LIHTC Syndicator Advocates for Guidance on Nine Issues

Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2021-28)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C.20044

Re: Notice 2021-28 Recommendations for 2021-2022 Priority Guidance Plan

Ladies and Gentlemen:

We are writing in response to Notice 2021-28, in which the Service invited public comment on items that should be included on the 2021-2022 Priority Guidance Plan.

Enterprise is a national nonprofit organization that creates opportunity for low- and moderate-income people through affordable housing in diverse, thriving communities. Since its inception in 1982, Enterprise has introduced neighborhood solutions through public-private partnerships with financial institutions, governments, community organizations and others that share our vision. Enterprise has raised and invested $61.5 billion in equity, grants and loans to help build or preserve approximately 793,000 affordable rental and for-sale homes to create vital communities. As a key part of our affordable housing finance work, Enterprise is a leading national syndicator of Low-Income Housing Tax Credits (LIHTC).

In December 2020, Enterprise, along with others in the affordable housing industry, submitted comments on Reg. 119890-18 Regarding Low Income Housing Tax Credit Average Income Test Regulations. Without final regulations, the Average Income Set-Aside will have very limited use due to both investor and developer concerns. Since these comments were submitted previously and since we know the IRS is considering final guidance, we have not included it in the list below. However, we have attached a copy of our previously submitted letter.

Below, we have outlined nine guidance issues that we believe impact many transactions and propose solutions that we believe would result in the credit working more efficiently and being more effective. Please note that all of these were submitted in prior years, but we believe that these issues continue to be important and should be considered in the plan. In some cases, we have noted additional authority supporting our position.

The issues for which we are requesting guidance are listed below:

1. Inclusion of Bond Issuance Costs in Eligible Basis: We would like the Internal Revenue Service to reconsider the rule that bond issuance costs, including those associated with construction period bonds, cannot be included in basis.

• TAM 200043015, issued on October 27, 2000, (the “TAM”) concludes that Bond Issuance Costs cannot be capitalized and included in eligible basis since they are not subject to depreciation, but are amortizable costs. However, this is not the case. While these costs are amortizable, pursuant to Internal Revenue Code (“IRC”) Section 263A, a portion of the amortization would then be capitalized and depreciable under IRC Section 168. Therefore, to the extent these costs would ultimately be depreciable, they would also be includible in eligible basis.

• IRC Section 42(d)(1) provides that the eligible basis of a building is its adjusted basis at the close of the first taxable year of the credit period.

• Generally, costs incurred in obtaining a loan are capitalized and amortized over the life of the loan. IRC Section 263A provides that indirect costs allocable to the production of real or tangible property are to be capitalized into the basis of the produced property. Property is “produced” by a taxpayer if it is constructed, built, installed, manufactured, developed, or improved by the taxpayer. The direct costs of such property and “such property's proper share of those indirect cost (including taxes), part of all of which are allocable to such property” must be capitalized. Therefore, IRC Section 263A requires the capitalization of direct costs and an allocable portion of indirect costs.

• Such allocable costs would include points and other financing costs associated with a loan used entirely or in part for construction or rehabilitation of the project, as well as interest incurred during the construction or rehabilitation of the project. If a project uses funding other than tax-exempt bonds, the owner would capitalize these costs pursuant to IRC Section 263A.

• In many cases, owners use tax-exempt bonds to fund the construction or rehabilitation of the project. In some cases, the bonds are completely paid off at or soon after completion of the project and in other cases, a portion of the bonds are paid off at or near completion of the project, with the balance remaining outstanding for a longer period of time.

• To the extent that these costs are amortizable, the amortization associated with the construction or rehabilitation period would be capitalized under IRC Section 263A.

• IRC Section 263A does not provide for different treatment for projects funded by tax-exempt sources. In those cases where the bond is a source of construction financing, the points and other costs of the bonds should be treated as an allocable cost and the portion relating to the construction and rehabilitation of the project should be capitalized into the basis of the building, pursuant to IRC Section 263A.

