Low-Income Housing Credit (I.R.C. 42)

Outline of I.R.C. 42:

1. In general
   • The credit for any taxable year in the credit period = Applicable percentage [(b)] * qualified basis [(c)] of each qualified low-income building
2. Applicable percentage
   • 70 percent present value credit for certain new buildings; 30 percent present value credit for certain other buildings
3. Qualified basis; qualified low-income building
   • Qualified basis
   • Qualified low-income building
     • Any building that is part of a “qualified low-income housing project” [(g)] at all times during the period beginning on the 1st day of the compliance period on which such building is part of such a project, and ending on the last day of the compliance period with respect to such building.
     • Any building to which the amendments made by section 201(a) of the Tax Reform Act of 1986 apply.
4. Eligible Basis
   • New buildings
   • Existing buildings
   • Eligible basis reduced where disproportionate standards for units
   • Special rules relating to determination of adjusted basis
   • Special rules for determining eligible basis
   • Credit allowable for certain buildings acquired during 10-year period described in (2)(B)(ii)
   • Acquisition of building before end of prior compliance period
5. Rehabilitation expenditures treated as separate new building
6. Definition and special rules relating to credit period
   • Credit period defined:  The credit period means, with respect to any building, the period of 10 taxable years beginning with (a) the taxable year in which the building is placed in service or (b), at the taxpayer’s election, the succeeding taxable year.  The building must be a qualified low-income building as of the close of the 1st year of such period.  The election for the succeeding taxable year is made on Form 8609.  Reasonableness and good faith may permit a taxpayer to receive a favorable determination to make the election late.  See PLR 201436046.  See PLR 201742020 regarding an extension to make an amended Form 8609 filing for failure to make a proper election.
   • Special rule for 1st year of credit period
   • Determination of applicable percentage with respect to increases in qualified basis after 1st year of credit period
   • Dispositions of property
   • Credit period for existing buildings not to begin before rehabilitation credit allowed
7. Qualified low-income housing project
8. Limitation on aggregate credit allowable with respect to project located in a State (1.42-6)
   • Credit may not exceed credit amount allocated to building
     1. The credit for any year for any building may not exceed the housing credit dollar amount allocated to the building.
     2. Normally, the allocation must be made not later than the close of the calendar year in which the building is placed in service, unless one of the following applies:
        1. An allocation can be taken into account if there is a binding commitment (by the end of the year in which the building is placed in service) by the agency to allocate a specified housing credit dollar amount to such building beginning in a specified later taxable year.
        2. Some exception where there is an increase in qualified basis.
        3. Exception where 10 percent of cost incurred:  An allocation is timely made if the allocation is with respect to a “qualified building” that is placed in service not later than the close of the second calendar year following the calendar year in which the allocation is made (i.e., the allocation is made two years before the placed in service date).  The building is a “qualified building” only if it is part of a project and the taxpayer’s basis in that project one year after the allocation is more than 10 percent of the taxpayer’s reasonably expected basis in the project at the end of the two-year period.  A “qualified building” does not include an existing building unless a credit is permitted for rehabilitation expenditures.
   • Allocated credit amount to apply to all taxable years ending during or after credit allocation year
   • Housing credit dollar amount for agencies
   • Credit for buildings financed by tax-exempt bonds subject to volume cap not taken into account
   • Portion of state ceiling set-aside for certain projects involving qualified nonprofit organizations
   • Buildings eligible for credit only if minimum long-term commitment to low-income housing
   • Special rules
   • Other definitions
9. Definitions and special rules
10. Recapture of credit
11. Application of at-risk rules
    • The at risk rules are an attempt to limit the amount of financing included in the credit basis to a 3rd party objective limitation.  In general, I.R.C. 42(k)(1) provides that rules similar to the rules in I.R.C. 49(a)(1) and (2) apply in determining the credit basis of qualifying property.
    • I.R.C. 49(a)(1) provides that the credit basis of otherwise qualifying property is reduced by eliminating financing that is not “qualified commercial financing.”  Qualified commercial financing applies where the property on which credit is claimed is acquired by the taxpayer from a person who is not a related person, and is borrowed from a qualified person or represents a loan from any federal, state or local government or instrumentality thereof.
12. Certifications and other reports to Secretary
13. Responsibilities of housing credit agencies
14. Regulations

Outline of Treasury Regulations:

• Treas. Reg. 1.42-1:
  • Limitation on low-income housing credit allowed with respect to qualified low-income buildings receiving housing credit allocations from a State or local housing credit agency
  • Filing of form 8586 (Low-Income Housing Credit)

• Treas. Reg. 1.42-1T: 
  • Limitation on low-income housing credit allowed with respect to qualified low-income buildings receiving housing credit allocations from a State or local housing credit agency (temporary)
  • In general:
    • Determination of amount of low-income housing credit
    • Limitation on low-income housing credit allowed
  • The State housing credit ceiling
  • Apportionment of State housing credit ceiling among State and local housing credit agencies
  • Housing credit allocations made by State and local housing credit agencies
  • Housing credit allocation taken into account by owner of a qualified low-income building
  • Exception to housing credit allocation requirement
  • Termination of authority to make housing credit allocation
  • Filing of forms
  • Transitional rules
  • Determination of amount of low-income housing credit
  • Limitation on low-income housing credit allowed

• Treas. Reg. 1.42-2:
  • Waiver of requirement that an existing building eligible for the low-income housing credit was last placed in service more than 10 years prior to acquisition by the taxpayer

• Treas. Reg. 1.42-3:
  • Treatment of buildings financed with proceeds from a loan under an Affordable Housing Program established pursuant to section 721 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA)

• Treas. Reg. 1.42-4:
  • Application of not-for-profit rules of section 183 to low-income housing credit activities

• Treas. Reg. 1.42-5:
  • Monitoring compliance with low-income housing credit requirements

• Treas. Reg. 1.42-6:
  • Buildings qualifying for carryover allocations

• Treas. Reg. 1.42-7:
  • Substantially bond-financed buildings [Reserved]

• Treas. Reg. 1.42-8:
  • Election of appropriate percentage month

• Treas. Reg. 1.42-9:
  • For use by the general public

• Treas. Reg. 1.42-10:
  • Utility allowances

• Treas. Reg. 1.42-11:
  • Provision of services

• Treas. Reg. 1.42-12:
  • Effective dates and transitional rules

• Treas. Reg. 1.42-13:
  • Rules necessary and appropriate; housing credit agencies’ correction of administrative errors and omissions

• Treas. Reg. 1.42-14:
  • Allocation rules for post-2000 State housing credit ceiling amount

• Treas. Reg. 1.42-15:
  • Available unit rule

• Treas. Reg. 1.42-16:
  • Eligible basis reduced by federal grants

Other Matters:

Multi-building project rules are summarized in the 2015 audit guidelines (see link below) and addressed in I.R.C. § 47(g)(7).  Under I.R.C. § 42(g) (7) and Treas. Reg. § 1.103-8(b) (4) (ii), two or more qualified low-income buildings can be included in a project only if the buildings: (1) are located on the same tract of land (including contiguous parcels), unless all of the dwelling units in all the buildings are rent restricted; (2) are owned by the same person for federal tax purposes; (3) are financed under a common plan of financing; and (4) have similarly constructed housing units.  Identifying which buildings are included in the project is important for determining whether the project met the minimum set-aside requirement under IRC § 42(g) (1).

No portion of bond issuance costs is included in eligible basis.  (Also, such costs cannot be paid from the 95% portion for I.R.C. § 142(d) purposes.)  See the I.R.C. § 42 audit guidelines and TAM 200043015. Update as of February 2024: 23rd Chelsea Associates, L.L.C., Related 23rd Chelsea Associates, L.L.C., Tax Matters Partner v. Commissioner of Internal Revenue, 162 T.C. No. 3, suggests that costs of issuance are now included in eligible basis. Nonetheless, such costs are still considered “bad costs” for purposes of the I.R.C. § 142(d) rules.

Tenant relocation costs:  “Costs Incurred to Temporarily Relocate Qualifying Tenants During the Rehabilitation : A determination may be made that an existing tenant is a qualified low-income household. In which case, the taxpayer will move the tenant and provide temporary housing while the tenant’s unit is being rehabilitated. The temporary housing may be another unit within the project or off-site. The tenant is expected to occupy the rehabilitated unit after the rehabilitation is completed. The costs attributable to moving the tenant and providing temporary housing for the tenant during the rehabilitation (e.g., legal costs, tenant moving expenses, costs for temporarily storing a tenant’s property, and temporary housing costs) are expensed as ordinary and necessary business expenses under IRC § 162.”   See the I.R.C. § 42 audit guidelines. This suggests tenant relocation costs are considered “bad costs” for purposes of the I.R.C. § 142(d) rules as well.

Combining with other tax credits: “Besides qualifying for the Low-Income Housing Credit under IRC § 42, the taxpayer may also qualify for the Rehabilitation Credit under IRC § 47 and the Energy Credit under IRC §48, but not the New Markets Credit under IRC § 45D. A building may also qualify for tax-exempt bond financing under IRC §146, in which case the taxpayer is also subject to the rules under IRC § 142(d). The taxpayer may also use other federally-sourced loans and grants to finance and operate the building. […] Projects financed with tax-exempt bonds under the IRC § 146 Volume Cap and as defined in IRC §142(d) can also qualify for IRC § 42 credits, but are limited to the 30% credit. The percentage of the aggregate basis financed by the tax-exempt bonds is identified on Form 8609, line 4, and the type of building is identified on line 6a or 6d. Note: the aggregate basis used for the percentage computation is different than eligible basis or qualified basis.”  See the I.R.C. § 42 audit guidelines.

Extended use agreement: “For all buildings allocated credit after 1989, IRC § 42(h) (6) requires taxpayers to enter into an extended use agreement with the state agency. The requirement also applies to buildings financed with tax-exempt bonds under IRC § 142(d) and receiving credits associated with the volume cap under IRC § 146. Taxpayers must agree to a long-term commitment beginning on the first day of the 15-year compliance period and ending on the later of (1) the date specified by the state agency in the agreement or (2) the date which is 15 years after the close of the 15-year compliance period. In other words, the taxpayer covenants to maintain the buildings as low-income housing for at least 30 years.” See the I.R.C. § 42 audit guidelines.

Allocating bond proceeds:  Treas. Reg. § 1.42-1T (f) (1) (ii) reads: “(ii) Determining use of bond proceeds. For purposes of determining the portion of proceeds of an issue of tax-exempt bonds used to finance (A) the eligible basis of a qualified low-income building, and (B) the aggregate basis of the building and the land on which the building is located, the proceeds of the issue must be allocated in the bond indenture or a related document (as defined in § 1.103-13(b)(8)) in a manner consistent with the method used to allocate the net proceeds of the issue for purposes of determining whether 95 percent or more of the net proceeds of the issue are to be used for the exempt purpose of the issue. If the issuer is not consistent in making this allocation throughout the bond indenture and related documents, or if neither the bond indenture nor a related document provides an allocation, the proceeds of the issue will be allocated on a pro rata basis to all of the property financed by the issue, based on the relative cost of the property.”  See also the examples in the I.R.C. § 42 audit guidelines.

Notice 88-116: Notice provide guidance under I.R.C. § 42(n) regarding: (1) what costs will be considered construction, reconstruction, or rehabilitation costs; and (2) when such costs will be considered to be incurred. Notice also provide guidance regarding when a building will be considered to be placed in service for purposes of I.R.C. § 42:

• Construction, reconstruction or rehabilitation: Must be a cost that is chargeable to capital account. Costs treated as expenses and deducted in the year they are paid or incurred or amounts that are otherwise not added to eligible basis do not qualify. For example, the cost of acquiring an existing building is a qualifying cost. Amounts incurred for taxes and achitectural and engineering fees, site survey fees, legal expenses, insurance premiums, development fees, and other construction related costs satisfy the definition of “construction, reconstruction, or rehabilitation” costs if they are included in the basis of the building. Production period interest (within the meaning of I.R.C. § 263A(f)) allocable to the construction, reconstruction, or rehabilitation of a building is a qualifying cost. But, the cost of land is not a qualifying cost.
• Placed in service: Placed in service has two defintions for purposes of I.R.C. § 42: (1) for buildings; and (2) for rehabilitation expenditures that are treated as a separate new building.
  • For a new or existing building used as residential rental property, the date is on which the building is ready and available for its specifically assigned function, i.e., the date on which the first unit in the building is certified as being suitable for occupancy in accordance with state or local law. A transfer of the building results in a new placed in service date if, on the date of the transfer, the building is occupied or ready for occupancy.
  • For rehabilitation expenditures treated as a new separate building, such expenditures and resulting building are placed in service at the close of any 24-month period, over which such expenditures are aggregated. The placed in service date of I.R.C. § 42(e)(4)(A) applies even if the building is occupied during the rehabilitation period.
  • A building may be placed in service even if the rental units in the building are not currently occupied by low-income tenants.