End-of-Year Tax Planning for LIHTC Properties

Published by Justin Chubb Lurya on Tuesday, August 4, 2020
Journal Cover Thumb August 2020

With less than half of 2020 remaining, it is time to set sights on year-end and start thinking about tax-planning strategies.

Outlined below are some items for owners of low-income housing tax credit (LIHTC) properties to consider as 2021 approaches.

Amended Tax Returns

The Internal Revenue Service (IRS) recently issued Revenue Procedure 2020-23, allowing eligible partnerships the option to file amended tax returns for tax years beginning in 2018 and 2019, and issue amended K-1s to their partners. Under this option, returns may be amended to account for changes brought about by the Coronavirus Aid, Relief and Economic Security (CARES) Act, and any other tax attributes to which the partnership is entitled. In order to take advantage of this, a partnership must file its amended return and provide amended K-1s to its partners before Sept. 30, 2020. As explained in the following section, this creates a small window of opportunity for LIHTC partnerships that were unable to claim credits in 2018 or 2019 because Forms 8609 had not been issued by the tax return due date to amend their returns to claim credits and for partners to report the credits in their 2018 or 2019 tax returns instead of having to report the credits in their tax returns for year 2020 or later.

Administrative Adjustment Request

LIHTC partnerships that are unable to file amended returns by Sept. 30, 2020, may need to file an Administrative Adjustment Request (AAR). The Bipartisan Budget Act of 2015 (BBA) repealed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and created a new centralized partnership audit regime effective for tax years beginning after Dec. 31, 2017. This resulted in a change to how partnership tax returns are amended that impacts many LIHTC partnerships.

Under TEFRA, a LIHTC partnership had the ability to amend its tax return and provide amended K-1s to its partners. However, partnerships that are subject to the new rules, referred to as BBA partnerships, are prohibited from amending information required to be furnished to their partners after the due date of the partnership’s tax return. Instead, a BBA partnership must file an AAR and provide Form 8986 to its partners. Partners receiving Form 8986 must then account for the adjustment on their tax return filed for the year the Form 8986 is issued.

BBA partnerships having adjustments to their 2018 or 2019 tax attributes arise subsequent to Sept. 30, 2020, will need to file an AAR. In order to ensure that the partners are able to claim the benefits of any adjustments on their 2020 tax returns, these AARs must be filed and Forms 8986 issued before year-end in order to ensure that the partners are able to claim the benefits of any adjustments on their 2020 tax returns. Otherwise, AARs filed after year-end will result in the adjustment being accounted for in 2021.

Electing Real Property Trade or Business

Tax reform legislation passed at the end of 2017, included a provision that limits the amount of business interest expense that can be deducted to 30 percent of adjusted taxable income (ATI). LIHTC partnerships can avoid this limitation by electing to be treated as a real property trade or business (RPTOB). However, in exchange they must depreciate real property using the alternative depreciation system, resulting in diminished depreciation deductions. The RPTOB election is a one-time election; it is irrevocable once it is made, but it can always be deferred to a later year. As 2020 comes to a close, LIHTC partnerships that did not make the RPTOB election on their 2018 or 2019 returns should assess whether or not it will be advantageous to make the election on their 2020 return.

Under the CARES Act, business interest deduction limitation has been temporarily changed, and as a result, LIHTC partnerships that have already made the RPTOB election will also need to revisit this analysis. For 2020, the amount of business interest expense that partnerships can deduct is increased to 50 percent of ATI. Additionally, taxpayers can elect to use their 2019 ATI to calculate their 2020 limitation. Under Revenue Procedure 2020-22, the IRS granted taxpayers the option to withdraw an earlier RPTOB election by filing an amended return or AAR. LIHTC partnerships that made the RPTOB election on a previously filed return should therefore assess whether or not it would be advantageous to withdraw the election, and receive the benefit of accelerated depreciation deductions, in light of this increased interest expense deductibility.

Bonus Depreciation

Under Internal Revenue Code (IRC) Section 168, taxpayers can deduct 100 percent of the depreciable basis of qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Qualified property is defined as property with a recovery period of 20 years or less. If qualified property is expected to be placed into service near the end of 2020, taxpayers should take measures to ensure that it is in service before year-end in order to take advantage of the accelerated deduction.

In order to maximize bonus depreciation, LIHTC property owners can obtain cost segregation studies. These are performed by a consultant or tax professional who analyzes the components of a given property for the purposes of determining the appropriate classes and applicable recovery periods. Cost segregation studies often result in the identification of qualified property that otherwise would be grouped with assets having a longer recovery period, allowing the property owner to benefit from increased depreciation deductions.

Casualty Loss

Casualty losses, resulting from unexpected or unusual events such as fires or floods, can render some or all of the units in a LIHTC property uninhabitable. When this occurs, the property owner must repair the damage within a reasonable period in order to avoid loss or recapture of tax credits. IRC Section 42 defines qualified basis of a building for any taxable year as an amount equal to the applicable fraction (determined as of the close of the taxable year) of the eligible basis of the building. If a damaged unit is not repaired by year-end, then it will not be included in qualified basis and will not generate any credits for the entire year. Owners of LIHTC properties damaged by casualty loss should therefore work diligently to ensure that all units are repaired and placed back in service before the end of the year.

Tenant Lease-Up

There are two important items to consider during the initial lease-up of a LIHTC property: meeting the minimum set-aside and maximizing first-year tax credits.

The first-year tax credit is based on the average applicable fraction, calculated by taking the applicable fraction at the close of each month of the first year of the credit period. As more units are leased to qualified tenants, the applicable fraction increases. Leasing up units sooner serves to maximize first-year tax credits. Furthermore, units that are not leased up by the close of the first year of the credit period could trigger what is known as “two-thirds” or “15-year” credits, meaning that those units will generate a lower amount of credits on an annual basis than they would had they been leased up by Dec. 31. It is therefore extremely important for buildings that are placed in service during 2020 to have all units leased up by year-end.

In addition to maximizing first-year tax credits, LIHTC property owners should consider that a building must meet its elected minimum set-aside in order to claim any amount of tax credits for a given year. This requires that a designated percentage of the residential units in a property must be both rent-restricted and occupied by households whose incomes do not exceed a designated limitation. Owners of LIHTC properties that are placed in service during 2020 should ensure that they are meeting their minimum set-aside by year-end in order to start claiming credits. Similarly, owners of existing LIHTC properties that were placed in service before 2020 will need to ensure that they continue to meet their minimum set-aside by year-end in order to continue claiming credits.

It is beneficial to start planning well in advance of year-end in order to maximize time allowed to implement any strategies. The planning considerations discussed here do not constitute an exhaustive list. LIHTC property owners should consult with their tax professionals to ensure that they are getting the most out of their investments.