IRS Notice 2022-05 Provides a Six-Month Extension to Lease LIHTC Units
Published by Thomas Stagg on Monday, January 24, 2022 - 12:00AM
Last week, the Internal Revenue Service (IRS) issued Notice 2022-05, which extended many of the provisions in Notice 2021-12 that provide temporary relief from certain low-income housing tax credit (LIHTC) requirements.
Similar to Notice 2021-12, Notice 2022-05 includes an extension of time for developments to complete lease up after the close of the first year of the credit period. Units leased by June 30 of the second year of a property’s compliance period can count towards a development’s first year qualified basis, which allows the development to avoid what is commonly referred to as 15-year credits.
The language in Notice 2022-05 is very precise in what it does and does not impact. The section in question is as follows:
E. EXTENSION TO SATISFY OCCUPANCY OBLIGATIONS If the close of the first year of the credit period with respect to a building is on or after April 1, 2020, and on or before December 31, 2022, then, for purposes of § 42(f)(3)(A)(ii), the qualified basis for the building for the first year of the credit period is calculated by taking into account any increase in the number of low-income units by the close of the 6-month period following the close of that first year.
The good news is that unlike Notice 2021-12, this notice is more forward looking in that it extends the benefit not only to developments that already missed their lease up deadline (i.e. 2021 developments), but also to developments that are leasing up in 2022. This allows owners to better plan ahead.
The most straight forward benefit of the provision is that it allows properties to include units leased through June 30 of the year following the first year of the credit period, (for calendar year tax payers) in the calculation of its end of the year qualified basis. For example, if a development’s first year of the credit period was 2021, a development could include in its Dec. 31 2021, qualified basis, all units leased through June 30, 2022. In addition, developments having lease up issues in 2022 will have until June 30, 2023, to lease up units and have them count towards the Dec. 31, 2022, qualified basis.
Typically, units initially leased after the close of the first year of the credit period would result in an increase in qualified basis, and therefore, 15-year credits. For example, if a building that was supposed to generate $1 million of credits was only 70% leased as of Dec. 31, 2020, typically it would either choose to defer the first year of the credit period or have 15-year credits equal to $200,000 per year.
However, under Notice 2022-05, if all units are leased by June 30, 2022, the Dec. 31, 2021, qualified basis would be 100%, and therefore, there would be no increase in qualified basis in future years. This would mean that the property would avoid 15-year credits.
This is good news for developments that were worried about having to choose to defer the first year of the credit period and potentially face a timing adjuster that would lower the equity for the development or take 15-year credits and face a potential credit shortfall adjustment that would also lower the equity for the development. The property is now able to avoid 15-year credits and still deliver some credits in 2020.
Impact to First-year Credits
The language in Notice 2022-05 clarified an ambiguous reference from Notice 2021-12, and makes it clear that this guidance only impacts the calculation of 15-year credits under Internal Revenue Code (IRC) Section 42(f)(3)(A)(ii). This is important as initially it was thought that the guidance under Notice 2022-05 may increase the amount of credits that can be claimed in the first year of the credit period. However, this reference limits the benefit to just eliminating 15-year credits.
In addition to avoiding 15-year credits, the development would also generate additional credits in the second year. When there is an increase in qualified basis after the first year of the credit period, not only is there typically 15-year credits, there is also typically partial year credit in the year the units are initially leased. Since the applicable fraction as of Dec. 31 of the first year of the credit includes these units, this guidance allows for units leased in the second year to avoid the first-year credit computation under IRC Section 42(f)(3)(B), and therefore, generate 100% of the credits in the second year, even though some of the units were not leased up until June of the second year. Under IRC 42(c)(1)(A)(i), the applicable fraction is determined as of the close of each taxable year with the exception being the first year, therefore, there is no loss of credits for the units leased up by June in the second year. Note, like all of the benefits discussed in this blog, it only applies to units leased up by June of the second year.
The following table illustrates the difference between credit calculations with or without Notice 2021-12. Note this calculation assumes that the December applicable fraction would be 100%.
Minimum Set-Aside Issues
If a property does not satisfy the minimum set-aside under IRC Section 42(g) at the close the first year of the credit period, it does not qualify for any credits. Unfortunately, this section of Notice 2022-05 does not provide any relief to properties that were not able to meet their minimum set-aside as of the close of the first year of the credit period. Notice 2022-05 is limited to Section 42(f)(3)(A)(ii) and the minimum set-aside is under Section 42(g). So, in order for a property to use this provision, it has to have met the minimum set-aside by the close of the first year of the credit period.
Deferring the First Year of the Credit Period
It is important to note that properties that were placed in service in an earlier year, but deferred the first year of the credit period, can still benefit from Notice 2022-05 as long as the first year of the credit period falls within the approved dates. The notice is applicable to properties, “if the close of the first year of the credit period with respect to a building is on or after April 1, 2020, and on or before June 30, 2022.” This means that if a building is placed in service, but the owner deferred the first year of the credit period to 2022, the building would still qualify for the relief in Notice 2022-05.
Impact to State Credits
It is important to note that this guidance is only extended to federal credits so the impact to state credits will vary based on how the state tax credits are calculated. If a state tax credit program conforms to all federal guidance, then this may benefit state credits as well.
Although this guidance doesn’t increase first-year tax credits, it can still be a valuable tool for property owners who do not want to defer the first year of the credit period. Typically, deferring the first year of the credit period results in a significant reduction in LIHTC equity. To get the maximum benefit from Notice 2022-05, all units need to be leased up by June 30. Contact a Novogradac professional to understand how this guidance affects your affordable housing property.