IRC section 42(h)(6)(A) provides that a building owner must agree to a long-term commitment to the low-income housing program for a building to be eligible for the low-income housing tax credit. This rule applies to post-1989 tax years and is one of the requirements which must be met for a building owner to claim the credit. The term
"extended use period" means the period beginning on the first day in the compliance period on which such building is part of a qualified low-income housing project, and ending on the later of: 1) the date specified by such agency in such agreement with the building owner or 2) the date which is 15 years after the close of the initial 15-year compliance period.
This extended low-income housing commitment is a required agreement between the building owner and the state housing agency, and, per IRC section 42(h)(6)(B), is to consist of the following elements:
1. The agreement must include a requirement which establishes an applicable fraction which will apply to the entire extended use period. Failure to maintain this
low-income participation level will be deemed an issue of noncompliance. With respect to the low-income tenants included in this applicable fraction if the extended use agreement terminates under IRC section 42(h)(6)(E)(I), two additional requirements are imposed on the building owner for the 3-year period following termination:
a. no eviction or termination of a lease can occur for any reason other than "good cause"; and
b. the gross rent of low-income units cannot be increased unless otherwise permitted under IRC section 42.
2. A requirement must be included which allows qualifying tenants (past, present or future) the right to enforce the guidelines provided by restriction (1) above in any state court.
3. It must be stated in the agreement that no partial dispositions of the building will be allowable. Full dispositions, however, are permissible.
4. A requirement must be included which states that the building owner cannot refuse to lease to section 8 (of the United States Housing Act of 1937) tenants merely because the tenants are section 8 tenants.
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5. It must also be stated that this agreement will be binding on all subsequent owners of the property.
6. This agreement must be recorded as a restrictive covenant attached to the property under state law.
If it is determined during a taxable year that an extended-use agreement was not effective as of the beginning of that year, then the owner has one year from the date of the determination to correct any failure or the credit is disallowed for that year and any prior year.
Rules are provided for certain instances in which an extended use agreement will terminate before the extended use period is over. Specifically, termination can occur on the following three occasions:
1. Foreclosure: An extended use period will terminate on the date the building is acquired by foreclosure (or instrument in lieu of foreclosure). Nevertheless, a foreclosure arranged by the building owner (with the purpose to effect a
termination of the agreement) will not terminate the extended use commitment.
See IRC section 42(h)(6)(E)(I)(I).
2. Qualified Contract: In addition, the extended use period will terminate if the allocating agency is unable to present to the owner a qualified contract from a buyer who will continue to operate the building as a qualified low-income building.
The building owner is provided an opportunity, after the 14th year of the compliance period, to make a written request to the applicable state housing agency to find a buyer who is willing to step into the shoes of the owner with regard to the project. The date this request is submitted starts a one-year clock running during which the state housing agency will attempt to secure a "qualified contract" for the acquisition of the low-income portion of the building by a buyer who is willing to operate it as a qualified project. If, on the last day of this one-year period, the state housing agency has not presented the building owner with a qualified contract, the extended-use period for the building will be considered terminated.
The qualified contract is defined as any bona fide contract to acquire the non low-income portion of the building for fair market value, and acquire the
low-income portion for an amount not less than the applicable fraction of the sum of:
* the outstanding indebtedness related to the building,
* the "adjusted investor equity" in the building, plus
* the amount of any other capital contributions, reduced by any cash
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distributions made or available to be made from the project.
The term "adjusted investor equity" is defined by the Code as the aggregate amount of cash taxpayers invested with respect to the project plus an amount reflecting any appropriate cost of living adjustments (not to exceed 5 percent per year).
3. An extended use agreement’s terms may also be terminated or suspended after the compliance period when a tenant exercises a right of first refusal to purchase the low-income building under IRC section 42(I)(7). See Rev. Rul. 95-49, 1995-2 C.B. 7.
The drafting of the extended low-income housing commitment also has significance in that this document specifies the amount of credit appropriate to be allocated to a building. This allocation amount, as provided in IRC section 42(h)(6)(C), may not exceed that amount of credit necessary to support the applicable fraction indicated in the agreement.
The examiner should note that the Code does provide for an amendment to the extended use agreement in the case of an increase to the qualified basis of a building after the first year of the credit period. The document reflects this as an increased applicable fraction.
AUDIT TECHNIQUES
Item 2(f) of the Information Document Request (IDR) asks the taxpayer to provide a copy of the restrictive covenant discussed above. Given the importance of the
existence of this agreement, as well as the specific items agreed to for this period, it is important that the examiner review this covenant.
Because the extended low-income housing commitments became a requirement for credit allocations after 1989, the issue of any terminations based on a building owner’s request will not be effective until at least the year 2005. Examiners will, however, encounter terminations due to the foreclosure of the property. Foreclosure does constitute a disposition, and will disqualify the former owner from taking future credits, as well as triggering recapture on credits claimed. See Chapter 7 for more information on recapture.
As indicated in the above text, if the Service determines that a foreclosure was
"staged" to free the building owner from the restrictions of the extended use commitment, the agreement would not be considered terminated. This is a difficult area to pursue, and relies more heavily on the judgment of the examiner than other
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issues encountered with IRC section 42. Communication with the state housing agency may prove valuable in this area in that they may have additional information relevant to this issue. Aside from being provided with an actual information report, the state housing agency may have received subsequent requests from the building owner for allocations for new projects -- indicating perhaps that a financing arrangement could have been negotiated for the foreclosed property instead.
Similarly, the examiner should inspect the balance sheets and P&L’s for the taxpayers to determine if foreclosure was the only available option for this project. The related facts and circumstances will need to be thoroughly reviewed during the exam and developed accordingly.
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