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Washington Wire: Thriving Through Tax Reform

Published by Michael J. Novogradac on Saturday, November 1, 2014

Journal cover November 2014   Download PDF

When the tax credit community broaches the topic of tax reform, the conversation is often focused on survival. But what if we look at tax reform as an opportunity to not only survive, but thrive? While the threat of tax reform still looms and the community development and affordable housing communities shouldn’t be complacent, tax reform legislation also may provide an opportunity to implement ideas to enhance tax credits that could make them even more successful. A few ideas for enhancement are described below.

Ideas to Enhance Multiple Credits
Some reforms could be made to the tax code that would enhance multiple tax credits’ economic and community benefits.

Eliminate Federal Taxation of State Income Tax Credits
Thirty-six states have active state historic tax credits (HTCs), 17 states have active state low-income housing tax credits (LIHTCs), 14 states have active new markets tax credits (NMTCs) and there are many active state-level renewable energy production tax credits (PTCs) and investment tax credits (ITCs).

Alone or combined with their federal counterparts, these state tax credits create a significant economic benefit. However, federal taxation of state tax credits diminishes their development value and economic impact. Eliminating federal taxation of state credits would put more dollars into affordable housing, community development, historic preservation and renewable energy developments, and allow them to serve more people, target resources to even deeper needs, and contribute more to local economies.

Eliminate Basis Adjustment for NMTC, HTC and ITC
Because the NMTC, HTC and ITC affect federal income tax basis of investors to differing extents, they are, in essence, “taxable” credits. If the tax code was reformed to eliminate the basis adjustment, it would increase the dollars investors are willing to invest for these credits, and ultimately increase the subsidy provided to community development, historic preservation and renewable energy developments and the communities they serve. Like removing federal taxation, the increased subsidies that would result from removing the basis adjustment would the NMTC, HTC and ITC reach lower-income communities, provide more community benefits and contribute more economic impact.

Ideas to Enhance the LIHTC
Perhaps in part because it is such a widely used and versatile tax credit, there’s a whole raft of ideas circulating concerning ways to enhance the LIHTC.

Set a Minimum 4 Percent LIHTC for Tax-Exempt Bond Financed Developments
In the past few years, the affordable housing community has advocated to establish a minimum 4 percent of volume cap LIHTC when it is used to acquire existing properties. As noted in previous columns, Congress may be poised to establish such a minimum along with the minimum 9 percent LIHTC in the postelection, “lame duck” session when tax extenders legislation will likely be considered.

If Congress establishes a minimum 4 percent for acquisition funded with volume cap credits, some advocates have suggested starting the push for a minimum 4 percent for LIHTC generated by tax-exempt bonds. The affordable housing community has hesitated pushing for expanding the minimum 4 percent in the past because of the much greater cost it would entail, but politically it would be much easier to advocate for such a minimum once Congress has established a precedent by adopting a minimum 4 percent LIHTC for volume cap acquisitions.

Having a minimum 4 percent for bond-generated LIHTC would make more preservation developments, especially Rental Assistance Demonstration conversion properties, financially feasible and reduce the pressure on 9 percent allocations for these developments. A minimum 4 percent rate floor would also increase affordable housing production financed by tax-exempt bonds. This could reverse the downward the trend in bond-financed rental housing since 2007. (For more information about this trend, see the Oct. 24 post at novogradac.wordpress.com.)

Encourage Income Mixing
In recent years, the Obama administration proposed various reforms to encourage income mixing at affordable rental housing developments. The goal of these proposals has basically been to allow LIHTC-supported developments to elect a criterion employing a restriction on average income.

For example, President Obama's proposed budget for fiscal year (FY) 2015 proposed creating a third income election, under which property owners could reserve at least 40 percent of units at an average of 60 percent of area median income (AMI), with a maximum of 80 percent AMI on initial certification. The average would be determined over the entire property, not on a building-by-building basis.

Encouraging income mixing would be especially helpful in high housing cost communities where residents earning between 60 and 80 percent AMI could help cross-subsidize the rent for residents earning below 40 percent AMI, low-income neighborhood revitalization, and rural areas where sparse populations and very low AMIs make it difficult to create financially feasible developments.

