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| Tax Credit Investments and General Tax, Affordable Housing: Recent Developments |
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Client Alert: Costs of Dedicated Improvements Ruled Includable in Project's Eligible Basis
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8/7/2009
Authors: GEJ
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In Private Letter Ruling 200916007, released on April 17, 2009 (PLR), the IRS determined that a low income housing tax credit project owner could include in eligible basis (tax credit basis) the costs associated with certain infrastructure improvements required by the city that were dedicated to and maintained by the city. The improvements included two-lane local streets, curbs, sidewalks, storm water drainage, domestic water in-flow and utilities, including utility steel casings, wiring and installation fees (Infrastructure Improvements).
Prior to the PLR's issuance, the IRS's position was unclear as to whether or not dedicated improvements, such as the Infrastructure Improvements, could be included in a projects eligible basis. Tax credit investors were unwilling to accept the risk of recapture if the IRS excluded those costs from eligible basis.
While the PLR's ruling is directed only to the owner of the subject project and may not be used as precedent, the PLR provides additional comfort to project owners and developers that dedicated improvements are includable in their project’s eligible basis of residential buildings when such improvements are (i) required by a governing authority as a condition to the issuance of a building permit, certificate of occupancy or similar permit, (ii) necessary to provide residents with access to existing infrastructure, or otherwise benefit the project (iii) required to be produced based solely upon the characteristics of the residential buildings, (iv) required to be produced without regard to ancillary project improvements and (v) are immediately dedicated to the government authority upon completion.
The recipient of the PLR is the owner of a multi-building project receiving federal low-income housing tax credits. The project includes landscaping, a children's playground, a basketball court and other related land improvements (Ancillary Improvements). The project spreads across more than seven acres and the residential buildings are located more than six hundred feet from the nearest existing arterial street and infrastructure of Jerome.
The city’s code requires the project owner to construct the Infrastructure Improvements at the project owner's own cost, and to dedicate all streets to the use of the public upon completion of the Infrastructure Improvements. "Streets" in this case include all of the streets, curbs, sidewalks, storm water drainage, domestic water in-flow improvements and the utility steel casings within the streets. The city is withholding the project's certificates of occupancy until the project owner dedicates the required Infrastructure Improvements. Upon the dedication, the city will own and maintain the streets and the utility steel casings.
The city's requirements for the dimensions of the streets are based upon the characteristics of the residential buildings, without reference to the Ancillary Improvements. If the project expands, there would be more required street construction; if the project constricts, there would be less required street construction.
The IRS ruled that the project owner could include the cost of the Infrastructure Improvements in the project's eligible basis. Pursuant to Treasury regulations, a taxpayer must capitalize, as amounts paid to create an intangible, the amounts paid for real property if the taxpayer transfers ownership of the real property to another person and if the real property can reasonably be expected to produce significant economic benefits to the taxpayer after the transfer. Intangible costs are not includable in eligible basis. However, there is an exception to this rule for costs of "dedicated improvements," which are improvements to real property constructed by the taxpayer where the improvements benefit new development or expansion of existing development, are immediately transferred to a state or local government for dedication to the general public use, and are maintained by the state or local government.
In the PLR, the IRS determined that the Infrastructure Improvements were dedicated improvements subject to the exception described above, and thus were not required to be capitalized as amounts paid to create an intangible. Prior to the PLR's release, it was unclear as to whether the IRS would determine that improvements such as the Infrastructure Improvements were dedicated improvements, the costs of which are included in depreciable and eligible basis.
In the PLR, the IRS noted that the costs of constructing the Infrastructure Improvements are clearly allocable to the project owner's construction activities. The IRS then determined that under the specific identification method, all of the costs of constructing the Infrastructure Improvements were allocable to the project's residential rental buildings. In making this determination, the IRS found that there was a cause and effect or other reasonable relationship between the costs and the cost objective. The IRS considered the following facts in finding this reasonable relationship: (i) the Infrastructure Improvements were necessary to provide residents of the project access to existing streets and infrastructure of the city, (ii) the city required the taxpayer to construct the Infrastructure Improvements as a condition to the issuance of certificates of occupancy, (iii) the scope of the Infrastructure Improvements was determined by the characteristics of the project's buildings and (iv) the Ancillary Improvements had no effect on the requirement to construct, or the scope of, the Infrastructure Improvements.
Since the costs of the dedicated improvements were determined to be capitalized into the basis of the project's residential rental buildings, the IRS determined that such costs were also includable in the project's eligible basis for tax credit purposes.
Please note that a project owner's ability to include infrastructure costs in eligible basis will depend upon an analysis of all applicable IRS laws and Treasury regulations, based upon the unique facts and circumstances of each project.
If you have questions about the PLR or would like additional information, please contact one of our Tax Credit attorneys:
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