• The TAM concludes that these costs cannot be included in basis because the legislative history to IRC Section 142 provides that bond issuance costs cannot be paid from the 95% portion of the issue and therefore does not qualify as residential property. This was only intended to cover the sources of funding and not to characterize the costs. These rules do not preclude the owner from incurring these costs, but limit how much of these costs may be paid from bond proceeds. In fact, the owner can utilize up to 2% of the bond proceeds to pay for bond issuance costs. The owner would be responsible for payment of any amount in excess of the 2%, using sources other than bond proceeds, such as equity or other financing sources.

• To the extent that these costs are incurred, the treatment would be governed by IRC Section 263A. IRC Section 142 does not address the character of the costs that can and cannot be funded using bond proceeds.

• Had Congress intended to exclude bond issuance costs from eligible basis, that would have been incorporated into IRC Section 42. For example, IRC Section 42(d)(5) states that costs funded by federal grants are excluded from eligible basis. If Congress had wanted to excluded costs that would otherwise be included in depreciable basis, an exclusion similar to this would have been included. Since there is no such provision, there is no indication of congressional intent to exclude bond issuance costs that would otherwise be included in basis.

• We request that the Internal Revenue Service reconsider its current position on the treatment of bond issuance costs and follow the rules prescribed by IRC Section 263A.

2. Loss of Low Income Housing Tax Credits upon a Casualty Loss: We would like the Internal Revenue Service to reconsider its position that credits are not allowed for a year to the extent that the building or units are not available for occupancy on December 31^st of that year, due to a casualty loss that is not part of a presidentially declared disaster area, even though the owner is in the process of a timely restoration of the damaged units or building.

• IRC Section 42(j)(4) states that there should be no tax credit recapture resulting from a reduction in qualified basis by reason of a casualty loss to the extent that such loss is restored by reconstruction or replacement within a reasonable period established by the Secretary.

• In Revenue Procedure 2007-54, which superseded Revenue Procedure 95-28, the IRS stated that the owner of a building that is beyond the first year of the credit period has suffered a reduction in qualified basis that would cause it to be subject to a recapture or loss of credit will not be subject to recapture or loss of credit if the building's qualified basis is restored within a reasonable period. However, the Revenue Procedure addressed this relief to casualties that resulted from a disaster that caused the President to issue a major disaster declaration since that was the general topic of the Revenue Procedure and it did not address casualty losses that did not result from such disasters

• In CCA 200134006 and CCA 200913012, the Chief Counsel to the Internal Revenue Service stated that the ability of the owner to claim credits on units while out of service is limited to those casualties resulting from a presidentially-declared disaster and is not appropriate for a casualty that resulted from some other cause, such as a fire experienced by a specific project, stating that the exception in Revenue Procedure 95-28 was limited to that. The reasoning for allowing credits for properties that are part of a major disaster area and not for projects outside of disaster areas is stated as “Such an event is quite distinct from the general loss situation confronting property owners.” However, it is not that distinct. In both situations, some sort of involuntary event has resulted in damage to the property. In both cases, the owner is motivated to restore the property in a reasonable time. While there are more widespread needs in a presidentially-declared disaster area that may lengthen the reasonable time to restore, there are also more resources deployed to those areas that can help accommodate the restoration in a reasonable period of time. In fact, a project that continues to occupy unaffected units or buildings while restoring damaged ones presents its own challenges. If the IRS felt it was appropriate to allow credits to continue following a casualty in a presidentially declared disaster area, the same should be allowed in a casualty situation that is outside a disaster area.

• For a casualty loss incurred outside of a presidentially-declared disaster area, while recapture does not result if the building or units are restored within a reasonable period of time, if not restored by the end of the year, pursuant to CCA 200134006, no credits are allowed for that year. Although credits would resume for the year in which the project is returned to service, these are credits that the owner would have been entitled to had the casualty not occurred. Credits would be lost for any year in which the units are not returned to service by the end of the year, regardless of when the casualty occurred, and these credits are not made up later, as in the 11th year, so it is a permanent loss of credits. This result is somewhat punitive to an owner who suffered a loss through no fault of its own, despite acting prudently to restore the unit or building in a reasonable period.

