Real Estate

March 13, 2024

7807 / What recapture rules apply when claiming the low-income housing tax credit?

<div class="Section1">If, at the close of any taxable year in the 15-year compliance period, the amount of the qualified basis of any building is less than the amount of such basis at the close of the preceding taxable year, part of the low-income housing credit may have to be recaptured and interest paid from the time when the recaptured credit was originally taken at the federal overpayment rate under IRC Section 6621. A decrease in qualified basis is not subject to the recapture rule to the extent the amount of the decrease does not exceed the amount of a previous increase in qualified basis for which an additional credit of ? of the applicable percentage has been taken (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7804">7804</a>). The recaptured credit and interest are added to the taxpayer’s regularly calculated tax. No deduction may be taken for the interest paid. The amount of low-income housing credit that is recaptured is determined by subtracting from the aggregate amount of credits allowed in prior taxable years the aggregate amount of credits that would have been allowable if the aggregate credits allowable for the entire compliance period were allowed ratably over 15 years.<a href="#_ftn1" name="_ftnref1">1</a> Temporary relief may be granted for buildings located in federally declared disaster areas.<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> Generally, the qualified basis will change if the applicable fraction of low-income housing units or floor space changes or if the property ceases to qualify as low-income housing. However, if there is a de minimis change to the floor space fraction and the property continues to be low-income housing following the change, no recapture results.<a href="#_ftn3" name="_ftnref3">3</a> A disposition of the building (or interest therein) beyond the 15-year compliance period does not result in recapture of the low-income housing tax credit. A disposition within the 15-year compliance period will result in recapture, unless the taxpayer posts a bond and the building is reasonably expected to qualify as low-income housing throughout the remainder of the 15-year compliance period.<a href="#_ftn4" name="_ftnref4">4</a> A partnership that has 35 or more partners may make an irrevocable election to have the partnership treated as the taxpayer to whom the credit was allowable. Two spouses (and their estates) are treated as one partner for this purpose. If the election is made, recapture is allocated to the partners in the same manner as the partnership’s taxable income is allocated for the year in which recapture occurs.<a href="#_ftn5" name="_ftnref5">5</a> No change of ownership will be deemed to have occurred with respect to a partnership that has made the election if within a 12-month period at least 50 percent (in value) of the original ownership remains unchanged.<a href="#_ftn6" name="_ftnref6">6</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 42(j). <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Proc. 95-28, 1995-1 CB 704. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 42(j)(4)(F). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 42(j)(6). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 42(j)(5). <a href="#_ftnref6" name="_ftn6">6</a>.  H.R. Conf. Rep. No. 99-841 (TRA 86), reprinted in 1986-3 CB (vol. 4) 96. </div></div>

March 13, 2024

7809 / Can property that is used for lodging qualify for the credit for rehabilitating old buildings and certified historic structures?

<div class="Section1">Editor’s Note: The 2017 tax reform legislation continues to permit a 20 percent credit for qualified rehabilitation expenses made with respect to a historic structure. This credit is to be claimed ratably over a five-year period beginning with the tax year in which the structure is first placed in service (i.e., 4 percent each year).<a href="#_ftn1" name="_ftnref1">1</a> The final bill eliminated the previously existing credit for pre-1936 non-historic buildings. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7808">7808</a> for details.<div class="Section1"> Unless the building is a certified historic structure, a building will not qualify for the special investment tax credit to the extent it is used for lodging purposes.<a href="#_ftn2" name="_ftnref2">2</a> Thus, the use of a building or structure that is not a certified historic structure must be commercial or nonresidential. <blockquote>Example 1. Expenditures are incurred to rehabilitate a five-story structure. The top three floors are apartments. The bottom two floors are commercial office space. The building is not a certified historic structure. The building and the rehabilitation work otherwise qualify for the tax credit. Expenditures incurred in connection with the rehabilitation of the top three floors do not qualify for the credit. However, the portion of the building’s basis that is attributable to qualified rehabilitation expenditures for the commercial part of the building is not considered to be expenditures for property used primarily for lodging. An allocation of expenditures would therefore be made in order to determine the portion of the basis that qualifies for the credit.<a href="#_ftn3" name="_ftnref3">3</a> Example 2. Expenditures are incurred to rehabilitate a five-story structure. Each of the five floors is an apartment. The building is a certified historic structure. The rehabilitation work otherwise qualifies for the tax credit. Because the building is a certified historic structure, the entire portion of the building’s basis attributable to qualified rehabilitation expenditures qualifies for the credit.<a href="#_ftn4" name="_ftnref4">4</a></blockquote> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 47(a). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 50(b)(2). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.48-1(h)(1)(iii). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.48-1(h)(2)(iv). </div></div>

