Section 42 (h) (5) of the Internal Revenue Code requires that Housing Finance Agencies set aside at least ten percent of their annual allocation for use by non-profit entities. This “non-profit pool” is available only to Qualified Nonprofit Organizations and for-profit entities are precluded from obtaining credits from this pool.
One of the most confusing requirements relating to the nonprofit set-aside is the “material participation” stipulation. A qualified nonprofit organization must materially participate in both the development and operation of the project throughout the 15-year compliance period. IRC §469(h) defines material participation as activity that is regular, continuous, and substantial. The IRS applies the following guidelines to determine if the participation is “material.”
- Is the activity a principle business or activity of the nonprofit?
- Is there involvement in the actual operations of the activity? Services provided must be integral to project operations. Simply consenting to someone else’s decisions or periodic consultation with respect to general management decisions is not material participation.
- Participation must be maintained throughout the year. Periodic consultation is not sufficient.
- Regular on-site presence at operations is indicative of material participation.
- Providing services as an independent contractor is not sufficient.
Meeting this “material participation” requirement should not be an issue when the nonprofit is the sole general partner and also manages the property.
However, it the partnership has one or more for-profit general partners, the nonprofit partner could have less participation in the partnership, which will attract scrutiny from the IRS. Also, if the management agent is a for-profit entity and operates the property without ‘regular, continuous and substantial’ oversight from the nonprofit, questions could be raised relating to material participation.
Nonprofit developers of LIHTC projects that receive an allocation of credits from the nonprofit pool should be diligent in ensuring constant and meaningful participation in project operations.
Keep in mind that from a tax standpoint, the nonprofit material participation requirement only applies to deals that receive credits from the nonprofit set-aside. Projects that receive points on their tax credit application for the participation of a nonprofit in the deal and an award of credits from other than the nonprofit set-aside are not subject to the material participation requirements from the standpoint of tax law. However, there may be an HFA requirement for material participation in these cases, and any such requirement should be outlined in the project’s extended use agreement.