Maximizing First Year Low-Income Housing Tax Credits
By Joseph Buckland, Senior Tax Manager, Sherbert CPA, PC joseph.buckland@sherbertcpa.com
Internal Revenue Code Section (IRC) 42 allows for a tax credit for the provision of low-income housing. The Low-Income Housing Tax Credit (LIHTC) is a 15-year credit, which is typically recognized over a 10–11-year period. The annual LIHTC for years 2 through 10 is the full year credit amount, however IRC Section 42(f)(2) discusses the special rules for the 1st year of the credit period and the disallowed 1st year LIHTC to be recognized in year 11. As part of these rules, a reduced applicable fraction based on the qualified lease up of the building must be calculated. Any LIHTC disallowed for year 1 under this reduced applicable fraction is pushed out and allowed in the first taxable year after the 10-year credit period, creating a year 11 credit.
Equity Adjusters:
Investors in a LIHTC project will generally include adjusters to their capital contributions based on timing and amount of credits received in the structuring of their investment in the project. Because investor equity pricing is often adjusted based on the amount of the first-year credits, it is imperative that a project maximize the amount of the first-year credits and reduce the deferred amount to year 11. The following are some tips to help a project maximize first year credits.
LIHTC Eligibility:
A building is eligible for LIHTC once it has been placed in service for a full month. For example, if a building is placed in service on June 1, then the building is first eligible for credits in the month of June. However, if a building were placed in service on June 2, the second day of the month, then the building does not become eligible for credits until the month of July (i.e. its first full month of being placed in service). This distinction is important since the applicable fraction is a proration based on months occupied over the full year. Knowing this, we recommend our clients to push to have buildings placed in service either late in the month or on the first day of the month. Buildings placed in service early in a month, but after the first day, lose nearly full month of eligibility.
Unit Occupancy:
Any unit occupied by a qualified tenant during the first eligible month, even if the unit were occupied on the last day of that month, is deemed to be qualified for the entire month. To magnify the importance of the placed in-service date and subsequently the first eligible month of credits consider situations from the two scenarios above. In scenario 1, a building is placed in service on June 1, and has a qualified tenant move in on June 30. That unit is deemed to be qualified occupied for the entire month of June. Whereas in scenario 2, the building is placed in service on June 2. The first eligible month for credits is July. Therefore, even if a qualified tenant were to occupy a unit on June 2, the unit still does not become qualified occupied until July.
Timing of Occupancy:
A sound strategy that may be employed is the timing of moving qualified tenants into the units. Many times, we see these tenants occupy the units on the first day of a month. During the period of initial lease up, the month of move in is key. In Scenario 1 above, if a qualified tenant occupies a unit on July 1, the unit will first become qualified for the month of July. If, however, that same tenant occupied the unit on June 30, one day earlier, the unit would first become qualified for the month of June. The result is that moving in a tenant one day earlier would add a month of qualification to the reduced applicable fraction and would assist in maximizing the first-year credit amount.
Conclusion:
Any of these measures can assist a low-income project with recognizing a higher amount of first-year credits and reducing the deferred amount of year 11 credits. With the increase in first-year credits, the project would likely be eligible to receive an increase in the tax credit equity due to the adjuster to investor equity.
Contact Us:
The Sherbert Group has developed procedures to analyze the first year LIHTC calculation, and we have experience looking for ways to maximize the allowable credit for the 1st year of the credit period. Please contact us if we can be of assistance with calculating your allowable credit for the 1st year of the LIHTC period.