Under this particular proposal, residents in existing buildings whose income had risen over time above 60 percent AMI could be counted as below 60 percent for LIHTC income qualification purposes, which would assist preservation transactions. A key aspect to note about this reform is that the Office of Management and Budget (OMB) has estimated there would be no cost for implementing this change, but the Joint Committee on Taxation estimates that it would cost $125 million over 10 years.

Allow a 150 Percent Basis Boost for Extremely Low-Income Units
Under current law, LIHTC allocating agencies can provide a 130 percent boost to a property’s eligible basis if it is located in a HUD-defined difficult development area (DDA), qualified census tract (QCT), or to developments receiving volume cap LIHTC allocations if the allocating agency determines that it is needed for financial feasibility.

However, for developments serving extremely low-income (ELI) households (i.e., households with incomes at or below 30 percent of the area median income), it can be difficult to arrange financing even with such a basis boost. Many affordable housing studies have documented that the greatest affordable housing needs are for ELI households. Allowing state agencies to provide a 150 percent basis boost for units serving ELI households will make many more of those developments financial feasible and address this pressing national need.

Clarify Nonprofit Rights of First Refusal
Internal Revenue Code (IRC) Section 42(i)(7) affords qualified nonprofit entities a right of first refusal to purchase a LIHTC development through a bona fide third-party offer at a price equal to all outstanding indebtedness secured by the development plus associated exit taxes.

Nonprofits often want to invoke this right when they are the sponsor of a LIHTC property approaching the end of the 15-year compliance period, and such nonprofits would like to acquire and refinance it so that nonprofit can continue owning and operating the property over the extended use period. The formula price under the right of first refusal is often much lower than the fair market value, and nonprofits plan to use this advantageous price as well as any accumulated cash reserves at the property to help finance and maintain the property over the extended-use period.

However, the right of first refusal is sometimes contested, leading to complicated negotiations between limited partner investors and nonprofit general partner sponsors on exiting the partnership at year 15. Congress could clarify the first right of refusal to facilitate these transactions.

Clarify Ability to Claim LIHTCs during Rebuilding after a Casualty Loss
The Internal Revenue Service (IRS) defines a casualty loss as damage, destruction or loss of property from any sudden, unexpected or unusual event such as a flood, hurricane, typhoon, tornado, fire, earthquake or even volcanic eruption. Of these, property fires are the most common. As such, every LIHTC property faces the risk of tax credit loss and/or recapture because of casualty loss.

Currently, a LIHTC property that is not located in a federally declared disaster area is generally subject to tax credit loss during the period the qualified basis is being restored. Units damaged by a casualty event would lose LIHTCs if the units were not back in service by Dec. 31 in the year of the event, and recapture would occur if the repairs were not made within a reasonable period. The Internal Revenue Service has indicated that a reasonable period is generally a period not to exceed 25 months following the close of the month of the casualty loss.

Congress could help maintain stable finances for all LIHTC properties with casualty losses by extending the rules available to properties in federally declared disaster areas to those located outside them. Allowing LIHTCs to continue to be claimed when the property is being repaired will prevent properties from going into foreclosure.

Extending HERA-Enacted Program Enhancements For Bond Properties
The Housing and Economic Recovery Act of 2008 (HERA) enacted a number of LIHTC enhancements, but limited the application of some of these enhancements only to volume cap LIHTC allocations, not tax-exempt bond financed ones.

For example, as mentioned previously, the state agency discretion on providing 130 percent basis boosts is limited to developments receiving volume cap LIHTC allocations. Extending the basis boost to bond-financed properties if needed for financial feasibility would make more of those properties financially feasible.

Similarly, HERA allowed volume cap LIHTC-financed developments in rural areas as defined by section 520 of the Housing Act of 1949 to use the higher of local AMI or the national nonmetro median income as the income qualification standard. Extending this income qualification standard for bond-financed developments in rural areas where local AMIs are particularly low would make developments in those areas more financially feasible.

ConclusionAs you can see, years of innovation and market efficiency have generated a number of ideas about how these successful tax credits could be made even more so. And if the impending process of reforming the nation’s tax code provides the opportunity, the tax credit community would be wise to take that chance to support the enhancement of the LIHTC, NMTC, HTC and ITC. We also encourage you to share your ideas with us. Send us an email at [email protected] with your ideas.

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