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Acquisition / Rehabilitation Credits
Basics
• To be eligible, an existing building must be purchased with adherence to the related party and 10 year rules and be substantially rehabilitated
• Rehabilitation must be completed in 24 months• Rehabilitation scope must be the greater of $6,600 per unit (2015) or
20% of the adjusted basis of the building (The amount is indexed yearly for inflation)
• Can place the rehabilitation in service any month after you reach the minimum rehabilitated
• In most cases, two 8609s will be issued for each building identification number (BIN), one for the cost of acquiring the existing building (4% credit) and a second one for the rehab of the building (9% credit)
Key terms to calculate the credit
• There are four components to calculate the credit: Qualified low income building Applicable fraction Credit percentage Eligible basis
Applicable fraction
IRC §42(c)(1)(B) – Applicable Fraction (“low income occupancy percentage”): the smaller of the unit fraction or the floor space fraction
Credit percentage
• The low-income housing credit percentage is equal to (per §42(a)):• The applicable percentages which yield over a 10-year period
amounts of credit that have a present value equal to: 70 percent of the qualified basis for new buildings (and rehab) 30 percent of the qualified basis for certain other buildings (federally subsidized
or an existing building)
• Credit allocations made before January 1, 2014, and that are not federally subsidized for the tax year can utilize the fixed 9% credit percentage
• There continues to be ongoing support in Congress to fix the credit rates at 9% and 4%
Eligible basis
• Costs incurred to develop low income property, from date construction starts until ready to be placed in service
• Determined as of the end of the first year of credit period• Costs needs to be depreciable, thus cannot include:
Land, land acquisition costs, land preparation costs Costs to obtain permanent financing Interest and other costs (taxes and insurance) attributable to units
placed in service, or costs to acquire land Costs to obtain tax credits or investor capital Reserves
Eligible basis – acquisition / rehabilitation
• Allocate the purchase price among the different classifications of the fixed asset components: Land, Building, Other Property As a reminder, land is not depreciable and thus is not used to calculate the
credit Most states require an appraisal for both the purchase price and value of
land If the purchase price includes cash reserves or other assets, this needs to be
considered in the allocation Predevelopment cost incurred by the seller and included in the purchase
should also be analyzed If some property (i.e. Appliances) will be replaced in the rehabilitation
consider whether they have value when allocating purchase price
Eligible basis – acquisition / rehabilitation
• Interest Costs should be included in eligible basis to the extent it finances construction
of property Target calculation of interest incurred in a acquisition / rehabilitation
development to capture:• Interest to acquire the building• Interest on construction for offline units• Avoided interest
• Loan Costs Costs to obtain permanent financing are not includable in basis Target calculation of loan costs required when construction financing and
permanent financing is one convertible loan or provided by the same lender
Eligible basis – acquisition / rehabilitation
• Developer Fee Allocate developer fee between acquisition and rehabilitation cost
buckets Difference between acquisition and rehabilitation credit rates and the
basis boost incentivizes developers to allocate more to the rehabilitation cost bucket
Most states provide guidance as to the minimum amount of developer fee allocable to the acquisition cost bucket
Basic calculation
Acquisition Rehabilitation Eligible Basis 2,500,000 2,900,000 High Cost Area 130%Adjusted Eligible Basis 2,500,000 3,770,000 Applicable Fraction (100%) 100% 100%Qualified Basis 2,500,000 3,770,000 Applicable Credit Percentage 3.19% 7.44%Credits Per Year 79,750 280,488
Total Credits (10 years) 797,500 2,804,880
Calculating the credit
• In the case of acquisition / rehabilitation credits, the two are “married.” Therefore, you cannot begin taking any credits until the rehabilitation of the building is complete.
• §42(f)(5)(A) says that in general, the credit period for an existing building shall not begin before the 1st taxable year of the credit period for rehabilitation expenditures with respect to the building.
• If certain criteria are met regarding the certification of tenants, when the rehab is complete you can “pull-back” or “tack back” the credits to begin as of the acquisition date (or the beginning of the year if the rehab is completed in a later year than the building was acquired).
