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Federal Tax

Tax Court Rejects IRS Clawback of Low-Income Housing Credit

Checkpoint Federal Tax Update Staff  

· 5 minute read

Checkpoint Federal Tax Update Staff  

· 5 minute read

The Tax Court rejected the IRS’ attempt to recapture low-income housing credits from a real estate developer and determined that the taxpayer properly included in eligible basis all financing costs, including bond fees that were incurred “by reason of” the taxpayer’s construction of residential rental property, for purposes of the low-income housing tax credit. (23rd Chelsea Associates, LLC, (2024) 162 TC No. 3)

23rd Chelsea LLC, a partnership, constructed residential rental property during 2001 and 2002. The partnership financed the construction with a loan from the New York State Housing Finance Agency, which funded the loan at least partially using tax-exempt bonds.

The partnership claimed low-income housing credits (LIHCs) for tax years 2003 through 2009. When calculating its yearly credit, 23rd Chelsea included in the property’s eligible basis bond fees some the financing costs it incurred in connection with the housing agency loan, including bond fees charged by the HFA.

The IRS, in a notice of final partnership administrative adjustment for 2009, determined that the partnership shouldn’t have included any of the financing costs in eligible basis. As a result, the IRS proposed reducing the partnership’s LIHC for 2009 and increasing its tax under the credit recapture provisions of Code Sec. 42J for 2003 through 2008.

The Tax Court rejected the IRS’ argument that financing costs were not part of the property’s eligible basis.

Note. The financing costs were the only part of 23rd Chelsea’s LIHC computation that the IRS disputed.

According to the Tax Court, the taxpayer was required to capitalize into the building’s basis the financing costs that were incurred by the construction of the residential rental property. Accordingly, the building’s eligible basis included all the financing costs that were (1) allocable to the residential rental property, (2) were incurred because of the taxpayer’s decision to finance the building’s construction with an HFA loan, and (3) incurred by the end of the first year of the credit period (2003).

The record clearly indicated that the financing costs includible in the building’s eligible basis was at least the amount that the taxpayer actually included in its calculation, the Tax Court said.

Further, the court held that financing costs for production activities are not allocable to a separate “financing” activity if those costs are allocable to the production period (here 2001 and 2002) but are an “indivisible part” of the construction to the extent that the financing was allocable to the production period.

For more information about the special rules for calculating the adjusted basis of a building for purposes of the low-income housing credit, see Checkpoint’s Federal Tax Coordinator ¶ L-15909.


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