February 21, 2018

7816 / What are the new “opportunity zones” created by the 2017 Tax Act?

<div class="Section1">The 2017 tax reform legislation created a new program to govern the taxation of capital gains stemming from investments in qualified opportunity zones (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). Qualified opportunity zones are low income communities that are formally designated as opportunity zones for investment purposes. Opportunity zones are to be designated by the states themselves during a “determination period,” which was the 90-day period beginning on the date of enactment of the 2017 tax reform legislation (a 30-day extension period is specifically permitted).<a href="#_ftn1" name="_ftnref1">1</a> The opportunity zone program was initially temporary, but was made permanent under the 2025 OBBB.<div></div><div> ___________________________________________________________________ Planning Point: Note that the OBBB essentially sunsets the current OZs after 2026 (instead of after 2028, as in the TCJA). State governors must designate new OZs every ten years.  Some zones that are currently eligible will likely not be eligible when states designate new OZs in 2027 (meaning that the tax breaks associated with the existing OZs may no longer exist beginning in 2027).  The effective date for new OZ designations will begin July 1, 2026 (and every ten years thereafter).  Once certified by the Treasury secretary, each OZ will remain a QOZ for ten years beginning January 1 of the following year. _____________________________________________________________________________ </div><div class="Section1"> The number of opportunity zones cannot exceed 25 percent of the number of low-income communities in the state (although if the number of low income communities in the state is less than 100, a total of 25 may be designated as opportunity zones).<a href="#_ftn2" name="_ftnref2">2</a> Low income community has the same definition as under the rules governing the new markets tax credit (IRC Section 45D), meaning that the poverty rate for the community is at least 20 percent or (1) if the community is not located within a metropolitan area, the median family income for the community does not exceed 70 perecent (80 percent prior to July 4, 2025) of statewide median family income or (2) if the community is located within a metropolitan area, the median family income for the community does not exceed 70 percent of the greater of (a) statewide median family income or (b) the metropolitan area median family income. Communities are determined based upon census tracts.<a href="#_ftn3" name="_ftnref3">3</a> Designation as a qualified opportunity zone remains in effect for a ten-year period.<a href="#_ftn4" name="_ftnref4">4</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1400Z-1. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 1400Z-1 (d). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC §§ 45D(e), 1400Z-1(c)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 1400Z-1(f). </div></div>

February 21, 2018

7817 / How are amounts invested in opportunity zones taxed?

