CCA 1352009: Credit consequences when nonprofit involvement in a housing project lapses

Plain-English summary

Chief Counsel analyzed the tax consequences when a low-income housing project no longer has the required qualified nonprofit organization involved throughout the compliance period. The advice describes a limited partnership whose nonprofit general partner was removed, whose replacement was not found before the state housing agency's deadline, and whose compliance was later restored. Chief Counsel concluded that, if the facts support a violation at the close of a taxable year, the Service may disallow the low-income housing credit for that year. The failure does not by itself reduce qualified basis in a way that triggers credit recapture under section 42(j)(1). The taxpayer may claim the credit for the taxable year in which the violation is corrected, assuming it is otherwise eligible. The advice also notes that state-court remedies may be available in some circumstances.

Ruling snapshot

• Question: What are the tax consequences when a project fails to maintain qualified nonprofit involvement required by IRC § 42(h)(5)(B)?
• Outcome: Advice given, with credit disallowance for a taxable year in which the violation remains uncorrected at year-end, and credit potentially available for the correction year if otherwise allowable.
• Key authorities: IRC §§ 42(f)(1), 42(h)(5)(B)-(C), 42(i)(1), 42(j)(1), 42(j)(6)(A), and 469(h)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201352009
       Release Date: 12/27/2013
       CC:PSI:5:JHGrant                                         Third Party Communication: None
       POSTN-128702-13                                          Date of Communication: Not Applicable

UILC: 42.00-00

date: September 16, 2013

 to:   Glenn Deloriea
       Program Manager, Technical Issues
       (Small Business/Self-Employed)

from: Christopher J. Wilson
Senior Counsel, Branch 5
(Passthroughs & Special Industries)

subject: Noncompliance under § 42(h)(5)(B) of the Internal Revenue Code

       This Chief Counsel Advice responds to your request regarding the tax consequence(s)
       of a failure to comply with the requirement of § 42(h)(5)(B) to maintain the involvement
       of a qualified nonprofit organization in the development and operation of the project
       throughout the compliance period. This advice may not be used or cited as precedent.


       LEGEND

       Taxpayer          =         ---------------------------------------------
       ---------------------------------------------------
       --------------------------------------------------------------------------------
       -------------------------------------------------------

       Date 1            =        ---------------------------

       Year 1            =        -------

       Year 2            =        -------

       Year 3            =        -------

       Date 2            =        ----------------------------

POSTN-128702-13 2

Date 3 = ---------------------------

FACTS

Taxpayer, a limited partnership, owns a multi-building low-income housing project.
Initially, Taxpayer consisted of: (1) a nonprofit corporation general partner (“nonprofit
GP”), a qualified nonprofit organization under § 42(h)(5)(C), (2) an investment limited
partner (“LP”), and (3) a special limited partner (“special LP”).

On Date 1, the project received from the applicable state housing credit agency an
allocation of low-income housing credits derived from the state ceiling set-aside for
projects involving qualified nonprofit organizations under § 42(h)(5). All of the project
buildings were placed in service in Year 1. The credit period for all the project buildings
also began in Year 1.

In Year 2, Taxpayer gave the nonprofit GP notice of removal from the partnership for
breach of the partnership agreement and failure to perform the duties of the general
partner under the agreement. The notice also informed the nonprofit GP that removal
constitutes an “event of withdrawal” from the partnership and a relinquishment of the
nonprofit GP’s entire partnership interest in the partnership. Under the partnership
agreement, the special LP, which is not a qualified nonprofit organization described
under § 42(h)(5)(C), became the general partner of Taxpayer.

The LP consulted with the state housing credit agency prior to removing the nonprofit
GP. The state housing credit agency allowed Taxpayer a specified period of time to
replace the nonprofit GP with another qualified nonprofit organization described under
§ 42(h)(5)(C). Taxpayer promptly started to search for another qualified nonprofit
organization as a replacement, without success. In Year 3, after the specified period of
time allowed by the state housing credit agency had expired, the agency reported the
noncompliance to the Service and provided that the project ceased to be in compliance
with § 42 as of Date 2.

On Date 3, Taxpayer found a qualified nonprofit organization replacement that is
described § 42(h)(5)(C). The state housing credit agency reported to the Service that
Taxpayer had corrected the noncompliance and was again in compliance.

The nonprofit GP is contesting removal from the partnership in state court.

LAW AND ANALYSIS

Section 42(h)(5) provides that each state must set aside at least 10% of its annual state
housing credit ceiling for allocations to projects involving a qualified nonprofit
organization. Under § 42(h)(5)(B), a qualified nonprofit organization is involved in the
project if it owns an interest in the project (directly or through a partnership), and
POSTN-128702-13 3

materially participates (within the meaning of § 469(h)) in the development and
operation of the project throughout the compliance period. Under § 42(h)(5)(C), a
"qualified nonprofit organization" is any organization described in § 501(c)(3) or (4) and
is exempt from tax under § 501(a), determined by the state housing credit agency as
not to be affiliated with or controlled by a for-profit organization, and has as one of its
exempt purposes the fostering of low-income housing.

