The Determination of Qualified Basis for LIHTC Projects
Qualified basis is a portion of a low-income building’s eligible basis associated with the low-income units. In simplest terms, it represents the amount of money spent on the construction of a building that benefits low-income residents.
Eligible basis x Applicable Fraction = Qualified Basis.
While qualified basis is a function of both eligible basis and the applicable fraction, there are specific IRC §42 rules and limitations that apply directly to qualified basis.
A qualified low-income building’s qualified basis is determined for each taxable year in the building’s 15-year compliance period.
Increases to Qualified Basis
Qualified basis is initially determined at the end of the first year of the credit period and, since the eligible basis is fixed at the same time, qualified basis is (generally) a function of the applicable fraction. The qualified basis may increase after the initial year determination, but only if the number of qualified low-income units increases after the end of the first year of the credit period; i.e., there is an increase in the applicable fraction.
The credit associated with an increase in qualified basis after the end of the first year of a building’s credit period is computed differently than the credit determined at the close of the first year of the building’s credit period. Under IRC §42(f)(3)(A), the applicable percentage under IRC §42(b) is equal to two-thirds of the applicable percentage that would otherwise apply to the building. As a result, the credit associated with an increase in qualified basis is commonly referred to as the “2/3 credit.”
Following is an example of how the credit for an increase in qualified basis is calculated:
- A taxpayer owns a qualified low-income building with 100 units with eligible basis of $10,000,000.
- The applicable percentage is .0900 (9%).
- The applicable fraction at the end of the first year of the credit period was .8500 (85 of the 100 units were low-income).
- The qualified basis for the first year of the credit period was:
- $10,000,000 x .8500 = $8,500,000.
- The maximum credit for the first year of the credit period is computed as the qualified basis times the applicable percentage:
- $8,500,000 x 9% = $765,000.
- The applicable fraction for the second year of the credit period was .9500 (95%).
- The qualified basis is $10,000,000 x .9500 = $9,500,000 and the increase in qualified basis is $1,000,000.
- The credit for the initial qualified basis is the same as computed for the first year of the credit period, $765,000.
- The 2/3 credit associated with the $1,000,000 increase in qualified basis is computed as:
- $1,000,000 x (.0900)(2/3) = $60,000
- In total, the taxpayer may claim credit equal to $825,000, computed as $765,000 + $60,000.
Rules Relating to Increases in Qualified Basis
Under IRC §42(f)(3)(B), when computing the applicable fraction for the increase in qualified basis for the first year of the increase, the special rule for the first year of the credit period in IRC §42(f)(2) is applies; i.e., the sum of the applicable fractions determined at the end of each full month of such year is divided by 12. For this reason, unless the 2/3 units are qualified in the first month of the second year of the credit period, they will not generate the full 2/3 credit for the year.
An increase in qualified basis can only result from an increase in the applicable fraction after the end of the first year of the credit period. There is no other circumstance in which a 2/3 credit is calculated.
The sum of the credit associated with the initial qualified basis and the 2/3 credit cannot exceed the maximum allowable credit allocated to the building by the state housing agency, as indicated on Line 1b of IRS Form 8609.
Maximum Qualified Basis
IRC §42(m)(2) requires that state housing agencies limit the amount of credit allocated to a building so that it does not exceed the amount necessary to ensure the building’s financial feasibility and viability as a qualified low-income housing project throughout the credit period.
This limit on the credit amount can be accomplished by limiting the qualified basis used to compute the credit. Under §42(h)(7)(D), the agency making the credit allocation specifies the applicable percentage and the maximum qualified basis associated with the low-income building. The maximum qualified basis specified may be less than, but never more than, the actual qualified basis. The building’s maximum qualified basis is documented on Form 8609, Line 3a.
When the actual qualified basis exceeds the maximum qualified basis, the difference is commonly referred to as “excess basis.”
Imputed Zero Qualified Basis
A building’s qualified basis can be deemed to be zero. Examples of when this could occur include:
- The entire building is noncompliant with IRC §42 requirements. For example, the building is not considered suitable for occupancy because of building-level noncompliance with the Uniform Physical Condition Standards (UPCS).
- The project, of which the building is a part, did not satisfy the minimum set-aside requirement.
- The extended use agreement is not in place at the end of the year and the taxpayer failed to correct the noncompliance within one year of the date it was determined that the agreement was not in place.
- The taxpayer disposes of the building and the taxpayer is subject to recapture.
In the event of a casualty loss in a presidentially declared major disaster area, Revenue Procedure 2007-54 provides that the building’s qualified basis at the end of the taxable years of the casualty loss and restoration period is the qualified basis at the end of the taxable year that preceded the President’s major disaster declaration. In other words, there is no reduction in qualified basis.
Qualified Basis Subject to Recapture
The allowable credit for the qualified basis at the end of the first year of the credit period is determined based on the premise that the taxpayer is obligated to provide low-income housing for 15-years (five years after the end of the credit period). This does not include the additional time required by the Extended Use Agreement. What this means is that a portion of the allowable credit each year is claimed before it is earned. If there is a decrease in qualified basis at any time after the first year of the credit period, then the credit that was claimed but not earned is subject to recapture.
The “2/3” credit associated with increases in qualified basis is based on providing low-income housing for that taxable year only. Thus, the credit claimed for these units is not subject to recapture.