The Housing and Economic Recovery Act of 2008 (2008 Act) made many changes to the low-income-housing tax credit provisions. This alert discusses particular changes that should have a significant impact on the preservation and rehabilitation of existing properties, especially those benefiting from HUD or RHS assistance, as well as similar state programs.
To understand the new rules, it’s a good idea to start with the prior tax rules. Under the law before the 2008 Act, two important rules applied to existing buildings.
First, the acquisition portion of the low-income-housing credit was not allowed for existing buildings unless there was a period of at least 10 years between the date of acquisition and the date the building was last placed in service (the 10-year rule). An exception to the 10-year rule applied to certain federally assisted buildings. For these purposes, a federally assisted building was a building substantially assisted, financed, or operated under Section 8 of the United States Housing Act of 1937; Section 221(d)(3) or 236 of the National Housing Act; or Section 515 of the Housing Act of 1949. To take advantage of this exception, a waiver had to be obtained from the Internal Revenue Service in the form of a letter ruling.
Second, the building must not have been previously placed in service by a “related party” of the purchaser. For this purpose, the definition of related party was taken from sections 267(b) and 707(b)(1) of the Internal Revenue Code, but using a tougher “more than 10 percent” threshold instead of the “more than 50 percent” standard that otherwise applied in these sections. Thus, under this second test, if the buyer and seller had as little as 11-percent capital or profits interest common partners, the acquisition was ineligible for the acquisition credit.
The 2008 Act makes important changes to these rules.
First, the new law eliminates the waiver provision for federally assisted buildings and replaces it with a new exception that exempts from the 10-year rule (without need for a ruling) any building that is “substantially assisted, financed, or operated” under (i) Section 8 of the United States Housing Act of 1937, Section 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 the Rural Housing Service of the Department of Agriculture; or (ii) any state law “similar in purposes” to the foregoing federal laws.
In addition, the 2008 Act increased the more-than-10-percent related-party threshold to more than 50 percent. Thus, the buying and selling partnerships can be far more related than used to be the case.
This increased flexibility, both with respect to the range of programs eligible for exemption from the 10-year rule and the definition of related parties, combined with the elimination of the lengthy private-letter ruling process needed to obtain a waiver under prior law, makes the acquisition of federally or state-assisted buildings far easier and also more attractive to developers who would like to retain an interest in a partnership acquiring the property.
Of course, these new provisions raise fresh tax questions that call for IRS guidance. For example, it is unclear how the term “substantially assisted” should be interpreted, or what it will take for a state law to be “similar” to the federal ones described in the new exemption from the 10-year rule. We will be closely following any clarification from the Internal Revenue Service and Treasury Department.