A bond issuer gets more time to fix which affordability test applies to a tax-exempt rental project

Plain-English summary

Interest on state and local bonds is generally tax-exempt, and one qualifying use is financing a "qualified residential rental project" under section 142(d). To qualify, the project must meet one of two affordability set-aside tests the issuer elects when the bonds are issued: the 20-50 test (at least 20% of units occupied by tenants earning 50% or less of area median income) under section 142(d)(1)(A), or the 40-60 test (at least 40% of units at 60% or less of area median income) under section 142(d)(1)(B). Here the issuer and borrower always intended to use the 20-50 test, and their planning documents said so, but bond counsel inadvertently referenced the 40-60 test in some final documents, including the Form 8038 filed with the IRS, creating an ambiguity that meant no valid election was made. The mistake was caught before the project was placed in service and before the IRS discovered it. Under section 301.9100-3, the IRS can extend a missed regulatory election deadline when the taxpayer acted reasonably and in good faith and relief will not prejudice the government. The IRS found the issuer acted promptly and without hindsight and that granting relief would not lower anyone's tax liability, so it granted a 45-day extension to make a proper election of the 20-50 test. This lets the issuer correct the paperwork error and preserve the bonds' tax-exempt status.

Ruling snapshot

• Question: Should a bond issuer that inadvertently failed to properly elect the 20-50 affordability test get a section 9100 extension to make that election for its residential rental project?
• Outcome: approved (45-day extension to elect the 20-50 test granted)
• Key authorities: IRC §§ 142(d)(1)(A), 103, 141(e); Treas. Reg. §§ 301.9100-1, 301.9100-3, 301.9100-7T

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201910020                                              Third Party Communication: None
Release Date: 3/8/2019                                         Date of Communication: Not Applicable
Index Number: 142.04-00, 9100.00-00;
                                                               Person To Contact:
---------------------------------------------                  ----------------- ID No. -------------
------------------------------------------------------------   Telephone Number:
-------------------------------                                ---------------------
--------------------------                                     Refer Reply To:
------------------------------------                           CC:FIP:B05
                                                               PLR-131418-18
                                                               Date:
                                                               November 21, 2018




LEGEND:

Issuer            =         -----------------------------------------------------------------------------------------
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----------------------------------------------------

County            =        --------------------------

Bonds             =         -----------------------------------------------------------------------------------------
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                           --------------------------------------------------

Borrower          =        --------------------------------

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

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


Dear ----------------:

This is in response to your request for an extension of time under § 301.9100-1 of the
Procedure and Administration Regulations to elect the use of the 20-50 test as
described in § 142(d)(1)(A) of the Internal Revenue Code (the Code).

Facts and Representations

Issuer is authorized to issue debt to improve the welfare of the people living in County.
Issuer issued the Bonds on Date 1 to finance a qualified residential rental project (the
“Project”) within the meaning of § 142(d)(1). Borrower, the conduit borrower of the
Bond proceeds, expects to place Project into service on or about Date 2.
PLR-131418-18                                 2


Borrower covenanted in the Bond documents to operate Project as a qualified
residential rental project under § 142(d)(1). To be qualified under that section the
Project must at all times during the qualified project period meet the requirements of
either § 142(d)(1)(A) (the 20-50 test) or § 142(d)(1)(B) (the 40-60 test).

Throughout the process of planning for, designing, and obtaining financing for the
Project, Issuer and Borrower intended that Project would proceed under the 20-50 test
as defined in § 142(d)(1)(A). Thus, documents prepared by or at the direction of
Borrower such as a feasibility study, a current and proposed rents worksheet, and a
agreement between Borrower and the dissemination agent, reference the 20-50 test.
Certain documents prepared by or at the direction of the Bond underwriter, including the
Bond purchase agreement and the Bonds preliminary limited offering memorandum,
also reference the 20-50 test. Finally, certain documents prepared by or on behalf of
Issuer including the Project lease agreement also reference the 20-50 test.

However, during the course of document preparation by Bond counsel certain Bond
documents inadvertently reference the 40-60 test under § 142(d)(1)(B) rather than the
20-50 test under§ 142(d)(1)(A). These documents include the final limited offering
memorandum, the regulatory agreement, the tax certificate, and Form 8038 filed with
the IRS.

The inclusion of the 20-50 test in certain Bond documents and the 40-60 test in other
Bond documents was the result of parties focusing on different aspects of the
transaction and an unintentional failure by certain parties to communicate fully with one
another.

Prior to lease-up of Project, Borrower discovered that the regulatory agreement
referenced the wrong test and promptly communicated the discrepancy to Bond
counsel. Bond counsel immediately identified the discrepancy in the other Bond
documents as noted above, and prepared amendments to the regulatory agreement,
the tax certificate, and Form 8038 reflecting the 20-50 election. Subsequently, this
ruling request was submitted to the IRS before the Project was placed in service.