• The distinction provided in CCA 200134006 was based on Revenue Procedure 95-28, which only provided relief in the form of the ability to claim credits during the replacement period if the property was in a location being designated as a major disaster area. However, that distinction is inappropriate. The Revenue Procedure was only dealing with such disaster areas, which is why relief was only given to such an area. It did not preclude a project that suffered a casualty outside a disaster area from claiming credits during the replacement period since that was not covered in the Revenue Procedure.

• Once placed in service, credits should continue to be allowed as long as the owner continues to operate the building as qualified housing. A temporary removal from service after a casualty occurs should not prevent the owner from claiming credits. This is supported by the depreciation rules. Income Tax Regulation 1.167(a)-10(b) states that depreciation “shall end when the asset is retired from service.” Reg. 1.167(a)-8(a) defines a retirement as “the permanent withdrawal of depreciable property from use in the trade or business or in the projection of income.” IRS Publication 946 provides that taxpayers should continue to claim a deduction for depreciation on property used in their business or for the production of income even if it is temporarily idle. There are numerous cases that support the concept that depreciation would be allowable during periods when the property is unusable, as long as the intent is to return it to service.

• Although IRC Section 42(j)(4) states that there should be no tax credit recapture resulting from a reduction in qualified basis by reason of a casualty loss to the extent that such loss is restored within a reasonable time, this section only deals with recapture and does not deal with the ability to continue to claim credits. In the General Explanation of the Tax Reform Act of 1986, it states that “In the year of a recapture event, no credit is allowable for the taxpayer subject to recapture.” It then goes on to say that “A reduction in qualified basis by reason of a casualty loss is not a recapture event provided such property is restored by reconstruction or replacement within a reasonable period of time.” This indicates that the intent was that the project be considered to remain in compliance if restored.

• We request that the Service clarify that there is no recapture and no loss of the ability to claim housing credits during a reasonable restoration period following the casualty loss, provided that the building is restored within a reasonable time as determined by the state housing credit agency, but not to exceed 25 months from the date of the casualty loss.

3. Continued qualification of over-income tenants covered by an extended use agreement after a transfer of project: We would like the Internal Revenue Service to issue formal guidance that would state that any household determined to be income qualified at the time of move-in for purpose of the extended use agreement is a qualified household for any subsequent allocation of IRC Section 42 or allowable through the issuance of tax-exempt bonds pursuant to IRC Section 42(h)(4). This guidance would formalize the IRS position to align with the informal guidance provided by the Guide for Completing For 8823 Low Income Housing Credit Agencies Report of Noncompliance or Building Disposition.

• In the Guide for Completing Form 8823 Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition (Revised January 2011) (“The Guide”) the Internal Revenue states that “any household determined to be income qualified at the time of move-in for purposes of the extended use agreement is a qualified low-income household for any subsequent allocation of IRC §42.” (p. 4-27)

• This is a reasonable position since these tenants may not be evicted without cause and relocation of the tenants will be very costly and inefficient.

• Rev. Proc. 2003-82 provides a safe harbor that will allow an owner to treat a unit occupied by a tenant whose income exceeds the maximum qualified income as qualified if “The unit has been a low-income unit under §42(i)(3)(B), (C), (D), and (E) from either the date the existing building was acquired by the taxpayer or the date the individuals started occupying the unit, whichever is later, to the beginning of the first taxable year of the building's credit period. Further, the safe harbor provided by the Revenue Procedure provides that in order for the unit to be qualified, “The individuals occupying the units have incomes that are at or below the applicable income limitation under 42(d)(4)(B)(i) on either the date the existing building was acquired by the taxpayer or the date the individuals started occupying the unit, whichever is later.”

