(This is the second in a series of Legal Alerts from Arent Fox LLP that will examine the potential legal and economic impact of the sweeping new Housing and Economic Recovery Act of 2008 signed into law by President George W. Bush on July 30, 2008)

Among the perceived hindrances in the investment in affordable housing projects are the strict rules governing the transfer of existing projects and attainment of acquisition tax credits. Investors have also been discouraged from investing in affordable housing as such investments are not credited in the Alternative Minimum Tax. The Housing and Economic Recovery Act of 2008 (the Act), which was signed into law by President Bush on July 30, 2008, addresses the use of low income and rehabilitation tax credits in the calculation of Alternative Minimum Tax (AMT) and the transfer of existing affordable housing projects.

Expansion of relief in Alternative Minimum Tax

The AMT is tax system that operates in parallel to the regular income tax.  Under the AMT: (1) some items of income that are exempt from regular income tax are subject to AMT, such as certain types of tax-exempt interest; (2) some items deductible for regular income tax are not deductible for AMT, such as state and local taxes; (3) some items of tax preference are not accorded such preference for AMT, such as accelerated depreciation (e.g., property is depreciated at a slower rate); and (4) many types of credits allowed against regular income tax are not allowed as a credit against AMT, such as numerous business tax credits.  Persons have to pay AMT to the extent that it exceeds their regular income tax. 

Congress originally enacted the predecessor to the current AMT almost 40 years ago, after reports that a number of very wealthy Americans paid no income tax at all because their income was sheltered by tax preferences or derived mainly from tax-exempt interest.  Although the current version of the AMT contains the equivalent of a large exemption amount that was intended to exclude many middle-class Americans from its bite, that exemption amount is not indexed for inflation. As a result, the AMT has increasingly affected middle-class Americans, particularly those who live in jurisdictions with high state and local taxes.

Because low income housing and rehabilitation tax credits are not allowed as a credit in calculating AMT under current law, tax credit investors, or potential tax credit investors who are subject to AMT, currently do not derive any tax benefit for investing in affordable housing projects to the extent that the credit would reduce their regular income tax below what the AMT would be. The Act, however, would expand the items that are taken into account in determining AMT and allow an exemption for AMT purposes for interest on tax-exempt housing bonds and a credit for such purposes for low income housing and rehabilitation tax credits.

By allowing these items to be taken into account in determining AMT, investors now have a greater incentive to invest in affordable housing projects. This change should stimulate an increase in the number of individuals investing in affordable housing.

Acquisition Tax Credits

In order to sell an affordable housing project and qualify for acquisition tax credits, certain provisions must be met including (i) the seller must be unrelated to the purchaser at the time of the sale or any time after the building was placed in service and (ii) the building must not have been placed in service within the previous 10 years from the date of proposed purchase.

(i) Common ownership/Related party

Under current law, a purchaser that is a related party cannot obtain acquisition tax credits. A purchaser is defined as a related party if the purchaser has a 10 percent or more common ownership interest in the seller. The Act amends the current definition of what constitutes a related party by changing the threshold from a 10 percent common ownership interest to 50 percent or more.  

(ii) Ten Year Requirement

Under current law, a purchaser of an existing building cannot qualify for acquisition tax credits if the building was placed in service during the previous 10 years from the proposed purchase date. The Act removes the 10-year requirement for certain affordable housing projects. Such projects include any federally or state assisted buildings that are substantially assisted, financed or operated under Section 8 of the US Housing Act of 1927, Sections 221(d), 221(d)(4) or 236 of the US Housing Act, Section 515 of the Housing Act of 1949 or any other housing program administered by the US Department of Housing and Urban Development or by the Rural Housing Service of the US Department of Agriculture or any “state assisted building” which is substantially assisted, financed or operated under any similar state law.

Recapture Bonds

Recapture Bonds were instituted to help ensure that investors comply with affordable housing and tax laws upon the sale of their properties. Investors in low income housing receive tax credits for a period of ten years if the property is maintained and continues to operate as low income housing for a period of 15 years. Even if the property is sold before the end of the 15- year period, the property must still remain as low income housing or the original investor will have to forfeit the 10-year tax credit that was received. In order for an investor to sell the property, the investor has to post a “recapture bond” in the amount of tax credits claimed. The recapture bond provides security to the Internal Revenue Service if the property fails to comply with affordable housing requirements and tax laws. If the property fails to comply with affordable housing requirements and tax laws, the IRS draws upon the recapture bond. The surety of the bond will then have to pursue the investor/seller to be made whole.

The Act removes the requirement that a recapture bond be posted upon the sale of an affordable housing project. In lieu of the recapture bond, the seller must show that there is a “reasonable expectation” that the affordable housing project will continue to be operated as affordable housing and comply with the laws governing such. This will be applied retroactively to any affordable housing project that can meet the “reasonable expectation” standard.

If you have any questions or comments on this Legal Alert, please do not hesitate to contact the Arent Fox attorneys listed.