2021 QCTs and DDAs

The Department of Housing and Urban Development (HUD), published a notice designating 2021 QCTs and DDAs on September 24, 2020 in the Federal Register. Designations are made annually for all 50 states including the District of Columbia, Guam, Puerto Rica and the US Virgin Islands. The Qualified Census Tracts (QCTs) and Difficult Development Areas (DDAs) are qualified for 30% basis boost in LIHTC properties under Internal Revenue Code Section 42.

DDAs, defined as “areas with high land, construction and utility costs relative to the area median income and are based on Fair Market Rents, income limits, the 2010 census, and 5 year American Community Survey (ACS) data” (HUD). QCTs, are “areas where either 50 percent or more of the households have an income less than 60 percent of the AMGI for such year or have poverty rate of a least 25 percent” (HUD).

The American Community Survey (ACS) is not widely known as the census. The census collects data from every household every 10 years. However, the ACS gathers data every year from random addresses. The ACS like the census is required by law under Title 13, US Code. The ACS data focuses annually on housing, jobs, and education along with social and economic needs of communities. Struggling communities experienced another devastating blow this year, a pandemic.

Since SARS-Cov-2 has greatly devastated communities across the world, it is no surprise that communities with lower Area Median Gross Income levels and high poverty rates have been hit the hardest.

The challenges Developer’s face with Low-Income Housing Tax Credits (LIHTC) projects are certainly compounded as the SARS-Cov-2 pandemic continues to rage. The pandemic has resurfaced the disparities around housing, a basic need, suggesting that creative and new initiatives to support Affordable Housing are needed in the foreseeable future just like they have been in the past.

By: Quinn Newton

Housing Infrastructure

Housing Infrastructure Legislation

Sweeping infrastructure legislation released Monday, June 22, 2020 in the House of Representatives includes provisions to establish a permanent minimum 4 percent rate for the low-income housing tax credit (LIHTC), increase the annual LIHTC allocation amount, temporarily reduce the 50 percent test for bond-financed housing to 25 percent and permanently extend the new markets tax credit (NMTC) at $5 billion (with additional allocation in 2020 and 2021). H.R. 2, the Moving Forward Act, also would increase the historic tax credit (HTC) applicable percentage from 20 percent to 30 percent for five years and delay the phasedown of the renewable energy investment tax credit (ITC) until 2026.

Among the affordable housing provisions, the bill would increase the annual 9 percent LIHTC allocation amount from $2.81 to $4.56 per capita and boost the state private activity bond ceiling from $105 per capita to $135 per capita. Both provisions would increase the small-state minimum. The legislation would also provide a 150 percent first-year LIHTC award to address issues related to COVID-19 and provide several basis boosts for LIHTC properties, similar to proposals in the Affordable Housing Credit Improvement Act (H.R. 3077/S. 1703). It would also provide more than $100 billion in supplemental appropriations for various HUD programs, mostly notably $70 billion for the public housing capital fund.

The NMTC would be permanently extended, with an additional $500 million allocation for the 2019 round (for a total of $4 billion) and temporary increases for 2020 (for a total of $7 billion) and 2021 (a total of $6 billion) before settling at $5 billion 2022, with an annual adjustment for inflation. The bill would also allow the NMTC permanently to be taken against the alternative minimum tax, and instructs Treasury to ensure that tribal areas receive a proportional allocation, similar to existing policy for non-metro areas.

The legislation would increase the HTC from its current 20 percent to 30 percent for 2020 through 2024, before beginning a phasedown for most HTC properties back to 20 percent through 2027. The bill would also permanently increase the HTC percentage for certain small projects to 30 percent, and several other proposals from the Historic Tax Credit Growth and Opportunity Act (H.R. 2825/S. 2615).

The bill would delay the phasedown of the renewable energy ITC until 2026 and allow many uses of the production tax credit to cover facilities that begin construction by the end of 2025. A section-by-section summary of the bill is available.

Opportunity Zones

Opportunity Zone Proposed Regulations

On October 19, 2018, the Department of the Treasury released taxpayer-friendly proposed regulations (the “Proposed Regulations”) under Section 1400Z of the Tax Code. Due to the lack of administrative guidance, fund managers and other investors have hesitated taking advantage of new tax benefits designed to incentivise private sector investment into economically-distressed “opportunity zones.” The Proposed Regulations have been well received and will cause many investments to move forward.

