Wednesday, May 9, 2012

IRS raises risks of losing #LIHTC affordability

More subsidized housing could go to market rate under "qualified contract" rules issued last week by the IRS after almost five years' delay. Hard to tell how many units are affected, but it's not happy news.

The new rules, issued May 3 and available here, affect what happens, after the first 15 years of operation, to properties subsidized with the low-income housing tax credit (LIHTC). Year 15 is when investors in such properties, at least under the federal minimum rules, get a chance to sell them off, or, just possibly, a chance to switch them up to market rate.

I'm saying "minimum rules" here because a lot of states, including California, require developers to waive the Year 15 escape clause before they get any tax credits at all. Some more jurisdictions give points for "extended affordability" promises in the scoring schemes for their annual tax credit allocation competitions.

With so many extended-affordability waivers out there, it's difficult to tell how many projects are really still candidates for Year 15 "qualified contracts." Still, though, probably enough to worry about.

Strict "qualified contract" rules, which the IRS issued in detail last week, govern the Year 15 sales. Starting in Year 14, the owner(s) can give the relevant state housing agency one year to come up with a willing buyer who will keep at least the subsidized part of the property affordable under a strictly specific "qualified contract." If a "qualified contract" deal is available, the original investors don't literally have to take the deal, but if they don't, they have to find some other way of keeping the property affordable, with whatever limited profit that may bring.

If the state agency can't come up with a real buyer's "qualified contract" offer, then the investors get to take the property up to market rate over the course of three years. After the three years are up, that could even mean raising rents above what the original low-income tenants can pay.

The "qualified contract" rules are what the IRS just rewrote. Despite much public-comment importunity, they've arguably made it too easy for the asking prices of Year 15 LIHTC properties to drift upward out of realistic range. Which presumably will discourage housing nonprofits and other potential buyers from purchasing the properties under qualified contracts to keep them affordable. That means more Year 15 properties may fail to find takers and hence fall out of the program. Which is good news for private tax credit investors. Despite the law's three-year anti-eviction cushion, it's potentially quite seriously not good for low-income tenants. As in, eviction serious.

The new IRS rule imposes a formula that can easily push the mandatory asking price for a "qualified contract" above the property's realistic market value, considering how the thing to be sold is a rental building that is subject to serious rent restrictions and to actually fairly whopping extra paperwork burdens.

Harold Berk, a Pennsylvania-based lawyer who knows and writes on LIHTC law, has been schooling me on some of the technicalities here, though opinions expressed above are my own.

He's noting as important that the IRS refused to impose a market-value cap on qualified contract asking prices. Commenters from low-income housing advocacy groups had argued that market-value caps should be imposed for the low-income portions of each property, but the IRS stated it had no authority to do that.

He writes:
"Now IRS 21 years after the Code adopted this Qualified Contract process has issued final regulations which further muddy the water. They add complexity to the calculation of the qualified contract price but most likely it will still exceed what a willing buyer would pay for the property while agreeing to operate it as low-income."
And again, regarding the danger of too-high asking prices:
"That was why people sought a fair market value cap on the qualified contact price, but IRS said it had no authority under the Code to do that, so the formula, as modified, is the formula and will usually lead to a high price above appraised value. Developers want to stay in the deal, and investors usually want out, sometimes with a payment. It all depends on location, location. But remember that agencies have required waivers of the qualified contract process from most developers, so for those who waived, these regulations offer no out."
There's another problem as well from tenants' point of view, emphasized in the @Novogradac firm's Tax Credit Tuesday 5/8/12 writeup and podcast (PDF summary here). It's that a different set of commenters (including the Novogradac firm itself) suggested potential buyers might push down asking prices by exploiting a provision allowing state housing agencies to make last-minute price reductions. Therefore, per Novogradac's summary, "the final regulations provide that the agency may adjust the fair market value of the non low-income portion of the building only with the consent of the owner." Of course that kind of consent would be perhaps not terribly forthcoming if the owner were interested in keeping a qualified contract unlikely.

As background, it may help to know that LIHTC projects pay back their private investors, with interest, in the form of reduced taxes during the first 10 or 11 years (depending how you count) after the initial investment. Then, in portentous "Year 15", investors in well-kept &/or nicely located LIHTC properties have a chance to get paid back again in the form of proceeds from reselling the property.

The investors are often large institutions with big tax liabilities that they can offset with credits. Also especially banks, which get credit from LIHTC projects toward their Community Reinvestment Act requirements. (This report, via Tax Credit Advisor's Twitter, @TCAMag), explains a little more about the current cui bono, but the exact profits can be difficult to work out from a distance.)

Hence the fuss.

It's odd how long the notice of proposed rulemaking took to appear. It was published June 19, 2007, comments were due September 17, 2007, and the hearing was held October 15, 2007, so all comments were gathered before the housing market crash. But Harold Berk says it doesn't deeply matter. He writes: "The formulas come from the Code and are only embellished by IRS. The issues remain the same."

Should any reader thirst for more detailed background on the subject, here's some:

Apart from the recent writeup I've mentioned, the Novogradac site has also been maintaining a compendium page on Year 15 and qualified contracts that includes links to individual states' official Year 15 policies. And, in 2008, Michael Novogradac and a top colleague produced this good ABA Journal of Affordable Housing article laying out the issues in more of a big-picture way.

Another short good explanation, with relevant case law, is this from the National Housing Law Project.

Also, marvelous convenience, Regulations.gov provides the whole public file on the rule, comments and all. (Yes, this is still a wonder to me. I'm old enough to remember a roomful of Washington news reporters sharing the day's hand-delivered stack of paper Federal Register booklets.)

The main pro-tenant comments in 2007 came from James Grow of the National Housing Law Project and Sheila Crowley of the National Low Income Housing Coalition. They were concerned about keeping down the likely asking prices for qualified contracts, and hence interested in putting market-rate caps on the asking prices.

After a detailed online search I can't find any clear statement how many LIHTC developers have waived their qualified contract requests. The nearest summary-type answer is in this 2008 article by Professors Alex Schwartz and Edwin Meléndez in the journal Housing Policy Debate. They say:
"Requests for qualified contracts will most likely involve a subset of properties that have for-profit general partners and were completed before themid-1990s—that is, before state housing finance agencies started to give priority to applications that waived the owner’s right to seek a qualified contract."
This was written four years ago. A property now reaching its Year 15 would have been placed in service in 1996. So it could be the IRS rule is coming into effect after the most affected cohort of buildings have passed their crucial Year 15 periods.

Schwartz and Meléndez say, anyway, that the "expiration of affordability restrictions" is "less daunting than the need to finance the acquisition and physical improvement of tax credit properties after year 15." That is, it may be less of a challenge to keep rent restrictions in place than it is to raise the money to keep the well-worn buildings affordable.

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