Sign Up For Novogradac Industry Alert Emails

Affordable Housing Industry Calls for Accounting Treatment Change for Tax Credit Investments

Published by Christina Apostolidis on Sunday, September 1, 2013

Journal cover September 2013   Download PDF

In April, the Financial Accounting Standards Board (FASB) issued an exposure draft of a proposed Accounting Standards Update of Topic 323, Investment – Equity Method and Joint Ventures. Comments were accepted until June 17. In a comment letter to the FASB, Muneera S. Carr, executive vice president and chief accounting officer of Comerica Inc. expressed the position of many investors and other stakeholders in the low-income housing tax credit (LIHTC) market. She wrote, “To the extent the principal risk related to compliance with tax code requirements is satisfied and the tax credits are available to the investor, we believe that net presentation of the results of investments in LIHTC as a component of income taxes is a far better reflection of the economics of these investments and will help users better understand the motivations and impact of such investments on the financial statements of the investing entity.”

Summary of Exposure Draft
The exposure draft was written in response to a majority vote by the Emerging Issues Task Force (EITF) in March 2013 whereby members agreed to draft a change of the current codification to allow for effective yield accounting for LIHTC investments when a guarantee is not provided. The update was the result of an industry request to revisit the guidance on accounting for investments in affordable housing properties that qualify for LIHTCs. Currently, among tax credit investments, the effective yield method only applies to the LIHTC, and only a small portion of the LIHTC investments meet the criteria to qualify for the effective yield method. As a result most investments in the LIHTC and other tax credit investment programs are accounted for under the equity method of accounting. The LIHTC community argues, however, that the presentation in the income statement of the pretax investment performance separately from the tax benefits distorts investment performance by reporting pretax losses on otherwise profitable investments and makes investment performance difficult to understand.

The amendments in the proposed update would permit reporting entities that invest in a qualified affordable housing project through a limited liability entity to elect to account for the investment using the effective yield method if all of the following conditions are met:

  1. It is probable that the tax credits allocable to the investor will be available.
  2. The investor retains no operational influence over the investment other than protective rights and substantially all of the projected benefits are from tax credits and other tax benefits (e.g., tax benefits generated from the operating losses of the investment).
  3. The investor’s projected yield based solely on the cash flows from the tax credits and other tax benefits is positive.
  4. The investor is a limited liability investor in the affordable housing development for both legal and tax purposes and the investor’s liability is limited to its capital investment.

For those investments in qualified affordable housing properties not accounted for using the effective yield method, the investment would be accounted for as an equity method investment or cost method investment in accordance with Subtopic 970-323. The decision to apply the effective yield method of accounting will continue to be an accounting policy decision rather than a decision to be applied to individual investments that qualify for use of the effective yield method.

A reporting entity would disclose information that enables users of its financial statements to understand the following:

  1. The nature of investments in qualified affordable housing projects, and
  2. The effect of the measurement of the investment in a qualified affordable housing project and the related tax credits on the financial position and results of operations of the reporting entity.

To meet these objectives, a reporting entity may consider disclosures such as the following:

  1. The amount of LIHTCs recognized during the year;
  2. For qualified affordable housing property investments accounted for using the equity method, the amount of investment income or loss included in pretax income;
  3. Whether the qualified affordable housing property is currently subject to any regulatory reviews and the status of such reviews (for example, investigations by the housing authority);
  4. Any commitments or contingent commitments (e.g., guarantees or commitments to provide additional capital contributions), including the amount of equity contributions that are contingent commitments related to qualified affordable housing project investments and the year or years in which contingent commitments are expected to be paid; and/or
  5. The amount and nature of the write-downs during the year resulting from the forfeiture or ineligibility of tax credits or other circumstances. These write-downs may be based on actual property-level foreclosures, loss of qualification due to occupancy levels, compliance issues with tax code provisions, or other issues.

The proposed updates to Subtopic 323-740 also included an update to the calculation of the effective yield method and internal rate of return to include to the amortization of other tax benefits in addition to tax credits.

Industry Comments
Overall, affordable housing stakeholders expressed support for and satisfaction with FASB’s decision to consider implementing a change that has been a concern for the industry for a number of years. Seventy-three responses, from investors, syndicators, developers, housing authorities, accounting firms and other industry leaders, were submitted to FASB in response to the proposed update.

The overwhelming response was positive regarding the provisions related to matching and the net presentation of the investment’s performance on an after-tax basis on the income taxes line of the income statement. The current accounting standards have limited the amount of investment dollars committed and have kept certain potential investors from investing in qualified affordable housing developments. However, limiting the accounting method to the effective yield method is not considered the most cost beneficial or preferred method. The effective yield method is complex and may require reevaluation based on operating results of the investment. The comments submitted recommended a ratable or proportional amortization method as an optional accounting method. The ratable or proportional method would amortize the cost of the investment based on the amount of tax credits received.

Although respondents agreed with the proposed amendments, many requested clarification. For example, some commenters suggested FASB provide language clarifying that an entity may invest directly or indirectly in qualified affordable housing properties. The update may be misinterpreted to apply only to direct investments. In addition, the condition that the investor retains “no operational influence” may also be unclear. Under provisions to the operating or limited partnership agreements the investor may have approval rights on certain elections for tax purposes, disbursements from operating reserves to cover operating deficits or loans from other partners. These rights are protective in nature and do not represent substantive investor participation in financial and operating decisions.

To avoid differences in interpretation, the wording in the proposed amendment should be modified to clarify the objective behind this condition. These rights are not significant and help ensure that the investors’ rate of return will be achieved and tax credits will continue to be generated and available. Allowing these protective rights and investor oversight has contributed to the success of the LIHTC program and low foreclosure rates. Affordable housing developments are also subject to oversight by the state housing agencies pursuant to Section 42, which governs the LIHTC. In addition, if a development receives other funding sources it may be subject to reviews by the respective agency. These regulatory reviews are routine and ensure compliance with program requirements so that the objective to provide safe, decent and affordable housing to the population that needs it most is met. The reviews often result in immaterial findings that do not affect the availability of the tax credits to the investor. The disclosure noted for consideration in the proposed update to report regulatory reviews and their status may lead to too much or confusing information.

Comments were also received from stakeholders in the new markets tax credit (NMTC), historic tax credit (HTC) and renewable energy tax credit (RETC) industries. Those comments noted that certain NMTC, HTC and RETC transactions meet the proposed conditions for the effective yield method and have similar attributes to LIHTC investments. As such, many commenters suggest that the effective yield treatment (or proportional amortization method) should not be limited to qualified affordable housing investments. Moreover, they noted that the proposed updates will provide for consistent accounting reporting and more useful decision making information to readers of financial statements. To that end, the comments suggest that if the proposed updates are not extended to tax credit investments similar to the LIHTC, financial statements may lack consistency.

Stay Tuned
Discussion on this topic, formally known as Issue No. 13-B, “Accounting for Investments in Tax Credits,” is slated for the Sept. 13, 2013 EITF meeting. The affordable housing community awaits the outcome of the meeting and the resulting final amendments to Accounting Standards Codification Subtopic 323-740 Investments – Equity Method and Joint Ventures – Income Taxes. Changes in accounting for tax credit investments will be significant and could encourage investment and expand the investor pool.

Learn more about Novogradac's expertise and many services