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On January 8, 2010 at the Maryland Affordable Housing Coalition annual meeting, Gallagher lawyers presented a summary of the notable changes affecting the affordable housing industry in 2009. Below are the highlights that we described.
I. Federal Highlights
American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA), Public Law 111-5, was signed into law, creating many new sources of funding for affordable housing. A summary of all the programs established by ARRA is beyond the scope of this memo, but we discuss the most helpful programs to the development of affordable housing below.
Section 1602 Exchange Funds
Under Section 1602 of ARRA, state housing credit agencies may return to the Secretary of Treasury a portion of their low-income housing tax credit ceiling in exchange for a grant from the Secretary. State housing credit agencies then use these funds to make subawards (which may be either in the form of a grant or a non-interest bearing forgivable loan) to the owners of projects that are eligible for low-income housing tax credits (LIHTC), which subawards cannot exceed 85% of the project’s eligible basis (taking into account any 130% basis boost). Projects in which a state agency has more than a 1% ownership interest are ineligible for exchange funds. These subawards must be made to owners by December 31, 2010, but funds may be disbursed after 2010 as long as (1) the subaward is made by December 31, 2010, (2) the project owner has paid or incurred at least 30% of the project’s reasonably expected aggregate adjusted basis in land and depreciable property by December 31, 2010, and (3) the entire subaward is disbursed to the project owner by December 31, 2011. The subawards will not result in taxable income to the project owners for federal income tax purposes.
A project receiving exchange funds must comply with many LIHTC rules: the project is subject to the same 2-year placed in service deadline and 15-year compliance period as an LIHTC project and the project owner must enter into an extended use agreement. A project receiving Section 1602 exchange funds is subject to recapture if the percentage of low-income occupied units in the project falls below the greater of (1) the percentage of Section 1602 exchange funds that comprise the eligible basis of the project (the Section 1602 Percentage) or (2) the minimum set-aside elected for the project. However, if the Section 1602 Percentage is higher than the applicable fraction required by the extended use agreement, there instead is a recapture event if the applicable fraction of the project falls below the greater of (1) the applicable fraction required by the extended use agreement or (2) the minimum set-aside selected by the project owner. The recapture amount is equal to 100 percent of the subaward amount less 1/15 of the subaward amount for each year of compliance before the noncompliance event. Click here for a Q&A regarding Section 1602 grants issued in September 2009.
Tax Credit Assistance Program
ARRA also established the Tax Credit Assistance Program (TCAP) to provide additional funding to projects, including bond-financed projects, that received an “award” of LIHTCs (to be defined by each state housing credit agency) between October 1, 2006 and September 30, 2009. The program is administered by the state housing credit agencies, which must give priority to projects that are expected to be completed by February 16, 2012. Although the TCAP funds are appropriated under the HOME program, most HOME requirements do not apply. TCAP funds may be used for any LIHTC basis-eligible costs except for swimming pools. Projects receiving TCAP assistance are subject to the same tenant income, rent and compliance monitoring restrictions as are required for projects receiving LIHTCs.
TCAP funds may be provided as grants or loans, at the election of each state housing credit agency. However, all state housing credit agencies must meet three deadlines: (1) commit at least 75% of the TCAP grant by February 16, 2010, (2) demonstrate that all project owners have expended 75% of the TCAP funds by February 16, 2011, and (3) expend the entire TCAP grant by February 16, 2012. Any project receiving TCAP funding is subject to environmental review under the National Environmental Policy Act prior to the commitment of TCAP funds to the project. Thus, once a project owner applies for TCAP funds, the project owner cannot engage in any “choice-limiting” activity before the successful completion of the NEPA review. A “choice-limiting” activity includes any activity that will result in a physical change to the project and/or acquisition of the project, including leasing and disposition of real property. Further, projects with construction costs in excess of $2,000 receiving TCAP funding are required to pay Davis-Bacon prevailing wages. In the event that a project fails to comply with TCAP requirements, the state agency must seek specific performance from the project owner. Click here for the most recent HUD notice on the TCAP program.
Recovery Zone Economic Development Bonds
ARRA authorizes “recovery zone economic development bonds” (RZEDBs), a new type of taxable government bond. RZEDBs must be used for capital expenditures paid or incurred with respect to government-owned property located in a recovery zone (defined below) and public infrastructure that promotes economic activity in a recovery zone. Thus, while RZEDBs cannot be used to fund construction of affordable housing or any type of privately-owned property, they could be used to finance necessary infrastructure improvements. In order for RZEDBs to be issued, a local government must designate the area to be part of a “recovery zone,” which must have significant poverty, unemployment, home foreclosure rates or general distress, be economically distressed due to military base closure or realignment, or be designated as an empowerment zone or renewal community. RZEDBs must be issued by December 31, 2010. Although RZEDBs are taxable bonds, the issuer receives a direct federal subsidy of 45% on the bond interest, which allows issuers to offer an attractive rate of interest on the bonds.