• The Revenue Procedure does not state that there would be a different result if an extended use agreement were in effect at the time of the transfer. However, since the purpose of the Rev. Proc. was to provide a safe harbor that would allow tenants to qualify in some situations, it presumably was not intended to cover all situations.

• Although The Guide does not have the standing of official guidance from the Office of the Chief Counsel, state agencies and developers rely on it. However, because it is not official guidance, investors and their counsel are reluctant to rely upon it and, in some cases, it forces the owner to relocate tenants that, according to the Service (as stated in The Guide) may not be necessary. This results in additional costs to the owner and displacement of the tenants.

• We request that the Internal Revenue Service issue formal guidance that would be consistent with The Guide.

4. Definition of federally- or state-assisted building for purposes of qualification for exception from ten year rule requirements for the acquisition credit: We would like the Internal Revenue to issue formal guidance on the minimum requirements that a project would need to meet in order to be deemed “a federally- or state-assisted building, which would allow the building to be exempt from the requirement that there be a period of at least ten years between the date the building is being acquired by the taxpayer and the date the building was last placed in service by the previous owner. Although the legislation that created this exception was enacted in 2008, the legislation did not define what was required to meet this exception. Without formal guidance, there is uncertainty as to what qualifies and investors are unwilling to accept the risk of claiming a credit that later could be disallowed. In order to achieve the purpose of this exception, it is important to provide guidance on what is required to meet the exception.

• The Housing and Economic Recovery Act of 2008 (“HERA”) expanded the exceptions from the ten year rule to include federally- or State-Assisted Buildings. HERA defined a federally-assisted building to be “any building which is substantially assisted, financed, or operated under section 8 of the United States Housing Act of 1937, section 221(d)(3), 221(d)(4), or 236 of the National Housing Act, section 515 of the Housing Act of 1949, or any other housing program administered by the Department of Housing and Urban Development or by the Rural Housing Service of the Department of Agriculture.” HERA defined a state-assisted building as a building “which is substantially assisted, financed, or operated under any State law similar in purpose to any of the laws” described under the federal definition.

• While HERA provided a broad list of the programs that qualified a building for the exception, they did not define “substantially assisted”. HERA did not say what portion of the project needed to be financed by subsidized funds or what portion of the units needed to be subsidized in order for the project to be “substantially assisted.” In addition, HERA did not clearly state if the subsidy had to be in place before the acquisition of the project and if so, for how long, or if the subsidy could be put in place at the time of the acquisition.

• Without a definition or guidance of “substantially assisted”, taxpayers are unsure whether a building qualifies, and investors are reluctant to invest in these credits due to the uncertainty.

• We request that the Internal Revenue Service provide guidance as to what would be deemed substantially federally subsidized. Without such guidance, the purpose of creating this exception to the ten-year rule will not be achieved. We request that the guidance provide that a project that has at least 20% of the project costs financed by federal or state debt or at least 20% of the units have a rent subsidy, then the project be considered “substantially assisted”. In addition, we request that the guidance provide that if the subsidy as described above is in place or committed to the project at the time of the acquisition, the project would qualify even if the project was not subsidized before the acquisition.

5. Requirements for a scattered site project: We would like to Internal Revenue Service to issue formal guidance that states that to be a scattered site project, all units in the project need to be rent restricted, but are not required to be occupied by families who meet the applicable income limitations. This is consistent with IRC Section 42(g)(7), but differs from the guidance provided in the Audit Technique Guide, which requires that all units be low-income units, which implies they must be occupied by families with incomes at or below the tax credit limits.

• Section 42(g)(7) provides the following for “Scattered Site Projects”: “Buildings which would (but for their lack of proximity) be treated as a project for purposes of this section shall be so treated if all of the dwelling units in each of the buildings are rent-restricted (within the meaning of paragraph [42(g)](2)) residential rental units.”

