The next few articles in this series of articles on the IRS Audit Guide will focus on the important issue of Eligible Basis, the beginning point for the calculation of credits. This first article will discuss the costs that may be included in eligible basis.
In any examination of eligible basis, the IRS examiner will begin with an analysis of the actual qualifying costs incurred by the taxpayer. It is the responsibility of the taxpayer’s accountant (usually the accountant who completes the cost certification) to determine the items to be included in the determination of eligible basis.
Defining Eligible Basis
Eligible basis is primarily defined by §§103 and 168 or the IRC, with additional clarification in §42.
Under §42(d)(4)(A), to be included in eligible basis, a cost must be related to a “residential rental property.” The term ‘residential rental property’ has the same meaning for §42 as it does for IRC §103 (Private Activity Tax-Exempt Bonds). Essentially, a residential rental project consists of buildings or structures, together with any functionally related and subordinate facilities. A building or structure is a “discrete edifice or other man-made construction consisting of an independent foundation, outer walls, and roof. A single unit which is not an entire building but is merely a part of a building” is not a building or structure for purposes of §42.
IRS Notice 88-91 further explains that buildings include apartment buildings, single-family dwellings, townhomes, row houses, a duplex, or a condominium. Housing owned by a cooperative housing corporation or a tenant-stockholder is not included in this definition.
Buildings that may qualify for the credit include:
>new buildings;
>existing buildings; and
>rehabilitation expenditures on an existing building.
Costs included in eligible basis must be depreciable property under ITC §168. For this reason, land may not be included in eligible basis, since land does not depreciate (i.e., it does not diminish in value over a period of time).
IRC §168(e)(2)(A) defines ‘residential rental property’ to mean any building or structure if 80% or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units, not including units in a hotel, motel, or other establishment if more than half the units are used on a transient basis. Also, depreciable residential rental property expensed under IRC §179 may not be included in eligible basis.
Residential Rental Unit
A unit is defined in Treasury Reg. §1.103-8(b)(8)(i) to mean “any accommodation containing separate and complete facilities for living, sleeping, eating, cooking, and sanitation”. Such accommodations may be served by centrally located equipment, such as air conditioning or heating. Thus, for example, an apartment containing a living area, a sleeping area, bathing sanitation facilities, and cooking facilities equipped with a cooking range, refrigerator, and sink, all of which are separate and distinct from other apartments, would constitute a unit.
Single room occupancy (SRO) units also qualify as residential rental units even though the units may provide eating, cooking and sanitation facilities on a shared basis.
Common Areas
Eligible basis includes the cost of common areas provided as comparable amenities to all residential rental units in a building. These are facilities for use by the tenants, and other facilities reasonably required by the project.
Community Service Facilities
The eligible basis of any building located in a qualified census tract (QCT) includes the adjusted basis of any property used to provide services for certain nontenants. These are known as “community service facilities,” and must (1) be located in a QCT, (2) serve primarily individuals whose income is 60% or less of area median income, and (3) used throughout the taxable year as a community service facility. Also, any fees charged for the services provided in the facility must be affordable to persons at or below the 60% income level, and the need for the services should have been stipulated in the project’s market study.
Transitional Housing & Supportive Services for the Homeless
If a project provides transitional housing for the homeless, the portion of the building used to provide supportive services may be included in eligible basis. To qualify as transitional housing: (1) the building must be used exclusively to facilitate the transition of homeless individuals (as defined in the McKinney-Vento Homeless Assistance Act) to independent living within 24 months, and (2) a governmental entity or nonprofit organization provides the individuals with temporary housing and supportive services designed to assist such individuals in locating and retaining permanent housing. No more than 20% of the building can be used for supportive services.
Functionally Related Facilities
Facilities that are functionally related and subordinate to residential rental projects may be included in eligible basis. Examples of such spaces are swimming pools, recreational facilities, parking areas, and other facilities reasonably required by the project (e.g., heating & cooling equipment, trash disposal equipment, and units for resident employees.
Landscaping & Land Improvements
If costs associated with land preparation are so closely associated with a depreciable asset so that it will have to be replaced at the same time as the depreciable asset, such costs may be included in eligible basis.
Date of Determination
For a new building, the eligible basis is the adjusted basis as of the close of the first taxable year of the credit period. The same rule applies for existing buildings, but there are additional rules. The rule also applies to rehab expenses treated as a separate new building, but only if the “minimum expenditure” test has been met.
In future articles on eligible basis, I will discuss
>How the IRS Reconciles Eligible Basis and Identifies “Large, Unusual, or Questionable” Items;
>How the IRS Verifies Assets Included in Eligible basis;
>Specific Issues Relating to Common Areas, Required Facilities, and the Provision of Services; and
>Developer Fees