Law and Analysis

Section 103(a) provides that, except as provided in § 103(b), gross income does not
include interest on any state or local bond. Section 103(b)(1) provides that § 103(a)
shall not apply to any private activity bond unless it is a qualified bond. Section 141(e)
provides that an exempt facility bond is a qualified bond. Section 142(a)(7) provides
that the term exempt facility bond includes any bond issued as part of an issue 95
percent or more of the net proceeds of which are to be used to provide a qualified
residential rental project.
PLR-131418-18                                  3

Section 142(d)(1) defines a qualified residential rental project as a project for residential
rental property that, at all times during the qualified project period meets the
requirements of either subparagraph (A) or (B), whichever is elected by the issuer at the
time of the issuance of the issue with respect to such project.
The project meets the requirements of § 142(d)(1)(A) if 20 percent or more of the
residential units in such project are occupied by individuals whose income is 50 percent
or less of area median gross income.

The project meets the requirements of § 142(d)(1)(B) if 40 percent or more of the
residential units in such project are occupied by individuals whose income is 60 percent
or less of area median gross income.

Section 301.9100-7T(g) of the Temporary Procedure and Administration Regulations
provides, in part, that the election under § 142(d)(1) must be made in the bond
indenture or a related document on or before the date of issue. Under § 301.9100-
7T(a)(4)(i), the election is irrevocable.

Section 301.9100-1 of the Procedure and Administration Regulations provides, in part,
that the Commissioner has discretion to grant a reasonable extension of time to make a
regulatory election (defined in § 301.9100-1(b) as an election whose due date is
prescribed by regulations published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal Revenue
Bulletin), or a statutory election (but no more than 6 months except in the case of a
taxpayer who is abroad), under all subtitles of the Internal Revenue Code except
subtitles E, G, H, and I.

Section 301.9100-3(a) provides that requests for extensions of time for regulatory
elections that do not meet the requirements for automatic extensions in § 301.9100-2,
such as this request, must be made under the rules of § 301.9100-3. Pursuant to
§ 301.9100-3(a), requests for relief will be granted if the taxpayer provides evidence
establishing to the satisfaction of the Commissioner that the taxpayer acted reasonably
and in good faith, and that the grant of relief will not prejudice the interests of the
Government.

Section 301.9100-3(b)(1) provides, in part, that a taxpayer is deemed to have acted
reasonably and in good faith if the taxpayer requested relief under § 301.9100-3 before
the failure to make the regulatory election is discovered by the IRS. Section 301.9100-
3(b)(3)(iii) provides, however, that the taxpayer has not acted in good faith if it used
hindsight in requesting relief.

Section 301.9100-3(c)(1)(i) provides, in part, that the interests of the Government are
prejudiced if granting relief would result in a taxpayer having a lower tax liability than the
taxpayer would have had if the election had been timely (taking into account the time
value of money).
PLR-131418-18                                  4


Based on the facts as recited above, election of the 40-60 test as reflected in certain
bond documents prepared by Bond counsel, including Form 8038 filed with the IRS was
inadvertent. Although other bond documents prepared by Issuer and Borrower prior to
those prepared by Bond Counsel accurately reflect the Issuer and Borrower’s intent to
elect the 20-50 test, we conclude that the ambiguity created by Bond counsel’s
inadvertent reference to the 40-60 test in certain documents caused an election not to
have been properly made.

We note that (1) the inadvertent reference was discovered before the property was
placed in service (and before discovery by IRS) and (2) if we grant the relief requested
by Issuer, neither the Bond holders nor the Issuer will have a lower tax liability than if
the election had been properly and timely made.

Based on all of the facts and circumstances, we conclude the Issuer acted promptly and
in good faith upon discovery of the mistake and that the request for relief is not based
on Issuer’s hindsight. We also conclude that the interests of the government will not be
prejudiced if we grant the relief requested by Issuer. Thus, we permit the Issuer, within
a reasonable time after the date of this letter ruling, to make a proper election under
§ 301.9100-7T to have the 20-50 test as described in § 142(d)(1)(B) apply to the
Project.

Conclusion

Issuer is granted an extension of time of 45 days from the date of this letter ruling to
make a proper election in accordance with § 301.9100-7T(g), of the 20-50 test
described in § 142(d)(1)(A).

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any transaction or item discussed or referenced in this letter.
This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.
PLR-131418-18                               5

The ruling contained in this letter is based upon information and representations
submitted by Issuer and accompanied by penalty of perjury statements executed by the
appropriate parties. While this office has not verified any of the materials submitted in
support of the request for a ruling, it is subject to verification upon examination.

                                         Sincerely,

                                         Assistant Chief Counsel
                                         (Financial Institutions and Products)

                                                      /s/
                                         By:_______________________
                                            Timothy L. Jones
                                            Senior Counsel, Branch 5