Does Foreclosure mean automatic recapture of LIHTCs?
Recapture of the low income tax credits results when, at the close of any taxable year in the compliance period, the amount of the qualified basis of any building with respect to the taxpayer is less than the amount of such basis as of the close of the preceding taxable year. As a result, the taxpayer’s tax for the taxable year will be increased by the credit recapture. A foreclosure, or instrument in lieu of foreclosure, would result in the taxpayer having a reduction in the basis of the building at the close of the taxable year. Furthermore, the legislative history of Section 42 provided that, in general, any change in the ownership of a low-income housing building during the compliance period is a recapture event and that all disposition of ownership interest in buildings are treated as transfers for purposes of recapture.
There has been new guidance generated by the IRS in the form of Chief Counsel Advice 201146016 regarding a foreclosure or deed in lieu of foreclosure which automatically results in the recapture of the low-income housing credits under Section 42(j)(1) and the corresponding termination of the extended use agreement under Section 46(h)(6)(E)(i)(I).
Under Section 42(h)(E)(i)(II), the extended use agreement shall terminate on the date that a building is acquired by foreclosure or instrument in lieu of foreclosure unless the Secretary determines that such acquisition is part of an agreement with the taxpayer whose purpose is to terminate such period.
Section 42(j) (6) (A) contradicts the legislative history in regards to the general rule. The code section provides that the increase in tax shall not apply solely by reason of the disposition of a building, or interest therein, if it is reasonably expected that such building will continue to be operated as a qualified low-income housing building for the remainder of the compliance period. A disposition in and of itself assuming that it is reasonably expected that the building will continue to be operated as a qualified low-income building for the remainder of the compliance period will not, as a matter of law, result in recapture of the low-income housing credits.
It is important to note that the Chief Counsel Advice does not say that there will not be a recapture event if there is a foreclosure or a deed in lieu of foreclosure, only that evidence must exist that the requirements under Section 42(j) (6) (A) have been met in order to defend the position that a recapture event has not occurred.
The Chief Counsel Advice also distinguishes between the termination of a low-income building’s extended use agreement and the disposition of a building. The conclusion generated from the Memorandum states that these two items are separate and independent concepts. Termination of an extended use period is not a disposition of a building whereas the disposal of a building by foreclosure or deed in lieu of foreclosure results in a disposition.
The disposition of a building, either through foreclosure or other methods, may result in an imputed decrease of the building’s qualified basis or recapture under Section 42(j). The termination of the extended use agreement does not necessarily result in a decrease in the building’s qualified basis upon which recapture can be predicted.
Even though the termination of the low-income building’s extended use agreement does not result in the recapture of low-income housing credits, it may prevent the new owner from taking additional credits. Section 42(h)(6)(A) generally provides that no credit shall be allowed for any building for the taxable year unless an extended low-income housing commitment is in effect as of the end of such taxable year. The Memorandum does not explicitly state, but does imply, that the termination of the extended use agreement would prevent additional credits from being taken with respect to the building after the termination of the agreement.
The Memorandum also clearly states that any reduction in the qualified basis of the project after the foreclosure event would result in a recapture of the low-income housing credits.
With additional care and due diligence, the disposition of a building through a foreclosure or deed in lieu of foreclosure and resulting termination of the extended use agreement may be structured to prevent the additional tax consequences of the recapture of the low-income housing credits.
Written by: Nancy Morton