<div class="Section1"> The 2017 tax reform legislation created new rules governing the taxation of capital gains stemming from investments in opportunity zones (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). Generally, the new rules allow a taxpayer to elect to defer recognizing any gains from a sale or exchange of any property held by the taxpayer to the extent that the gains do not exceed the aggregate amount that the taxpayer has invested in a qualified opportunity fund during the 180-day period beginning on the date of the sale or exchange.<a href="#_ftn1" name="_ftnref1">1</a> The sale must not be to a related party. The OBBB modified the 2017 rules for investments made after December 31, 2026. Under the 2025 OBBB, for investments made after December 31, 2026, deferred gains are recognized in the tax year that includes the earlier of (1) the date the investment is sold or exchanged, (2) the date that is five years after the OZ investment is made.<a href="#_ftn2" name="_ftnref2">2</a> Investments held for at least five years receive a 10 percent basis step-up.  The OBBBA eliminated the original additional five percent basis step-up that would have applied after year seven of the investment. OBBB also creates new “Qualified Rural Opportunity Funds” (QROFs) designed to encourage investment in low-income rural communities.  The rules are essentially the same, except the investment must be entirely in a rural community.  “Rural area” is defined by exclusion, meaning it includes any area other than (1) a city or town with a population of greater than 50,000, and (2) an urbanized area adjacent to a city or town with a population in excess of $50,000.<a href="#_ftn3" name="_ftnref3">3</a><a href="#_ftn1" name="_ftnref1"></a> QROFs provide enhanced benefits to investors, including: (1) a 30 percent basis step-up after five years (as compared to the 10 percent basis step-up for traditional OZ funds) and (2) a reduced substantial improvement requirement, where only in excess of 50 percent of adjusted basis must be reinvested in property improvements (compared to in excess of 100 percent of adjusted basis for traditional OZ funds).  The reduced substantial improvement provision is effective immediately, while the remainder of the OZ provisions only take effect after December 31, 2026. The OBBB also changes the way basis is determined for long-term OZ investments.  For OZ investments held for less than 30 years, the basis is the fair market value of the investment on the date of the sale or exchange.  For investments held at least 30 years, the basis is the fair market value of the investment on the date that is 30 years after the date the investment was made.<a href="#_ftn4" name="_ftnref4">4</a><a href="#_ftn3" name="_ftnref3"></a> Original 2017 OZ Rules For participants in the original OZ program, which remains in effect through December 31, 2026, pursuant to the 2017 TCJA, the gain will be included in income in the year that includes the earlier of (1) the date the investment is sold or exchanged or (2) December 31, 2026.<a href="#_ftn3" name="_ftnref3">5</a> The amount included is the excess of (1) the lesser of the amount excluded or the fair market value of the investment as of the date of the sale or exchange or December 31, 2026 over (2) the taxpayer’s basis in the investment.<a href="#_ftn4" name="_ftnref4">6</a> <div class="Section1"> <hr> Planning Point: Clients must make the deferral election by filing Form 8997 with the IRS along with their federal income tax for the year following the year in which the investment was made.  For example, clients who invested in QOFs during 2024 filed the form along with their 2025 federal income tax return. <hr> The basis in the investment begins at zero and is increased as gain is recognized. If the investment is held for at least five years, the basis is increased by 10 percent of the gain deferred. If the investment is held for at least seven years, the basis is increased by an additional 5 percent of the gain deferred (15 percent total). If the taxpayer so elects and the investment is held for at least 10 years, the basis is equal to the fair market value of the investment on the date the investment is sold or exchanged.<a href="#_ftn5" name="_ftnref5">7</a> <hr> Planning Point: Under the original program, December 31, 2019 was the final day that investors could elect to roll their gains into opportunity zone funds in order to obtain the full 15 percent reduction in the amount of the deferred gain (so that the funds were invested for a full seven years). In turn, the qualified opportunity fund had 180 days to acquire qualified property once the taxpayer invested the gain. Because gain on the sale of Section 1231 property is not determined until year-end, taxpayers who wished to roll over Section 1231 gain should have tracked Section 1231 sales carefully to determine whether such sales resulted in gain (treated as long-term capital gain) or loss (treated as ordinary loss). <hr> A “qualified opportunity fund” means an investment vehicle organized as a corporation or partnership for the purpose of investing in qualified opportunity zone property where at least 90 percent of its assets are qualified opportunity zone property (the “90 percent asset test”).