Build America Bonds
Unlike RZEDBs, Build America Bonds (BABs) can be used to finance government-owned affordable housing projects. BABs offer flexibility to an issuer, as the issuer can elect to have the BABs treated either as taxable tax credit bonds, in which case the bondholder receives a tax credit equal to 35% of the interest paid on the bonds, or as tax-exempt bonds, in which case the issuer receives payments from the Treasury Department equal to 35% of the interest payments on the bonds (assuming all available bond proceeds, except those used to fund a reasonable reserve, are used for capital expenditures). The tax credit paid to the bondholder can be decoupled from the bond and transferred, and the credit can be carried forward to future taxable years if it cannot be utilized in the year of receipt. BABs must be issued after February 16, 2009 and by December 31, 2010.
Green HUD-Assisted Housing
This program, administered by HUD’s Office of Affordable Housing Preservation, permits grants or loans for energy retrofit and green investments for projects receiving Section 8 project-based assistance, HUD Section 202 funds or HUD section 811 funds. Funds must be expended within 2 years of receipt.
Grants in lieu of Energy Tax Credits
Section 1603 of ARRA permits solar, fuel cell, geothermal, wind, hydro and biomass facilities (including the expansion of existing facilities) to qualify for a grant in lieu of the energy tax credits available under Code Section 45 (the production tax credit) [All references to the Code are to the Internal Revenue Code of 1986, as amended] and Code Section 48 (the investment tax credit). In most cases, the grant is equal to 30% of eligible cost basis, although grants relating to microturbine, combined heat and power and geothermal heat pump facilities and to geothermal facilities described in Code Section 48 are only equal to 10% of eligible cost basis. Facilities owned in part, directly or indirectly, including through a pass-through entity, by a federal, state or local government, a tax-exempt organization under Code Section 501(c) or a qualified issuer of clean renewable energy bonds under Code Section 54(j)(4) are ineligible for Section 1603 grants, although such ineligible entities are permitted to own an interest in the facilities through a taxable C corporation. The original use of the facility must begin with the applicant/owner, and either (1) the facility must be placed in service in 2009 or 2010 or (2) construction of the facility must have begun in 2009 or 2010 and the facility must be placed in service prior to January 1, 2013, 2014 or 2017, depending on the type of facility. In order to apply for the grant, significant physical work must have begun on the facility.
There is a five-year recapture period for Section 1603 grants, with the amount of recapture declining each year by 20%. Selling or otherwise disposing of the facility to a person who would have qualified to receive the Section 1603 grant does not cause recapture as long as the facility continues to qualify as eligible property and the purchaser agrees to be jointly liable with the original owner for any recapture. Also, temporary cessation of energy production will not cause recapture as long as the owner intended to resume production when the energy production ceased. Section 1603 grants do not result in income to the applicant, although the basis of the energy facility is reduced by 50% of the payment. However, absent any authority to the contrary, Section 1603 grants should be federal grants for purposes of Section 42, so eligible basis for LIHTC purposes would be reduced by 100% of the Section 1603 grant.
Status of Legislative Efforts to Continue Certain ARRA Provisions
On December 9, 2009, the House of Representatives passed the Tax Extenders Act of 2009, H.R. 4213. The bill would extend for one year both the Section 1602 exchange program created by ARRA and the new markets tax credit program. The Senate referred the legislation to the Senate Finance Committee on December 10, 2009, and the bill has not yet been reported out of committee.
Use of Master Lease Structures in HUD-Financed Projects
A new HUD policy permits a project with a master lease structure to receive HUD financing under the Section 220, 221(d)(4) and 231 mortgage insurance programs. See HUD Notice 09-18 (Oct. 19, 2009). Master leases are commonly used in new markets tax credit and historic tax credit deals. Under prior HUD policy, the owner/mortgagor was required to be a single asset entity and to operate the project subject to a HUD regulatory agreement. This policy in effect prohibited master leases because, in a master lease structure, the master tenant, not the owner, operates the project. For projects that can take advantage of HUD financing under the Section 220, 221(d)(4) and 231 mortgage insurance programs, the new policy offers some flexibility in structuring deals with new markets and historic tax credits. However, some hurdles remain: HUD headquarters approval is required and will be granted on a case-by-case basis, HUD limits payments of cash at the master tenant level, and HUD will have the option to terminate the master lease if the HUD-insured mortgage is assigned to HUD, which could be problematic for syndication of the credits. HUD will, however, provide certain limited notice and cure rights to the master tenant prior to the assignment of the HUD-insured mortgage to HUD.
