Rev. Rul. 79-300

ISSUE

Is the construction and operation of an apartment project for low and moderate income housing under section 236 of the National Housing Act an activity to which section 183 of the Internal Revenue Code applies?

FACTS

A limited partnership was organized to construct and operate an apartment project consisting of 300 units of low and moderate income housing. The apartment project is financed by the state Housing Development Authority under section 236 of the National Housing Act (the Act), as codified at 12 U.S.C. sections 1701, 1715Z-1, and as enacted by the Housing and Urban Development Act of 1968, 82 Stat. 476 (the Act of 1968), Pub. L. 90-448, 1968-2 C.B. 734, which subsidizes mortgage payments. This program is administered by the U.S. Department of Housing and Urban Development through the Federal Housing Administration.

Under section 236 of the Act, the state Housing Development Authority made a 20-year loan to the limited partnership for 90 percent of the project costs. Because the partnership must operate the project in accordance with such requirements with respect to tenant eligibility and rents as the Department of Housing and Urban Development may prescribe, the partners anticipate that little or no funds will be available for distribution and that the partnership will sustain losses for federal income tax purposes each year during the 20-year period. For example, Part 236 of Housing and Urban Development regulations provides at sec. 236.10(c) that the partnership shall be restricted as to distribution of income and shall be regulated as to rents, charges, rate of return, and methods of operation.

LAW AND ANALYSIS

Section 183(a) of the Code provides that in the case of an activity engaged in by an individual, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under Chapter One (Normal Taxes and Surtaxes) of the Code, except as provided by section 183.

Section 1.183-2(a) of the Income Tax Regulations provides that,

The determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the objective of making a profit.

Although section 183(a) of the Code refers to an activity engaged in by an individual, it also applies to the activities of a partnership. See Rev. Rul. 77-320, 1977-2 C.B. 78, which holds that the provisions of section 183 are applied at the partnership level and reflected in the partners' distributive shares.

Section 901 of the Act of 1968 "declares that it is the policy of the United States to encourage the widest possible participation by private enterprise in the provision of housing for low or moderate income families." Consequently, the Act of 1968 added section 236 to the National Housing Act and contemplated the formation of partnerships as the vehicle for the participation of private investors in undertakings for the provision of housing primarily for families of low or moderate income, pursuant to federal programs or otherwise.

The Senate Committee on Banking and Currency described the incentive of such a partnership to investors as follows:

The partnership arrangement makes it possible to assure an adequate return to investors. Under existing Internal Revenue Service regulations and rulings, partnership losses for tax purposes flow to the individual partners. In the case of new housing units financed on a 10-percent equity--90-percent debit basis, the annual accelerated depreciation of the building cost results in substantial book losses during the initial 10 years after the project is built. Assuming the member of the partnership is in relatively high income tax bracket, his share of the depreciation losses, plus cash income from project operations would provide an after-tax return on his investment which would compare favorably with the return which most industrial firms realize on their equity capital.

S. Rep. No. 1123, 90th Cong., 2d Sess. 85 (1968).

When section 183 of the Code was adopted in 1969, the Committee on Finance expressed its desire that this provision would be reasonably administered and stated that the Service should limit the disallowance of the deduction of losses under this provision to cases in which it is generally recognized that this is appropriate. S. Rep. No. 91-552, 91st Cong., 1st Sess. 103-104 (1969), 1969-3 C.B. 423, 490.

The above legislative history indicates that in limiting rental charges, Congress assumed deductions of tax losses would be allowed to encourage investment in projects providing decent housing for low or moderate income families under the Act. Consequently, application of section 183 of the Code to the present case would frustrate congressional intent in enacting the housing legislation. Therefore, section 183 will not be applied to disallow losses incurred in activities to provide low and moderate income housing under section 236 of the National Housing Act.

HOLDING

The construction and operation of an apartment project for low and moderate income housing under section 236 of the National Housing Act is not an activity to which section 183 of the Code applies. Consequently, the Service will not use the "not for profit" argument to deny related deductions under sections 162, 165, 167 and 212 of the Code.