Initial year calculation
The calculation for the first year of credits is completed on a monthly basis:
• §42(f)(2)(A)(i) – The first year credit calculation begins with the first full month in which the property is in service and the occupancy for each month is determined as of the last day of the month
• §42(g)(3)(A) - Minimum set-aside must be satisfied by the end of the first year of the credit period for the building
• When does a unit start to count as “low-income qualified?” In service for a full month Must be initially leased to a low-income qualified household at the proper rent
level as of the last day of the month
Initial year calculation - excess basis
• When the actual qualified basis exceeds the maximum qualified basis, the difference is commonly referred to as “excess basis” Any development can have excess basis
• Timing of fixed 9% rate legislation creates a lot of excess basis as developments were not underwritten using the 9% rate
• Additional costs are more common on the rehabilitation portion of acquisition / rehabilitation projects
• Basis boost not needed to support credit award (qualified census tract, difficult to develop area, or designated by state housing credit agency)
Creates opportunity to accelerate credit delivery in first year
Sample calculation - excess basis
Building Acqu Rehab Acqu Rehab# OF CREDIT QUALIFIED UNITS*FOR CURRENT YEAR January 5 5 4 4 February 5 5 March 5 5 April May 4 4 June 5 5 4 4 July 5 5 4 4 August 5 5 4 4 September 5 5 4 4 October 5 5 4 4 November 5 5 4 4 December 5 5 4 4 (A) TOTAL 50 50 36 36 (B) # of Units in Building 5 5 4 4 (C) B X 12 60 60 48 48 (D) A/C** 0.8333 0.8333 0.7500 0.7500
(E) max credit per 8609 1,125 6,750 938 7,200(F) total bldg basis 30,000 95,000 25,000 85,000
(G) eligible basis (F)X(D) 25,000 79,167 18,750 63,750(H) Credit % 3.75% 9.00% 3.75% 9.00%(I) credit calc (G)X(cr%) 938 7,125 703 5,738
lesser of (I) or (E) 938 6,750 703 5,738Credits using basis from 8609s 938 5,625 703 5,400Additional first year credits - 1,125 - 338
Sample IRR- credit delivery
Sample IRR- credit delivery using excess basis
10 year hold rule
• A building that was placed in service on or before July 30, 2008, satisfies the 10 year hold requirement if at least 10 years have elapsed between the date of its acquisition by the taxpayer and the later of The date on which the building was last placed in service or The date of the most recent nonqualified substantial improvements
• The Housing Act of 2008 eliminated the nonqualified substantial improvement test for building placed in service after July 30, 2008
10 year hold rule
• In determining when a building was last placed in service, all transfers are considered the date of the last placed in service date with the exception of five specifically defined transfers; These excepted transfers are for carryover basis transactions, devises or
inheritances, not for profit acquisitions, purchase money debt foreclosure, and owner-occupied use.
• Effective July 30, 2008, buildings that are substantially assisted by the federal or state government are not subject to the 10 year hold rule.
• Prior to July 30, 2008, taxpayer could apply to the Treasury Department for a waiver of a 10 year hold rule with respect to federally assisted buildings.
10 year hold rule exception
• There is an exception to the 10 year rule for property acquired by a governmental unit or qualified non-profit organization Under this exception, the placement in service by a governmental unit
or nonprofit organization is not counted in calculating the 10 year hold requirement
This exception applies only if the acquisition of the property by the non-profit organization itself satisfies the 10 year hold requirement and the income earned by the property is exempt from federal tax
Related party rule
• To be eligible acquisition credits, the seller and the buyer must not be related parties for tax purposes.
• The seller can be a “related party” to the purchaser if the seller or a partner of the seller is a partner in the purchaser partnership. In that case, the rights and obligations under the partnership
agreements must be evaluated to determine that a transfer of at least a 50% economic interest in the partnership has occurred
Partnerships are often structured to include incentive management fees and disposition fees to avoid related party rule issues