• Section 42(g)(2)(A) provides that “For purposes of paragraph [42(g)](1), a residential unit is rent-restricted if the gross rent with respect to such unit does not exceed 30 percent of the imputed income limitation applicable to such unit. . . .”

• We note that the IRS Section 42 Audit Technique Guide (“the Audit Guide”) is not consistent on whether all units need to be only rent-restricted or whether all units also need to be Low-Income Units. The Audit Guide discusses the requirements for multi-building projects to be one project in three places. The Audit Guide language relating to the rental of units is listed below.

  • In Chapter 1 the Audit Guide states “two or more qualified low-income buildings can be included in a project only if the buildings: are located on the same tract of land (including contiguous parcels), unless all of the dwelling units in all the buildings are rent-restricted.”

  • In Chapter 4, the Audit Guide states “two or more qualified low-income buildings can be included in a project only if the buildings are located on the same tract of land, unless all the units in all the "scattered site" buildings to be included in the project are low-income units.”

  • In the definitional Section of the Audit Guide in Chapter 9, it states “Project, Scattered Site: Buildings which would, but for their lack of proximity, be treated as a project shall be treated as a project if all the dwelling units in all the buildings are rent-restricted residential rental units. IRC §42(g)(7).”

  • In order to be a “Low-Income Unit”, a unit must be both (1) rent-restricted and (2) occupied by individuals meeting the income limitations under Section 42(g)(1) (“Income Restricted”). The clear wording of Section 42(g)(7) is that units need to be rent-restricted. Nothing in Section 42(g)(7) states that all units need to be Low-Income Units or Income Restricted. Therefore, assuming all of the units will be rent-restricted and the minimum set-aside is satisfied, we believe that the rental of some units to over-income tenants should not cause the Project to fail to be considered a single project for purposes of Section 42. Congress could have drafted Section 42(g)(7) using the defined term “Low-Income Unit” and that would have imposed the additional requirement of all units being Income Restricted. But importantly Congress did not use such language.

• In two of the three places in the Audit Guide, the requirement is correctly stated that units only need to be rent-restricted. In Chapter 4 it says that all units need to be Low-Income Units. We note that an Audit Guide is just the IRS interpretation of the law, and that the plain language in a statute passed by Congress would supersede any such interpretation. Furthermore, the Audit Guide is not even internally consistent in stating the requirements.

• We request that the Internal Revenue Service issue formal guidance that is consistent with the statute and eliminate the confusion caused by the statements in the Audit Guide.

6. Inclusion of Relocation Costs associated with a rehabilitation in eligible basis: We would like the Internal Revenue Service to reconsider its position that the costs of relocating tenants in order to facilitate the rehabilitation of a building not be includable in eligible basis.

• IRC Section 42(d) states that the eligible basis of a new building is it adjusted basis at the close of the 1st taxable year of the credit period. IRC Section 42 (e) states that a rehabilitation expenditures paid or incurred by the taxpayer with respect to any building shall be treated as a separate new building. It goes on to define rehabilitation expenditures as amounts chargeable to a capital account and incurred for property subject to the allowance for depreciation in connection with the rehabilitation of a building. Under IRC Section 263A, a taxpayer shall capitalize all direct and certain indirect costs properly allocable to real and personal property produced by the taxpayer.

• The costs incurred to relocate tenants during the rehabilitation of a building are incurred solely to facilitate the rehabilitation. IRC Section 263A would require that these costs be capitalized and would preclude a deduction for these costs. We agree that costs of relocating tenants in order to demolish a building should not be included in eligible basis, nor should the cost of relocating tenants because they are over-income or otherwise a suitable tenant. However, if the relocation costs are incurred in order to allow for the rehabilitation of the building, it should be capitalized as part of the rehabilitation basis.

• Currently, the “Audit Technique Guide Section 42 Low Income Housing Credit” dated September 2014 states that such costs are not to be capitalized, but should be expensed under IRC§162. However, because this cost in solely incurred in connection with the rehabilitation of the property, the cost would not be deductible under IRC §162 and would be required to be capitalized as depreciable basis pursuant to IRC§ 263A. To the extent that these costs would be capitalized pursuant to Internal Revenue Code Sec. 263A, these costs should also be included in eligible basis.

• We request that the Internal Revenue Service issue formal guidance clarifying this rule and follow the rules prescribed by IRC Section 263A.

7. Planned Foreclosures: We would like the Internal Revenue Service to issue formal guidance on what would characterize an acquisition is part of an arrangement to terminate those the restrictions imposed by the extended use agreement and is not a legitimate foreclosure, and the procedures by which this determination would be made.

• IRC Section 42(h)(6)(A) states that “No credit shall be allowed unless an extended low-income housing commitment is in effect. IRC Section 42(h)(6)(D) states that the extended use period would end on the later of the date specified by the Agency or the date that is 15 years after the close of the compliance period. IRC Section 42(h)(6)(E) provides an exception that would apply in the event of a foreclosure, “unless the Secretary determines that such acquisition is part of an arrangement with the taxpayer a purpose of which is to terminate such (extended use) period.”

• The purpose of the extended use agreement is to preserve the affordability and availability of the housing to low-income tenants. By not having guidelines and a process, there is no control over whether foreclosures are appropriate or whether they are being done in order to terminate that restrictions on the property.

• We request that the IRS provide formal guidance that would allow the state housing credit agencies to review a proposed foreclosure and determine that its purpose was not to terminate the extended use agreement. In addition, we request that the guidance require that the owner or successor of the property provide at least 60 days written notice to the state housing credit agency of its intention to terminate the restrictions provided by the extended use agreement.

8. Loss of Tax Credit for Erroneous Overcharging of Rent: We request formal guidance that would provide that an inadvertent de minimus overcharge in rent would not cause a loss or recapture of LIHTC credits.

• Per IRC Section 42, for a unit to be qualified, rents may exceed 30% of the applicable rent limitation. Occasionally, an owner inadvertently overcharges a tenant, but upon realizing the overcharge, refunds the amount to the tenant. The calculation of rental amounts and utility allowances is complicated and errors can occur, but if the amount is refunded, the owner has not benefitted from the overcharged amount.

• Imposing a loss and recapture of credit resulting from a foreseeable error that has actually been fixed would add unreasonable risk to an investor and would be punitive in nature. In addition, if the credits are lost or recaptured, the owners would not be motivated to refund the overpayment as quickly or at all, thus hurting the tenants.

• We request that formal guidance be provided that would allow a prompt correction of the over-charged rents without a loss of credit or recapture of credits.

9. Non-Profit Right of First Refusal: IRC Section 42(i)(7) states that no tax benefits would be lost if a tenant, qualified nonprofit organization, 501(c)(4) organization or governmental agency had the right of first refusal to buy a building after the end of the compliance period for a price that is no less than the building's debt plus exit taxes. While this can be a substantial benefit to a housing non-profit and a way to preserve affordable housing, there is some confusion how this right can be exercised.

• We request that the Service provide formal guidance that (1) the right of first refusal apply to an acquisition of the property or of a partnership interest; (2) that the property that can be acquired using the right of first refusal include all assets associated with the development, operation and maintenance of the project, including reserves; (3) that the right of first refusal may be exercised in response to any offer to purchase the property, including from a related party; and (4) exercise of the right of first refusal does not require approval by the investor.

We appreciate the opportunity to present our recommendations on items that should be included in the 2021-2022 Priority Guidance Plan. We believe that these changes will improve the use of the tax credits to provide affordable housing that is needed in this country. Thank you in advance for your consideration of these suggestions. If you have any questions about any of the items described above, please feel free to contact me at 410-772-2539 or swilson@enterprisecommunity.com.

Very truly yours,

B. Susan Wilson
Vice President
Enterprise Housing Credit Investments, LLC
Columbia, MD

Attachment

cc:
Marian McFadden, Senior Vice President, Public Police, Enterprise Community Partners