Opportunity Zone Tax Benefits

As part of the Tax Cuts and Jobs Act enacted into law in December 2017, the Opportunity Zone statute (codified as Section 1400Z of the Tax Code) provides two main tax incentives designed to encourage investment in opportunity zones. First, the legislation allows for the deferral of gain to the extent that corresponding amounts are reinvested into one of more “qualified opportunity funds” (or QOFs). Second, the legislation excludes from gross income the post-acquisition gains on investments in QOFs that are held for at least 10 years.
The Opportunity Zone legislation left a lot of questions unanswered regarding how to comply with the rules. This lack of guidance meant that taxpayers have been unwilling to make investments for fear that they would not be entitled to receive the favorable tax treatment that the legislation provides. While the Proposed Regulations still leave some questions unanswered, they provide enough certainty to allow for prudent investment.

Proposed Regulations

The Proposed Regulations both describe and clarify the requirements that must be met by a taxpayer in order to defer the recognition of gains by investing in a QOF and provide rules for QOFs relating to self-certification and some of the ongoing requirements imposed on QOFs.

The proposed regulations do not address all questions. The Department of Treasury and the IRS are working on additional published guidance, including a second round of proposed regulations expected to be published in the near future. While not intended to be a complete description of all changes, we note the following:

Rules Relating to Taxpayers Deferring Gain

Clarification of eligible taxpayers. The proposed regulations clarify that taxpayers eligible to elect gain deferral are those that recognize capital gain for Federal income tax purposes. These taxpayers include individuals, C corporations (including RICs and REITs), partnerships, and certain other pass-through entities. 

The proposed rules include special rules for partnerships and their partners. Specifically, while there was no question that a partnership could defer gain, the proposed regulations clarify that a partner may elect gain deferral with respect to its allocable share of partnership gain, assuming the partnership fails to do so.

Capital Gains Only. The proposed regulations clarify that only capital gains are eligible for deferral. Eligible gains generally include capital gain from an actual, or deemed, sale or exchange, or any other gain that is required to be included in a taxpayer’s computation of gain. (Certain statutory exceptions apply, including gains from a sale or exchange to a person closely related to the taxpayer.) Short or long term capital gains are both eligible.
The proposed regulations provide limitations/exceptions for gains under “Section 1256 contracts” and for gains from positions that are of have been part of an offsetting-position transaction (meaning, a transaction in which the taxpayer has substantially diminished its risk of loss from holding one position with respect to personal property by holding one or more other “offsetting” positions).

Equity Investments Only. To unlock QOF benefits, the taxpayer must make an investment in exchange for an equity interest. An equity interest includes preferred stock or a partnership interest with special allocations. Provided that the taxpayer is the owner of the equity interest for Federal income tax purposes, the taxpayer may use that interest as collateral for a loan (whether a purchase-money borrowing or otherwise) without jeopardizing eligibility.
That said, if the taxpayer instead chooses to structure its investment as a loan to a QOF (as opposed to an equity investment), the taxpayer will not be entitled to defer its prior gains or otherwise enjoy the tax benefits that the Opportunity Zone legislation provides.

Timely Elections. To be able to elect to defer gain, a taxpayer must generally invest in a QOF during the 180-day period beginning on the date of the sale or exchange giving rise to the gain. For a partner (or other person indirectly realizing gain through a pass-through entity), the 180-day period begins on the last day of such entity’s taxable year.  
That said, the proposed regulations provide a special rule for partners where the partnership is the entity realizing gain and will not elect to defer the gain: In this scenario, if the partner knows both the date of the partnership’s gain and the partnership’s decision not to elect deferral, the partner may choose to begin its own 180-day period on the same date as the start of the partnership’s 180-day period. Similar rules apply to other pass-through entities (including S corporations, decedents’ estates, and trusts) and to their shareholders and beneficiaries.

Election for Investments Held at Least 10 Years. Under the opportunity zone legislation, a taxpayer that holds a QOF investment for at least ten years may elect to increase the basis of the investment to its fair market value on the date that the investment is sold or exchanged and thus, effectively exclude that gain from income. This basis step-up election is available only for gains realized upon investments that were made in connection with a proper deferral election. The proposed regulations reiterate that it is possible for a taxpayer to invest in a QOF in part with gains for which a deferral election is made and in part with other funds. This results in a “mixed” QOF, where the tax benefits associated with a QOF are available only with respect to that part of the taxpayer’s investment relating to realized gains.

Under the opportunity zone legislation, all qualified opportunity zones will lose their designation on December 31, 2028. This raises issues regarding gain deferral elections that are still in effect when the designation expires. The proposed regulations address these issues by permitting a taxpayer to make a basis step-up election after a qualified opportunity zone designation expires. The ability to make this election is preserved until December 31, 2047, which is 20 ½ years after the latest date that an eligible taxpayer may make an investment that is part of an election to defer gain.