Under § 42(i)(1), the compliance period for any building is the period of 15 taxable years
beginning with the 1st taxable year of the building’s credit period. Under § 42(f)(1), the
building’s credit period begins the year the building is placed in service, or, at the
election of the taxpayer, the succeeding taxable year.

Under § 42(j), if 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, the taxpayer’s tax for the
taxable year will be increased by the credit recapture amount as determined under
§§ 42(j)(2) and (3).

The legislative history to § 42 provides generally that any change in ownership of a low-
income building during the compliance period is a recapture event and that all
dispositions of ownership interests in buildings are treated as transfers for purposes of
recapture. H.R. Conf. Rep. No.841, 99th Cong., 2d Sess., II-96 and II-102 (1986), 1986-
3 (Vol.4) C.B. 1, 96, 102.

Section 42(j)(6)(A) provides, however, that the increase in tax under § 42(j) 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 building for the remainder of the building’s compliance period.

Neither the statute, regulations, nor legislative history to § 42 provide the tax treatment
for a failure to maintain the involvement of a qualified nonprofit organization in a project
throughout the compliance period under § 42(h)(5)(B). Failure to maintain the
involvement of a qualified nonprofit organization in a project under § 42(h)(5)(B) occurs
when the qualified nonprofit organization does not own an interest in the project (directly
or through a partnership) or fails to materially participate (within the meaning of
§ 469(h)) in the development and operation of the project throughout the compliance
period.

Although the statute and legislative history are silent regarding the tax consequences
resulting from noncompliance with the requirements of § 42(h)(5)(B), it is reasonable to
infer that negative tax consequences can result from a violation of these requirements.

POSTN-128702-13 4

Under § 42(j)(1), recapture of credit results when the amount of qualified basis of any
building with respect to the taxpayer is less than the qualified basis as of the close of
the preceding taxable year. Failure to maintain the involvement of a qualified nonprofit
organization in a project under § 42(h)(5)(B) does not, in and of itself, result in an actual
(or an imputed) decrease in the qualified basis of a building that results in recapture
under § 42(j)(1). This is distinguishable from the disposition of a building (or an
ownership interest therein) where the statute and legislative history to § 42(j) specifically
provide that recapture can occur, and if so, a decrease of qualified basis must
necessarily be imputed because there is no actual decrease in the qualified basis of the
building. There is no evidence of Congressional intent to extend the tax consequences
for a disposition of a building (or ownership interest therein) to a violation of
§ 42(h)(5)(B), and we do not infer such an intent.

Section 42(h)(5)(B) provides that a qualified nonprofit organization is to own an interest
in the project (directly or through a partnership) and materially participate in the
development and operation of the project throughout the compliance period. (emphasis
added) This language infers that failure to meet the ownership or material participation
requirements of this section during the compliance period results in a negative tax
consequence. In this instance, we believe the proper tax consequence is loss of credit
for any taxable year where the violation remains uncorrected as of the close of the
taxable year. We recognize that this tax consequence may be viewed as inadequate for
a violation of § 42(h)(5)(B) occurring after the 10-year credit period for projects where
there remains no allowable credit and therefore, no credit to disallow. However,
alternative approaches may be available in state court. For example, as is the case
here, a qualified nonprofit may bring suit in state court if it believes that it has been
improperly removed. Similarly, it may be possible for a state allocating agency to
enforce the terms of the allocation in state court, or, if impracticable, to seek some other
form of remedial relief (e.g., damages) for a breach of the terms of the contractual
arrangement represented by the allocating document.

In summary, if the Service finds that the facts and circumstances support a finding that
Taxpayer failed to maintain the involvement of a qualified nonprofit organization in the
project under § 42(h)(5)(B) as of the close of a taxable year, the Service may disallow
credit for the taxable year. Taxpayer may claim credit for the taxable year that the
violation is corrected (assuming Taxpayer is otherwise eligible to claim credit for that
taxable year).

Finally, we point out that the cause of most § 42 violations are usually under the control
of the taxpayer (i.e., ownership entity). However, a violation of § 42(h)(5)(B) can occur
solely by the actions of the qualified nonprofit organization (e.g., loss of § 501(c)(3) or
(4) status, a decision by the nonprofit to terminate the organization or withdraw from the
partnership, etc.) and thus, outside the taxpayer’s control. --------------------------------------

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POSTN-128702-13 5

In accordance with § 6110(k)(3), this document may not be used or cited as precedent.
Please call me or Jian H. Grant at (202) 622-3040 if you have any further questions
about this matter.