But NAHB doesn’t just lobby Congress in favor of NAHB policies. We continually monitor Treasury Department regulations for their potential impact on housing programs or other business conducted by NAHB members, submitting comment letters when necessary as part of our efforts to safeguard members’ interests. In 2006, NAHB worked on a number of tax issues that had the potential to have an impact on multifamily builders and property managers, including those involved in Low Income Housing Tax Credit (LIHTC) partnerships. Here are summaries of the issues we’ve been tracking, followed by an at-a-glance chart of those issues.

Excise Tax on Certain Tax-Exempt Organizations (Internal Revenue Code Section 4965)

This new section of the tax code establishes a set of excise taxes on certain tax-exempt organizations that are party to a “prohibited tax shelter.” Prohibited tax shelters include what are commonly thought of as tax shelters (listed transactions), but also “reportable transactions.”  Under Section 4965, a reportable transaction includes any business arrangement entered into for a tax-related purpose that includes contractual protection.
 
Although the IRS has not precisely defined these terms, NAHB is concerned that “credit-adjuster” clauses (agreements to provide monetary compensation in the event that promised tax benefits are not delivered) in LIHTC partnerships with a tax-exempt partner could qualify as reportable transactions. These agreements, which NAHB believes are relatively common in the LIHTC industry, could not only make tax-exempt LIHTC partners subject to an excise tax, but also result in increased business expenses for other LIHTC partners, making it generally more difficult to produce affordable rental housing under the LIHTC program.

Congress intended these new excise taxes to apply to malicious tax shelters, and NAHB believes it obvious that these should not include tax code-sanctioned arrangements such as LIHTC partnerships. Consequently, NAHB submitted comments on the proposed regulations urging the IRS and the Department of the Treasury to explicitly exclude LIHTC, New Markets Tax Credit and historic housing rehabilitation credit arrangements from the set of reportable transactions. Treasury and IRS officials have noted in various public forums that they are indeed examining how the proposed regulations can be modified to possibly exclude such business arrangements.  NAHB continues to monitor this issue, seeking to ensure that future IRS guidance will provide fair treatment for LIHTC partnerships and avoid burdening them with an additional tax that would be inconsistent with Congressional intent.

Domestic Activities Deduction (Internal Revenue Code Section 199)

Established by the American Jobs Creation Act of 2004, this section of the tax code provides a deduction to builders for conducting regular business. For example, a multifamily builder may claim a deduction for constructing a new multifamily building. Moreover, many of the tasks that are done to support such construction, such as engineering and architecture services, also qualify for the deduction. The deduction is roughly equal to a percentage of the profit earned from qualified activities. The percentage is equal to 6% for 2007 through 2009, and grows to 9% in 2010. Clearly, the deduction is good news for multifamily builders.

However, NAHB was concerned that the proposed regulations published by the Department of the Treasury could make it excessively difficult for some builders to benefit fully from the deduction. As a result, NAHB, along with other organizations representing builders, filed comments asking for certain regulatory modifications. In the final regulations, Treasury adopted  many of these suggestions, which include a safe harbor for new construction partnerships and entities, a favorable exclusion of option ownership from land ownership requirements, and a de mininis for determining gross receipts. 

The Treasury Department continues to modify the Section 199 regulations, and NAHB continues to monitor the changes. An outstanding issue concerns new rules on the definition of domestic wages, which is used to limit the size of the deduction. NAHB currently is studying these new rules and will comment, if necessary. 

Capital Asset Exclusion Rules (Internal Revenue Code Section 1221)

An important component of the finance system for multifamily housing is the secondary mortgage market, where Fannie Mae and Freddie Mac play a key role. These government sponsored enterprises (GSEs) buy and sell securitized bundles of mortgages, thereby pooling risk and reducing the interest rate paid by borrowers.

For no obvious reason, the IRS released new regulations in 2006 that would change the tax treatment of certain notes bought and sold on secondary markets. Tax law enacted in 1954 treats mortgage-backed securities as ordinary — not capital — assets for tax purposes. The new regulations change this practice and require market participants, including the housing GSEs, to treat these securities as capital assets. This represents less favorable tax treatment. (Ordinary income can be offset by ordinary business expenses, but capital gains can be offset only by capital losses.) Consequently, in many cases the new regulations would increase the tax liability of secondary mortgage market participants and reduce the effectiveness of the market in supporting the multifamily housing finance system.

NAHB, along with Fannie Mae and other organizations, submitted comments recommending that the proposed regulations be withdrawn because they are inconsistent with decades of existing tax practice, tax court cases and Congressional intent. So far, the IRS has not been sympathetic to the NAHB argument. Therefore, depending on what changes are incorporated into the final regulations, NAHB may have to address the issue by advocating Congressional action.

Expense or Depreciate? (Internal Revenue Code Section 263(a))

The IRS and Treasury have issued major proposed revisions to the regulations dealing with the section of the tax code that governs the tax treatment of costs incurred with respect to the acquisition, construction and repair of property, including multifamily property. The intent of the proposed rules is to eliminate uncertainty that has existed in this area of tax law. However, NAHB has concerns about certain aspects of the proposed regulations and suggested several modifications in a comment letter.

NAHB has general policy in favor of “expensing” (deducting costs in the year they are incurred) rather than capitalizing the costs and realizing the tax deductions in the form of depreciation over the life of the project. The new rules tend to favor capitalizing expenses incurred for repair or restoration, but provide a safe harbor in the form of an annual repair allowance equal to a percentage of the property’s tax basis. Due to the potential size of multifamily property repair and restoration activities, and the likelihood of these activities to occur less frequently than annually, NAHB recommended that the IRS allow for a carryover of the annual repair allowance from year to year.

Further, NAHB suggested that for determining the unit of property rules (e.g. whether an entire building or each individual component should be defined as property for capitalization purposes), builders and subsequent owners of owner-occupied multifamily properties should be allowed to make an election defining the appropriate unit of property. This would allow this term to be defined appropriately for various ownership and physical structure forms of multifamily properties.  Finally, NAHB recommended the IRS establish a de minimis rule for acquisition costs, and define the rule by a percentage of basis, as opposed to some nominal amount. Such a rule would benefit builders and owners of land and structures, and prevent abuse of the rule by purchasers of large quantities of relatively smaller units of property (e.g. computers).

NAHB expects the IRS to produce a revised set of proposed regulations in early 2007. After another round of comments, the Treasury Department should publish final regulations in the summer.

Energy Efficiency Deduction (Internal Revenue Code Section 179D)

The IRS is in the early stages of providing guidance process on a new deduction for energy-efficient commercial buildings, which can apply to multifamily rental properties of four stories or more. The deduction is for expenses associated with the installation of heating, cooling, ventilation, hot water, or building envelope systems that produce a 50% reduction in building energy use.  A partial deduction is available for a 50% reduction in energy use for specific building systems.

The IRS has published its initial rules in a notice, rather than a proposed regulation, which means that the IRS is not soliciting comments. However, NAHB continues to study and monitor the issue, and will submit regulatory comment — as we have done with other energy tax issues — if the need arises. For example, with respect to the Section 45L Energy Efficient New Home Credit, NAHB has urged the IRS to make regulatory changes concerning certain certification standards. These changes will help home builders utilize the credit. 

Alternative Minimum Tax and the LIHTC (Internal Revenue Code Section 42)

The LIHTC annually leverages approximately $6 billion of private investment and produces more than 120,000 affordable apartments (including those produced through acquisition and rehab as well as new construction). Since the creation of the LIHTC program in 1986, the role of individual (as opposed to corporate) investors has changed from significant investor to minor player; individuals now supply very little capital to this housing tax program. In contrast, corporations now provide more than 95% of all new capital — a result of changes in tax laws, banking laws, the LIHTC program itself, and other changes in the investment landscape. The increasing impact of the alternative minimum tax (AMT) on individuals is likely to further erode the already limited role of individual investors. 

