spectrum recently changed its review process to communicate violations to property managers more quickly after an audit. Previously, all letters identifying initial audit violations were generated at the end of each calendar quarter to facilitate state agency review. Recently, Spectrum changed this procedure so that such letters of non-compliance to property managers are now attempted to be sent within two weeks after a property inspection. Spectrum anticipates this will improve a property’s chances of successfully correcting violations. If you would like further information or have specific questions about a property’s compliance issues, you are encouraged to speak with the local Maryland Spectrum representatives as well as those in Spectrum’s chief office in Maine.
|
|
