How Tax Relief for Disaster Recovery Works for Low Income Housing
The recent round of devastating and tragic tornadoes in the South has reminded us that the IRS has been able, through tax relief, to assist communities in the rebuilding process. This relief comes for the Low Income Housing Tax Credit Program through the easing of program requirements and through the additional allocation of credits in those affected areas.
Unfortunately, there is quite a misunderstanding about how casualty losses for low-income housing tax credit properties are handled.
Tax Relief Requires “Presidentially Declared Disaster Areas” Status
As stated in Revenue Procedure 2007-54 (to provide temporary relief under § 42 of the Internal Revenue Code):
A building (1) that is beyond the first year of the credit period and (2) that, because of a disaster that led to a major disaster declaration, has suffered a reduction in qualified basis that would cause it to be subject to recapture or loss of credit will not be subject to recapture or loss of credit if the building’s qualified basis is restored within a reasonable restoration period. The Agency that monitors the building for compliance with § 42 shall determine what constitutes a reasonable restoration period, not to exceed 24 months after the end of the calendar year in which the President issued a major disaster declaration for the area where the building is located. If the Owner of the building fails to restore the building within the reasonable restoration period determined by the Agency, the Owner shall lose all credit claimed during the restoration period and suffer recapture for any prior years of claimed credit under the provisions of § 42(j)(1).
To put this in layman’s terms, a taxpayer can continue to claim the credits on buildings affected by such disasters as the recent tornadoes so long as they are in presidentially declared disaster areas.
However, this does not extend to properties suffering casualty losses outside of these declared disaster areas. So if the building is damaged by a tornado but is not located in a presidentially declared disaster area, the IRS does not extend the same relief. Internal Revenue Code 42(j)(4)(E) provides relief from recapture of previously earned credits if the building is restored by reconstruction or replacement within a reasonable time. However, it does not provide authority for claiming the credit during the time that the building is being restored.
Two Casualty Losses with Two Separate Outcomes
So, we have two casualty losses with two separate outcomes. These disparate outcomes have spurred lively conversations, questions and a-ha moments. The biggest a-ha moment is the fact, reiterated by the IRS, that credits after the first year are annual credits.
As stated by the IRS, the credit is determined at the close of the taxable year under IRC §42(c)(1). Credit is determined on a monthly basis only for the first year of the credit period under IRC §42(f)(2)(A), and for additions to qualified basis under IRC S42(f)(3)(B). Otherwise, there is no authority to disallowing credits on a monthly basis.
How does this affect the owners of the properties damaged by the recent tornadoes? Owners of buildings in presidentially declared disaster areas do not have to worry about loss of credits if the building is not placed in back in service by the end of the year. However, owners of buildings not in a declared disaster area will lose credits for the year if their units are not back on line by December 31.
Because there is no way to calculate credits on a monthly basis after the first year, either a unit is in compliance on December 31 or it is not. The unit is either eligible for the credits or it is not. An owner could have units in a building that were in compliance for the entire year but if a tornado or fire damages them in December and they are not restored by December 31, those units will not be able to produce a penny of credits to the investors for that tax year.
Ways for Owners to Protect Themselves from Potential Loss of Tax Credits
How do we deal with this problem? There are a couple of answers here. The first is for owners to protect themselves against these casualty losses (or any other non-compliance that carries over to the next year) by purchasing insurance against such losses. Insurance actually is available for loss of credits and can be quite reasonable, especially compared to the total loss of credits for the year.
The second is to affect a change in the way the IRS treats all casualty events. Most in the housing industry believe that the rules should be the same across the board whether the property is in a presidentially declared disaster area or not.
In either case, owners should look into ways to protect themselves from potentially catastrophic loss of credits in the same way they protect themselves from liability and loss of rents.
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