Treatment of Multi-Building Project as One Building
In three private letter rulings, PLRs 200947004 and 200947005 (Nov. 20, 2009) and PLR 200949019 (Dec. 4, 2009), the IRS concluded that separate buildings could be treated as one building for purposes of both depreciation under Code Section 1250 and the residential rental property test under Code Section 168(e)(2) (a project that is residential rental property is ineligible for new markets tax credits but is eligible for LIHTCs). In the project covered by two of the rulings, two of the existing buildings to be renovated were contiguous; the third was separated from the other two buildings by a public street, although that building was connected to one of the two contiguous buildings by a skywalk running across the street. In the project covered by the third ruling, two of the buildings were connected by a breezeway and the third building, while located on a contiguous parcel, was not connected to the other buildings. In each ruling, the IRS held that the buildings discussed in the ruling were a “single integrated unit” and, therefore, the buildings could be treated as one single building for purposes of depreciation and the residential rental property test. In so ruling, the IRS noted the following facts: (1) in the project discussed in two of the rulings, the skywalk and connections between the two contiguous buildings permitted the seamless movement of tenants and equipment among the buildings, and, in the project covered by the third ruling, a breezeway connected two of the three buildings, (2) one of the buildings housed equipment or amenities used by tenants in other buildings in the project, (3) the buildings would be renovated and placed in service within the same one-year period, (4) the buildings will be financed as one project by an overall plan of financing, (5) the buildings will be managed as one project by one management agent, and (6) the buildings will be treated as one project for accounting and tax reporting purposes.
Dedicated Improvements Includable in Eligible Basis
The IRS has clarified that the costs associated with certain city-required infrastructure improvements that were dedicated to and maintained by the city can be included in LIHTC eligible basis. See PLR 200916007 (Apr. 17, 2009). The project owner in the ruling was required as a condition to receiving certificates of occupancy for the project to construct and dedicate to the city certain improvements, including a playground, two-lane local streets, curbs, sidewalks, storm water drainage, domestic water in-flow and utilities, including utility steel casings, wirings and installation fees. The ruling provides additional comfort that these types of improvements are includable in eligible basis when: (i) the improvements are 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 constructed based solely upon the characteristics of the residential buildings, (iv) required to be constructed without regard to ancillary project improvements, and (v) are immediately dedicated to the governmental authority upon completion.
Updated 8823 Guide
In October 2009, The IRS issued a revised Guide for Completing Form 8823 Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition, which took into account changes made to Code Section 42 by the Housing Assistance Tax Act of 2008, revisions to HUD Handbook 4250.3 and revisions to the utility allowance regulations. The revised Guide makes several other key changes. The IRS takes new positions with respect to existing tenants in a LIHTC project that receives a new LIHTC allocation: existing tenants who were income-qualified when they moved into the project remain income-qualified even though the project receives new credits. Further, if the project receives additional LIHTCs related to the rehabilitation of the project but the ownership remains the same, then, subject to the vacant unit rule, vacant units that had been occupied by income-qualified tenants continue to be low-income units as long as the units are suitable for occupancy. If there was a change in ownership, however, such vacant units must re-qualify as low-income units. The revised Guide also adds a new exception to the full-time student rule for students previously in foster care programs. In addition, the Guide clarifies that maximum allowable rents must be calculated on both an annual and a monthly basis, and that, if a unit is out of compliance with the rent limits for one month, the unit is deemed to be out of compliance for the remainder of the owner’s tax year. Finally, the owner of a 100% low-income building need not complete annual tenant income certifications, although the state credit agency may still require such certifications as a condition of project financing and the state credit agency always must review the initial tenant certifications if annual tenant certifications are not being performed.
II. Maryland Highlights
Maryland Statute Exempts ARRA Exchange Funds from Maryland State Taxation
Section 24 of the Maryland Budget Reconciliation and Financing Act of 2009, House Bill 101 (Chapter 487, Acts of 2009), provides that Maryland’s automatic decoupling provisions do not apply to any change included in ARRA. Thus, grants under Sections 1602 and 1603 of ARRA, which are not taken into recipient’s income for federal income tax purposes, are not taken into income for Maryland state income tax purposes.
Multifamily Energy Efficiency and Housing Affordability Program
The Maryland Department of Housing and Community Development (DHCD) entered into a Memorandum of Understanding with the Maryland Energy Administration to provide $9.5 million of grants to fund the purchase and installation of energy efficiency and renewable energy improvements in and energy audits for affordable multifamily rental housing developments. Developments with existing income or rent restrictions or housing with units that serve low to moderate income tenants, as determined by DHCD, are eligible for funding under DHCD’s Multifamily Energy Efficiency and Housing Affordability Program (MEEHA). MEEHA grants must be fully expended by April 2012 and are capped at $500,000 per project, or $2,500 per unit, although project owners may seek a waiver if the project involves the installation of renewable energy technologies. Projects that have received or are in the pipeline to receive DHCD rental housing financing are given priority for a MEEHA grant award. To the extent that MEEHA grants are made to the project owner and are used to fund project costs, the MEEHA grants should be federal funds and should be removed from LIHTC eligible basis. However, if the MEEHA grant is used solely for energy audit costs, the MEEHA grant should not reduce LIHTC eligible basis.
Affordable Housing
Gallagher has been involved in cutting-edge affordable housing transactions for 40 years, serving as counsel for developers, syndicators, and investors in more than 1,000 low-income housing tax credit projects nationwide. Gallagher also assists clients with compliance and property management issues. Click here for more information on our firm and our affordable housing practice or contact any one of the lawyers below:
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