Guidance Clears the Way for Some Stalled Recovery Act Projects

Published by Jeffrey T. Nishita on Saturday, May 1, 2010
Journal thumb May 2010

On March 17, 2010, the Internal Revenue Service (IRS) released greatly anticipated guidance regarding issues stemming from sections 1404 and 1602 of the American Recovery and Reinvestment Act of 2009 (Recovery Act). In Notice 2010-18 the IRS clarifies how a grant under Section 1602, otherwise known as the tax credit exchange program, is taken into account when calculating a state’s housing credit ceiling. It also discusses whether a subaward under Section 1602 is taxable to the recipient and if it decreases depreciable or eligible basis. This notice helps clear some of the major roadblocks that were holding up the closing of many Section 1602 projects.

Section 1602 created a program whereby states could exchange a portion of their 2009 low-income housing tax credit (LIHTC) allocations for federal government grants. In turn, the states are to distribute subawards from these grants to finance the construction or acquisition and rehabilitation of low-income buildings.

As the Recovery Act was being debated in Congress, the House of Representatives’ version of the bill specified that the grants should not be taxable income to the recipients and should not reduce the tax basis of the qualified low-income building financed by the Section 1602 funds. The Senate’s version of the bill mirrored the House’s version, but when the Recovery Act legislation was drafted, the taxability clause was left out of the final version and the word “tax” was left out of the clause regarding whether a subaward reduces the tax basis of a qualified building. In addition, there was no discussion on what “basis” meant. These omissions created considerable uncertainties for developers and investors and those thinking of syndicating losses from Section 1602 projects. In turn, projects were stalled even longer in an industry that was already experiencing a downturn.

In response to these concerns, the LIHTC Working Group sent a letter to the Treasury Department requesting timely clarification of the taxability and reduction of basis questions. The group suggested that Treasury provide guidance stating that due to the legislative history of the Recovery Act, the subawards should not be taxable, also adding that if the subawards were taxable, it would lower the effectiveness of the Section 1602 program and the impact the program would have on housing. With regard to the basis question, the group believed that when the House said that the subawards should not reduce the tax basis of a qualified low-income building, it meant both depreciable and eligible basis should not be reduced.  

In Notice 2010-18, Treasury confirmed the LIHTC Working Group’s positions using similar logic. “We are very excited to see this guidance released as it has been a year and a day since we originally addressed the problem with Treasury,” said Michael Morrison, a partner in the San Francisco office of Novogradac & Company LLP and co-founder of the LIHTC Working Group. “This notice confirms what we originally thought, and now, Section 1602 projects can proceed without this uncertainty hanging over them. In addition, accountants and attorneys are going to feel more comfortable advising clients on how to structure a 1602 project. This could also lead to structures where the losses are used by the developers or sold to help fill financing gaps.”  

The notice also provided additional guidance on how to take into consideration the Section 1602 grants when calculating a state’s housing credit ceiling. Any grant to a state housing credit agency needs to be converted to the credit equivalent before reducing the credit ceiling for any Section 1602 grant amount.

The notice reminds states that a cash grant needs to be divided by 8.5 to translate to the credit equivalent. The 8.5 stems from the maximum grant election amount of 85 percent of the sum of 100 percent of the state’s 2009 credit ceiling. That number is attributable to amounts described in Internal Revenue Code (IRC) sections 42(h)(3)(C)(i) and (iii) and 40 percent of the state’s 2009 credit ceiling that is attributable to amounts described in IRC sections 42(h)(3)(C)(ii) and (iv), multiplied by 10 for the 10-year credit period.

“We have been working with Treasury on clarifying many issues surrounding the American Recovery and Reinvestment Act of 2009, and it is nice to see the results of the group’s efforts,” said Michael Novogradac, managing partner in the San Francisco office of Novogradac & Company LLP and co-founder of the LIHTC Working Group. “Unfortunately, there is still an issue regarding the taxation of the subawards at the state level for states that do not automatically conform to federal tax law. We will continue working with the states to get this resolved as well.”

In addition to the state taxation issue, there are still additional questions concerning Section 1602 subawards. On July 30, 2009, the LIHTC Working Group sent another letter addressing Section 1602 recapture. In response, Treasury issued its revised Frequently Asked Questions and Answers on September 14, 2009, answering one of the group’s questions regarding how to calculate recapture for Section 1602. There are still a few more questions surrounding casualty losses, the disposition of a building during the compliance period and the applicable fraction during lease up that the Working Group is seeking to clarify and that need to be addressed.

Many in the industry have been waiting a long time for Treasury’s guidance surrounding the taxability and basis issues. By clarifying the largest issues for Section 1602 projects, Notice 2010-18 has cleared the path for developers to start closing their projects and to consider whether they can use the additional losses or should look to sell their losses to close financing gaps caused by the economic crisis. Although the major questions have been resolved, there are additional Recovery Act issues that need to be addressed, and the LIHTC Working Group will work to keep these issues at the forefront of Treasury’s agenda.

The LIHTC Working Group’s membership comprises a variety of  industry participants, including developers, syndicators, not–for-profits, lawyers, accountants and lenders. The group works to resolve technical and administrative LIHTC program issues. If you have an issue that can be better addressed by a group, join the LIHTC Working Group to get your issue in front of a larger audience and supported by an industry leader. For more information, visit www.lihtcworkinggroup.com or email Jeff Nishita at [email protected].