Four Rules for Claiming Extra Credits After Building’s Applicable Fraction Increases
Sometimes tax credit site owners aren’t entitled to claim all the credits they were allocated for a building. This happens when owners don’t lease up as many units to qualified low-income households as they must in the first year of the building’s compliance period. As a result, the building’s first-year “fraction,” which reflects the percentage of the building that’s leased to qualified low-income households, falls short of the target.
For instance, say a site owner must lease 80 percent of its building’s units to qualified low-income households in the first year to claim all the credits allocated for the building. The owner leases up only 70 percent of the units to qualified low-income households. Since the building’s first-year fraction (70%) would fall short of the target (80%), the owner would be entitled to claim credits for only 70 percent of the units.
The owner can make up for this shortfall if it leases more units in its building to qualified low-income households after the first year of the compliance period. This will increase the building’s applicable fraction, which will entitle the owner to claim extra credits.
The tax credit law spells out how owners can claim extra credits to make up for a shortfall if their building’s applicable fraction increases after its first-year fraction misses the target. The following are four rules to help you navigate this complicated law. Show these rules to the owner of your site. And remind the owner that it should consult with its attorney or accountant about whether it may be able to claim any extra credits, says Stewart A. Grubman, CPA, president of Grubman Anand, P.C.
Rule #1: Claim Only Two-Thirds of the Extra Credit
If an owner becomes entitled to claim extra credit for a building in a particular year, it can claim only two-thirds of the extra credit in that year. This rule applies only to the extra credit an owner may claim. So while an owner must claim extra credit at only two-thirds’ value, Grubman explains, the owner should still claim its original credit at full value.
For instance, say an owner is entitled to claim $100,000 in tax credits in the fifth year of its building’s credit period, based on the building’s first-year fraction. Because of an increase in its building’s applicable fraction, the owner can also claim extra credits that year worth $15,000. Because of the two-thirds rule, the owner would be entitled to claim only $10,000 in extra credits (2/3 of $15,000). But the amount of the owner’s original credits for that year would still be $100,000, since the two-thirds rule applies only to extra credits.
Rule #2: Prorate Extra Credits in First Year Claimed
In the first year that an owner leases an extra unit to a qualified low-income household, the owner may not be able to claim extra credits based on the full target fraction. That’s because the new low-income household may not have lived in the unit for the entire year. So an owner must prorate extra credits for each extra low-income occupancy, based on the number of full months of the extra occupancy that year. This works the same way as determining how many credits to claim during the first year of the credit period, Grubman notes. To calculate this prorated amount, the owner should take the following four steps:
Step #1: Calculate fraction for months without extra occupancy. Multiply the lower first-year fraction by the number of months when there was no extra low-income occupancy in a unit for the entire month.
Step #2: Calculate fraction for full months with extra occupancy. Multiply the higher applicable fraction by the number of full months the owner leased the unit to a new low-income household.
Step #3: Total calculations. Total the amounts you calculated in Steps #1 and #2.
Step #4: Calculate average. Divide the total amount you calculated in Step #3 by 12 to get the average. This number is the building’s prorated fraction that the owner must use to determine the extra credits it’s entitled to claim in the first year.
For example, say your building’s first-year fraction is 70 percent but the owner was allocated credits for 80 percent. On April 1 of the fifth year of the compliance period, you rent one extra unit to a qualified low-income household. This makes your building’s applicable fraction increase to 80 percent, the target. The owner can’t claim credits for the full 80 percent in the fifth year because the low-income household lived in its unit for only nine months. The owner must instead claim extra credits based on a prorated fraction. Here’s how to calculate this fraction using the steps stated above:
Step #1: Multiply the building’s first-year fraction by the number of months when there was no extra low-income occupancy for the entire month. In this example, the first-year fraction is 70 percent. Because the new low-income household moved in on April 1, there are three months of no extra low-income occupancy. So multiply three by 70 percent to get 2.1.
Step #2: Multiply the building’s applicable fraction by the number of full months the new low-income household lived in the unit. Since the applicable fraction is 80 percent and the household occupied the unit for nine full months, multiply nine by 80 percent to get 7.2.
Step #3: Total 2.1 and 7.2, the amounts you calculated above, to get 9.3.
Step #4: Divide the total by 12 to get an average of 77.5 percent. This amount is the fraction the owner would need to use to calculate extra credits for the unit in the first year of the extra low-income occupancy.
Rule #3: Claim Extra Credits During the Compliance Period
Owners normally claim their credits over the 10-year credit period. But an owner may claim extra credits during any year of the 15-year compliance period. This means an owner may be entitled to claim extra credits after it can no longer claim its original credits.
For example, say your building’s owner was allocated credits for 70 percent of your units, but your building’s first-year fraction was only 60 percent. In the 12th year of the compliance period, the building’s applicable fraction increases to 70 percent. The owner can claim extra credits in the 12th year—even though the credit period ended with the 10th year.
If an increase in a building’s applicable fraction first occurs before the credit period ends, the owner can continue claiming extra credits if the increase is maintained after the credit period ends. Even though the owner must stop claiming its original credits when the credit period ends, the owner may be entitled to claim the extra credits for up to five more years (through the end of the compliance period).
Rule #4: Don’t Claim More Credits than Allocated
Remember that owners can’t ever claim more credits than they were allocated for a building. So if a building’s applicable fraction increases above its first-year fraction, an owner might become entitled to claim extra credits for only part of the increase.
For example, say an owner was allocated credits for 80 percent of the units in the building, but the building’s first-year fraction was 70 percent. In the eighth year of the compliance period, the building’s applicable fraction increases to 90 percent. The owner would be entitled to claim credits for 80 percent of the units—not 90 percent.
To claim credits for the full 90 percent in this example, the owner should have applied to the state housing agency for a new allocation to cover the extra 10 percent, assuming it anticipated the increase. Without the new allocation, the owner would probably have nothing to gain by leasing extra units to qualified low-income households. And the owner would also probably lose rent revenue, since it wouldn’t be able to charge market-rate rent to the new low-income households.
Stewart A. Grubman, CPA: President, Grubman Anand, PC, 7272 Wisconsin Ave., Bethesda, MD 20814; www.grubmancpas.com.