Section 42(d)(4)(B) of the Internal Revenue Code reads: “The adjusted basis of any building shall be determined by taking into account the adjusted basis of property (of a character subject to the allowance for depreciation) used in common areas or provided as comparable amenities to all residential rental units in such building.” This is basically the statutory provision that allows owners of Low-Income Housing Tax Credit (LIHTC) projects to include in eligible basis the cost of common areas, as long as certain requirements are met.
Common Area
Common areas are facilities expected to be used by the tenants and can be reasonably associated with residential rental property. Examples provided in IRS guidance include parking areas and swimming pools. To qualify, the facility must meet two requirements:
- The common area must be made available on a comparable basis to the tenants of all residential rental units (not only low-income tenants); and
- No separate fee is required for the use of the facilities. This was made clear in the legislative history when §42 was originally passed as part of the Tax Reform Act of 1986, which stated, “…the allocable cost of tenant facilities, such as swimming pools, other recreational facilities and parking areas, may be included provided there is no separate fee for the use of these facilities and they are made available on a comparable basis to all tenants in the project.”
If such common area is excluded from eligible basis, IRC §42 does not control the taxpayer’s use of the common area.
Reasonably Required Facilities
A facility reasonably required by the project is, under Treasury Regulation §1.103-8(b)(4)(iii), residential rental property that is functionally related and subordinate to the residential rental units.
Examples of such facilities include employee units, which are not considered residential rental units, but rather as facilities reasonably required by a project that are functionally related and subordinate to the rental units. Therefore, such employee units may be included in eligible basis for cost purposes, but are not part of the applicable fraction of the building.
Revenue Ruling 2004-82, Q&A #1 explains that units occupied by security officers are also treated as reasonably required facilities.
Facilities Used to Provide Services
Eligible basis also includes facilities used by the owner of the project to provide tenants with services not normally associated with the leasing of residential rental property. For example, projects that provide common dining areas in which regularly prepared meals are served, may include the cost of the dining and kitchen facilities in eligible basis. Any fees charged to residents for meals or other services must be optional to the tenants; otherwise, the fees must be included for purposes of the gross rent calculation.
In summary, to be included in eligible basis, common areas must be (1) a facility reasonably required by the project; (2) subordinate to the residential rental units; (3) available to all residents on a comparable basis; and (4) available for no fee. LIHTC operators should be reminded that the “no fee” requirement is absolute. In other words, an outside entity also could not be charged a fee to use common area that was included in eligible basis.