Rules Governing Qualified Opportunity Funds

Certification Process. To facilitate the certification process and minimize the information collection burden placed on taxpayers, the proposed regulations generally permit any taxpayer that is a corporation or a partnership for tax purposes to self-certify as a QOF, assuming the entity is statutorily eligible to do so. It is expected that taxpayers will use IRS Form 8996, Qualified Opportunity Fund, both for initial self-certification and for annual reporting of compliance with the 90-percent asset test.

The proposed regulations allow a QOF both to identify the taxable year in which the entity becomes a QOF and to choose the first month in that year to be treated as a QOF. Any investments made by taxpayers prior to this date will not be eligible for QOF tax benefits.

Valuation Method for 90-Percent Asset Test. To avoid penalties, the opportunity zone legislation requires a QOF to hold at least 90 percent of its assets in qualified opportunity zone property, determined by the average of the percentage of qualified opportunity zone property held in the fund (A) on the last day of the first 6 month period of each taxable year and (B) on the last day of such taxable year. The proposed regulations require the QOF to use the asset values reported on the QOF’s applicable financial stated for the taxable year. If the QOF does not have an applicable financial statement, the proposed regulations require the QOF to use the cost of its assets.

Nonqualified Financial Property. With certain limited exceptions, the opportunity zone legislation does not consider cash as qualified opportunity zone property. As such, cash held in the QOF may cause the QOF to fail the 90-percent asset test, even if that cash is held with the intent of investing in qualified opportunity zone property.

The proposed regulations provide a working capital safe harbor for QOF investments in qualified opportunity zone businesses that acquire, construct, or rehabilitate tangible business property. Provided there is both a written plan that identifies the financial property as property held for the acquisition, construction, or substantial improvement of tangible property in the opportunity zone and a written schedule consistent with the ordinary business operations of the business that the property will be used within 31 months, then this safe harbor will apply, assuming the business substantially complies with this schedule.

Substantial Improvements. Among other things, to be considered qualified opportunity zone business property, the original use of such property in the opportunity zone must commence with the QOF or the QOF must substantially improve the property, which is satisfied by the QOF making additions to basis with respect to the property within 30 months of acquisition in an amount which exceeds the acquisition price for the property. In other words, improvements to the property must result in at least doubling the QOF’s basis in the property.

For purposes of this requirement, the proposed regulations provide that the basis attributed to land on which a building sits is not taken into account in determining whether the building has been substantially improved. 

Contemporaneous with the issuance of the proposed regulations, the IRS released Revenue Ruling 2018-29, which addresses the application to real property of the “original use” and “substantial improvement” requirements of the legislation.

Qualified Opportunity Zone Businesses. Under the opportunity zone legislation, for a trade or business to qualify as a qualified opportunity zone business, it must (among other requirements) be one in which substantially all of the tangible property owned or leased by the taxpayer is qualified opportunity zone business property. 

The proposed regulations provide that if at least 70 percent of the business’s tangible property is qualified opportunity zone property, then the trade or business is treated as satisfying this “substantially all” requirement. The proposed regulations note that the phase “substantially all” is used throughout the opportunity zone legislation, and that the 70 percent threshold is intended only to apply to such term as is used for determining whether the business is a qualified opportunity zone business.

Mixed Funds. If only a portion of a taxpayer’s investment in a QOF is subject to the deferral election, then the opportunity fund legislation requires the investment to be treated as two separate investments, which receive different treatment for Federal income tax purposes. The proposed regulations reiterate that a taxpayer may make an election to step-up basis in an investment in a QOF that was held for 10 years or more only with respect to that portion of such investment for which a proper deferral election was made. 

For investments made through partnerships, the proposed regulations clarify that deemed contributions of money under Section 752(a) (i.e., partnership liabilities) do not constitute an investment in a QOF. Therefore, such a deemed contribution does not result in the partner having a separate “mixed fund” investment. Thus a partner’s increase in outside basis is not taken into account in determining what portion of the partner’s interest is subject to the deferral election (or what portion is not subject to the deferral election).

Effective Date

The proposed regulations are effective after a 60-day comment period and once they are later published as final. However, taxpayers and QOFs may rely on the proposed regulations now, provided they apply the proposed rules in their entirety and in a consistent manner.
The full text of the taxpayer-friendly proposed regulations can be accessed here: https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf.