Tax-Exempt Use Property

Aleks Frimershtein

(213) 629-6010

Section 47(c)(2)(B)

• HTC is based on amount of QREs

• “Qualified Rehabilitation Expenditures” do not include —

• (v) … Any expenditures in connection with the rehabilitation of a building which is allocable to the portion of such property which is (or may reasonably be expected to be) tax-exempt use property

What is Tax-Exempt Use Property?

Ownership

-- Tax-exempt entity

-- Property owned by partnership with tax-exempt partners

-- Property owned by partnerships with partners that are subsidiaries of tax-exempts

Disqualified Lease

-- Tax-exempt entity

-- Partnership with tax-exempt partners

What is a Tax-Exempt Entity

• The US, any state, political subdivision, possession of the US, any agency or instrumentality

• Exempt organizations (e.g., 501(c)(3), (c)(4), and pension funds)

• Any foreign person or entity or Indian tribe

• Tax-exempt controlled entity - corporation 50% of value is owned by tax-exempt

Section 168(h)(6) Election

• If we have a tax-exempt controlled entity, then it can make an election to not have the rules apply

• The election makes dividends, interest from the subsidiary, liquidating distributions, and sales of the corporate stock taxable to the exempt parent(s)

“Proportionate Share”

• Only the tax-exempt’s “Proportionate Share” of the property is considered “tax-exempt use”

• This is defined to be the tax-exempt’s highest interest in the partnership’s income or gain

• Ownership - If the tax-exempt’s interest in all tax items is the same, then we have a “qualified allocation”, and there’s no problem

.

Illustration of Proportionate Share

• A tax-exempt has a .01% interest in tax credits, and operating profits and losses. It also has a 50% interest in profits from a capital transaction (the “back end”)

• Proportionate share is 50%

• HTC cannot be claimed on 50% of the property unless qualified allocation

Disqualified Lease

A "disqualified lease" is defined as a lease to an exempt organization where

(1) Part or all of the property was financed directly or indirectly by tax-exempt debt … and the exempt org (or a related entity) participated in the financing, or

Disqualified Lease

(2) Under the lease there is a fixed or determinable purchase price or an option to buy that involves the exempt org, or

Disqualified Lease

(3) The lease term is in excess of 20 years,

– the term of the lease is deemed to begin when the property is first made available to the lessee under the lease.

– Include “realistic contemplation of the parties” at the time the property is first put into service.

– Includes enforceable option to renew

– Renewable at fair market value exception

Disqualified Lease

(4) The lease occurs after a sale or other transfer of the property from the exempt org (or a related entity) and the exempt org (or a related entity) used the property before the sale or lease.

– There’s a 3-month exception when first placed in service

Exceptions

• 35% Test - The disqualified lease rules apply only if the portion leased to tax-exempt entities under disqualified leases is more than 35% of the property

– Test applies to the “net rentable floor space” of the building. It does not include the common areas of the building.

• Short Term Lease - Less than 3 years

What Constitutes a Lease?

• Lease means any “grant of a right to use property”

• License

• Booking Arrangements

• Management/Servicing Contract

Lease Term

• Options to renew

• Service Contracts

– Part of the same transaction which includes a lease

– With respect to the property or substantially similar property

• Successive Leases

The Master Lease Problem

• Reg §1.168(j)-1T provides that you add together “multiple leases covering the same or substantially similar property that are part of the same (or substantially similar) transaction”

• Can apply to a master lease with a shorter lease to an exempt organization executed at the same time.

Recapture

Regs, 1.48-12(f)(3): if all or a portion of a rehab becomes tax-exempt use property within five years after the credit is claimed, the credit is recapture as if the property had then been sold.