<a href="#_ftn6" name="_ftnref6">8</a> Qualified opportunity zone property means property that is: <blockquote>(1)  qualified opportunity zone stock (generally, stock in a qualified opportunity zone acquired for cash after December 31, 2017); (2)  qualified opportunity zone partnership interests (generally, interests in a qualified opportunity zone partnership acquired for cash after December 31, 2017); and (3)  qualified opportunity zone business property (tangible property used in a trade or business of the qualified opportunity fund where substantially all of the property’s use (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) is in a qualified opportunity zone, the property was acquired by purchase after December 31, 2017 and the original use begins with the qualified opportunity fund or the fund substantially improves the property (see below)).</blockquote> Qualified opportunity zone business means a trade or business that meets the following requirements: (1) substantially all of the property owned by the business is qualified opportunity zone business property, (2) at least 50 percent of the gross income of the entity is derived from the active conduct of business, (3) a substantial portion of the intangible property of the entity is used in the active conduct of any such business, (4) less than 5 percent of the average of the aggregate unadjusted bases of the property of the entity is attributable to nonqualified financial property, and (5) the business is not used to provide facilities such as a golf course, country club, massage parlor, sun tanning salon, racetrack or other gambling facility, or store that primarily sells alcohol.<a href="#_ftn7" name="_ftnref7">9</a> What constitutes “substantial improvement” for purposes of the opportunity zone rules is tested on an asset-by-asset basis. However, under the final regulations, multiple assets may be aggregated into a single property for testing purposes. In general, buildings located on a single parcel of property can be aggregated. Buildings located on different parcels may be aggregated if (1) the buildings share facilities or centralized business aspects, such as accounting, legal, personnel and similar business elements, (2) the buildings are operated in coordination with (or reliance on) one or more trades or business and (3) the buildings are operated exclusively by the qualified opportunity zone fund or business. The regulations provide a 30-month period during which tangible property purchased by the entity can be treated as qualified opportunity zone property while undergoing substantial improvement—as long as it is reasonably expected that the property will be substantially improved and then used by the QOZF by the end of the 30-month period. If tangible property ceases to be qualified opportunity zone business property, it will continue to be treated as such for the lesser of (1) five years after the date it ceases to be qualified or (2) the date when the property is no longer held by a qualified opportunity zone business.<a href="#_ftn8" name="_ftnref8">10</a> Covid-Era Relief In response to the COVID-19 pandemic, the IRS twice extended several key deadlines that apply to opportunity zone investments. The extensions were automatic and generally provide: For taxpayers whose last day of the 180-day investment period within which to make a QOF investment was on or after April 1, 2020 and before March 31, 2021, the last day of the 180-day period was extended to March 31, 2021. QOFs that failed to satisfy the 90 percent investment rule for a period ending on or after April 1, 2020 and on or before June 30, 2021 were not subject to a penalty (i.e., the failure is disregarded). The 30-month substantial improvement period for tangible property that is used prior to being acquired was suspended between April 1, 2020 and March 31, 2021. QOZ businesses using the 31-month working capital safe harbor prior to June 30, 2021 had an automatic 24-month extension of time in which to spend the capital on qualified property. If a taxpayer’s original 12-month reinvestment period includes June 30, 2020, the QOF had an additional 12 months’ time to reinvest in QOZ property when the proceeds were received by the QOF from the return of capital or disposition of the QOF property.<a href="#_ftn1" name="_ftnref1"></a><a href="#_ftn8" name="_ftnref8">11</a> <a href="#_ftnref1" name="_ftn1"></a> </div><div class="refs"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1400Z-2(a). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1400Z-2(b)(1), as modified by the 2025 OBBB. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 1400Z-2(b)(2)(C). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 1400Z-2(c)(3). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 1400Z-2(b)(1). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 1400Z-2(b)(2). <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 1400Z-2(c). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 1400Z-2(d)(1). <a href="#_ftnref8" name="_ftn8">9</a>.    IRC § 1400Z-2(d)(3). 10.    IRC § 1400Z-2(d)(3)(B). </div> 11. Notice 2020-39.</div>