Income Tax Effects of the Housing and Economic Recovery Act of 2008 on Real Estate Transactions, The

Real Estate Issues, Spring 2009 by Hardin, J Russell

INTRODUCTION

IF REAL ESTATE INVESTORS ARE TO MAXIMIZE AFTER-TAX profits and maintain appropriate levels of capital investment, they must have a working knowledge of the latest legislative changes enacted by the United States Congress that pertain to real estate. On July 30, 2008, President George W. Bush signed into law the Housing and Economic Recovery Act of 2008 (hereinafter Act). This sweeping piece of legislation contains, among other things, numerous amendments to the Internal Revenue Code. Several of the provisions of the Act have implications for real estate investors and/or real estate transactions.

The purpose of this article is to summarize the provisions of several of the important changes to the Internal Revenue Code that are now the law or that will soon become the law and that pertain to real estate transactions. Investors in real estate are urged to look closely at this tax legislation to seek ways in which they can significantly diminish their future income taxes. The following discussions focus on the major provisions of the new bill which, directly or indirectly, affect real estate transactions. Some suggestions for tax planning are also included in the discussions. To determine the particular effect, if any, each of these provisions will have on a particular investment, each investor should consult with his/her CPA, tax attorney or other tax professional.

LOW-INCOME HOUSING TAX CREDIT

The Act states that the low-income housing tax credit for new buildings placed in service after the date of enactment of this change (July 30, 2008) and before Dec. 31, 2013, shall be subject to a tax credit rate of not less than nine percent. The nine percent rate applies only to new construction and substantial rehabilitation projects that are not subsidized by the federal government. The applicable rate for new buildings that are federally subsidized or are existing buildings is four percent. The appropriate credit may be taken for 10 consecutive years on the lowincome housing project. A loan including federal funds is not considered to be subsidized if the loan bears an interest rate that is at or above the prevailing Treasury interest rate.

The basis that is available for the credit is determined in three basic steps and one additional step. In step one, the eligible basis is determined. Eligible basis includes all depreciable construction costs and all depreciable "soft" costs such as architectural fees and engineering costs. Nondepreciable costs such as the cost of the land are excluded from the eligible basis. In step two, the fraction of qualified low-income housing units is determined. The applicable fraction is the lower of the percentage of low-income units to total units or the square footage occupied by lowincome units out of the total square footage for the project. In step three, the basis amount that qualifies for the lowincome housing credit is determined. In the additional step, the credit may be increased up to an additional 30 percent. This extra credit is only available for areas that are designated as Qualified Census Tracts (QCTs) or Difficult Development Areas (DDAs) by the U.S. Department of Housing and Urban Development (HUD).1

SAMPLE COMPUTATION:

A local real estate developer is proposing to build 100 rental units in Boomtown, U.S.A. The developer will not use any additional federal funds. The development will not be located in a DDA or a QCT. Forty-five percent of the units and forty percent of the square footage will be set aside for low-income households. The total development costs for the project are estimated as follows:

Generally, the value of the tax credit is calculated as follows:

* Eligible Basis = $8,000,000 (Total Development Costs - Land Cost)

* Qualified Basis = $3,200,000 (Eligible Basis x Applicable Fraction: $8,000,000 x 40%)

* Annual Credit = $288,000 ($3,200,000 x 9% Credit Rate)

* Total Amount of Housing Tax Credits = $2,880,000 ($288,000 x 10 years)

Tax Planning Tips: Since the above change is temporary and expires on Dec. 31, 2013, developers who wish to qualify for the low-income housing credit should make sure that construction projects are completed and the housing is placed in service prior to Jan. 1, 2014. Developers also should consider avoiding federally subsidized loans so that the projects qualify for the nine percent credit rather than the four percent credit.

FIRST-TIME HOMEBUYER CREDIT

The Housing and Economic Recovery Act of 2008 offers a first-time homebuyer credit. This credit is available to a first-time homebuyer of a principal residence in the United States during a taxable year. The credit is refundable in a manner similar to the earned income credit. In other words, the taxpayer will receive the credit in the form of a refund even if the tax liability for the year is zero. The credit is an amount equal to 10 percent of the purchase price of the principal residence, up to a maximum of $7,500. This credit is equivalent to an interest-free loan because taxpayers receiving the credit must repay any amount received under this provision back to the federal government over 15 years in equal installments. The provision applies to homes purchased on or after April 9, 2008, and before July 1, 2009. This credit begins to phase out for taxpayers with an adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return).