The diminished role of individual investors has, in turn, affected the type, size, and location of LIHTC projects that receive funding. In general, corporations invest in large projects ($5 million to $10 million). There also is some evidence that corporations are reluctant to invest in special-needs projects or in projects designed to spur economic or community revitalization. Because individual investors invest much smaller amounts and generally do not have the opportunity to invest in a portfolio comprised of large projects, individuals generally invest in smaller projects and base their investment decisions on idiosyncratic characteristics, such as the location of the project, the size of the project or the type of tenants. 

In order to counteract the trend away from individual investors and to increase investor resources for small, special-needs and rural projects, this past year NAHB has pursued — and will continue to pursue — a legislative change to allow LIHTCs to be among the tax credits that may be used against the AMT. In support of that effort, NAHB staff conducted a study of the issue and produced a detailed report outlining the economic and policy rationale for making a change in the tax law. This proposal was included in H.R. 4873, legislation introduced by Representatives Jim Ramstad (R-MN) and Richard Neal (D-MA) in the Spring of 2006 in the House of Representatives that would modernize and improve the Housing Credit program. On the Senate side, NAHB met with several key Senators on the Finance and Banking Committees to build support for the provision. Although legislation containing this proposal did not pass in the 109th Congress, NAHB will push for its inclusion in legislation moving in the 110th.

Exit Tax (Internal Revenue Code Section 1250)

Prior to the enactment of the LIHTC in 1986, one key tool for financing affordable housing was more rapid depreciation deductions for private investors. Today those investors carry a low or negative basis in their partnership interests which, in turn, trigger large depreciation recapture or “exit” tax obligations when the property is sold. As a result, most investors choose to hold onto their investment until the time of their death. At that time, when the property is passed to the heirs, a “stepped-up” basis goes into effect, and recapture taxes are eliminated. 

Exit taxes adversely affect the stock of affordable rental housing in two distinct ways. Lower-valued properties, the sale of which would not generate enough cash to cover exit taxes, deteriorate without the recapitalization dollars that could preserve the property. Properties in hot housing markets, on the other hand, will cover exit tax liabilities easily if they are converted to market-rate housing. In either case, limited affordable housing resources are endangered.

NAHB is working with a coalition of housing organizations to secure exit tax relief for affordable rental housing properties. In the fall of 2005, legislation was introduced in the House of Representatives by Representatives Jim Ramstad (R-MN) and Ben Cardin (D-MD). In July, 2006, companion legislation was introduced in the Senate by Senator Charles Schumer (D-NY) and Senator Gordon Smith (R-OR). Both pieces of legislation would give owners of federally-assisted housing relief from recapture taxes if they sell these properties to new owners who agree to maintain the property as affordable housing for 30 years. One important difference between the bills is that the Senate bill does not include LIHTC properties among the projects eligible for exit tax relief.

Since introduction of the House legislation, NAHB has worked with Rep. Ramstad to secure a revenue estimate from the Joint Committee on Taxation (JCT). To that end, NAHB staff developed an economic model for analysis of the cost impact of the House bill, which was submitted by Rep. Ramstad as part of the revenue estimate request to the JCT. Since the introduction of the two bills, NAHB staff has met extensively with staff of members of the House Ways and Means and Senate Finance Committees to promote the changes and build co-sponsorship. While these bills did not pass prior to the adjournment of the 109th Congress, they serve as markers for the next Congress. In the 110th Congress, NAHB will go back to our lead sponsors to reintroduce these bills.

NAHB staff will continue to monitor these and other tax issues in 2007. A new majority in Congress and the possibility of a tax reform effort in the next few years means that this area of Federal policy will continue to be of interest to the residential building community.

Finally, we encourage builders and developers to consult with a tax professional if it sounds as if the issues discussed above may affect your business. The set of financial and tax circumstances associated with every business tends to be unique, so only a tax practitioner can provide the guidance necessary to match your business interests and needs. [ return to top ]