IRS Exempts Tax Credit Deals from Tax Shelter Regulations

Tax Credit Housing Management Insider, March, 2007 by Anonymous

On Jan. 26, 2007, the IRS issued guidance providing that low-income housing tax credit deals are not considered transactions with contractual protection under the reportable transaction rules. The IRS guidance is contained in Revenue Procedure 2007-20 and can be found at www.irs.gov/pub/irs-drop/rp-07-20.pdf.>The uncertainty of whether low-income housing tax credit transactions could be considered as having contractual protection had increased the amount of documentation that developers and investors were retaining and providing to the IRS when they use tax credits to finance construction of affordable housing, says Glenn A. Graff, an attorney with Chicago law firm Applegate & ThorneThompson, EC.

In addition, the contractual protection issue had raised the possibility that certain tax-exempt entities that participated in low-income tax credit transactions could be subject to an excise tax passed by Congress in 2006.

"Under the new IRS revenue procedure, reportable transaction disclosure, record maintenance, and the related excise tax should no longer be an issue for the typical low-income housing tax credit transaction," says Graff. "The low-income housing tax credit program already requires a significant level of disclosure to the IRS and to state housing credit agencies. There was no reason for-or benefit derived from-additional reportable transaction filings," he adds.

Defining Contractual Protection

According to IRS regulations, a transaction with contractual protection is one that provides for a full or partial refund of fees, or that makes promoter fees contingent on the receipt of promised tax benefits. Transactions with contractual protection must be disclosed to the IRS, Graff says. Consequently, contractual protection of tax credit deals was a concern for low-income housing tax credit housing developers, he notes. Whether the guarantees in tax credit transactions would be viewed as a type of contractual protection was unclear-until now, he adds.

Through its power to issue regulations, the IRS can determine which transactions don't have contractual protection, Graff says. "The IRS has already used this power to exempt certain tax credits, such as the Work Opportunity Credit," Graff says. "I am glad to see that it has decided to provide the same treatment for low-income housing tax credits."

Reporting Requirements

Tax credits are an equity-funding mechanism permitting a developer to seek equity from investors when setting up a low-income housing tax credit deal. In a tax credit deal, investors put money into a partnership, and the partnership pays fees to the developer to build the housing project. The investors expect to receive tax credits. Typically, they receive a tax credit guarantee.

If the reportable transaction rules had applied, then developers and investors would have been required to comply with all IRS disclosure and record maintenance requirements, says Graff. Investors would have been required to retain all records relating to the transaction, such as the expected tax treatment, the decision to use tax credits as a shelter, and any documents that contribute to an understanding of the deal.

Penalty for Nondisclosure

The 1RS levies steep fines for noncompliance with its disclosure requirements. "The standard penalty for failing to file the required documentation is $50,000," says Graff. Therefore, even though it was unclear whether IRS disclosure requirements applied, developers and investors generally complied with the reporting and filing requirements by making a protective disclosure to avoid even the possibility of such a huge penalty, Graff says.

Along with other American Bar Association committee members, Graffhad drafted a comment letter that may have helped lead to the IRS's ruling. The letter, which provides background on reportable transactions issues, can be downloaded from www.att-law.com/publications.html.>"My purpose as an attorney in the area of affordable housing is to see that units get built," Graff says. "What no one wants is to get bogged down in paperwork that takes time away from building. For that reason, it's in everyone's interest to cut down on the unnecessary filings and excessive record retention currently required by the IRS."

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[Reference]

Insider Source

Glenn A. Graff, Esq. Applegate & Thorne-Thompson, P.C., 322 South Green St., Ste 400, Chicago, IL 60607, (312) 421-8400, ggraff@att-law.com