In January 2021, the IRS released Notice 2021-12, extending various COVID-19 relief provisions for the Low-Income Housing Tax Credit (LIHTC) and Tax-Exempt Bond programs. The service also added relief with regard to deadlines for satisfying occupancy obligations.
Section IV.E of Notice 2021-12 provided an extension to satisfy certain occupancy obligations. It stated that for purposes of Section 42(f), “if the close of the first year of the credit period with respect to a building is on or after April 1, 2020, and on or before June 30, 2021, then the qualified basis for the building for the first year of the credit period is calculated by taking into account any increase in the number of low-income units by the close of the 6-month period following the close of that first year.”
Section 42(f) is “Definition and special rules relating to credit period.” This section includes special rules for the first year of the credit period, including how the applicable fraction is determined for the first year. Since the applicable fraction is used to determine qualified basis, Notice 2021-12 seemed to indicate that the six-month extension applied to any determination of a first-year qualified basis. This would mean that units qualified after the end of the first year of the credit period, but within the six-month extension, would qualify for first-year credits.
On March 16, 2021, the IRS issued Notice 2021-17, which was included in the April 5, 2021, Internal Revenue Bulletin. This notice provides a more precise reference citation, clarifying that Section IV.E of Notice 2021-12 applies only for purposes of §42(f)(3)(A)(ii). This section of the code stipulates that units qualified after the first year of the credit period will only be entitled to 2/3 of the credit that units qualified during the first year of the credit period may claim. This clarification indicates that increases in qualified occupancy during the six-month extension may be used to avoid two-thirds tax credits in the future but may not be used to actually claim first-year credit for units not qualified during the first year. In other words, units qualified after the first year of the credit period but within the six-month extension will claim accelerated credit beginning in the second year of the credit period. Units qualified during this extension will not be entitled to credits during the first year of the credit period.
We know two things with certainty based on the IRS Notice: (1) Units not qualified in 2020 will not be eligible for inclusion in a building’s applicable fraction in 2020 [i.e., no 2020 credit for those units]; and (2) if such units are qualified no later than June 30, 2021, they will not be considered “2/3” units, meaning taxpayers may claim an accelerated credit for those units beginning in 2021.
What We Don’t Know with Certainty
How will the credit in 2021 for units not qualified in 2020 but qualified no later than June 30, 2021, be determined? There are currently three schools of thought in the industry regarding how the credits for these units will be determined:
- A monthly weighted average will be applied to the units for the 2021 tax year and any disallowed credit will be claimed in year 12;
- A monthly weighted average will be applied to the units for the 2021 tax year and any disallowed credit is permanently lost; and
- Credit for 2021 will be determined based on the applicable fraction at the end of the tax year since 2021 is the second year of the compliance period.
To determine which of these scenarios is most likely, an examination of the credit calculation requirements outlined in the Code is required.
First Year Credit Calculation
Section 42(f)(2) of the Code outlines that credits during year one of the credit and compliance period are calculated using a monthly weighted average of applicable fractions as of the last day of each month (for buildings that are in service for the full calendar month). This is clear and is the method that will be used in the determination of 2020 credits. In other words, units not qualified during 2020 will not be eligible for 2020 credits.
Increases in Qualified Basis
§42(f)(3)(A) states that if qualified basis increases after the first year of the credit period, units that qualify and cause the increase in qualified basis after the first year will be subject to a “2/3” credit. In these cases, §42(f)(3)(B) states that the credit for these units will be determined using the same weighted average method as used in year one. This is the reason that some in the industry believe that numbers one or two noted above apply to the situation addressed in Notice 2021-12 and 17. However, there are two problems with this position:
- Since Notices 2021-12 and 17 state that units qualified no later than June 30, 2021, will be included in qualified basis at the end of 2020, there is no increase in qualified basis based on the qualification of these units, if qualified by June 30, 2021.
- There is only one first year of the credit period. In the scenarios envisioned by the IRS relative to the two notices, 2020 is the first year of the credit period – 2021 is year two of the credit period.
§42(c)(1)(A) stipulates that except for the first year of the credit period, the applicable fraction will be determined as of the close of each taxable year. So, based on the language in the Code, option three above is the most likely method for determining the credit for units qualified after 2020 but no later than June 30, 2021. Put another way, as long as low-income units are qualified by June 30, 2021, for properties that first claim credit in 2020, the units will generate credit for the entire 2021 tax year (assuming the units are in the applicable fraction at the end of 2021).
While we can never have complete confidence in positions that the IRS may take, the language in Section 42 seems to indicate that option three above is the most likely methodology to be used in the determination of credits for units qualified after 2020 but before June 30, 2021.