IRS Clarifies Treatment of Developer Fees
The IRS recently released its latest LIHC Newsletter, which provides a forum for information about Section 42, the Low-Income Housing Tax Credit (LIHTC), and communicates technical knowledge and skills, guidance, and assistance for developing LIHTC properties.
Issue #53 provides guidance on rules regarding developer fees. A cost incurred to construct an LIHTC site building is includable in its eligible basis under IRC Section 42(d)(1) if the cost is included in the adjusted basis of depreciable residential rental property [IRC §§168 and 103], or included in the adjusted basis of depreciable property used in common areas or provided as a comparable amenity to all residential rental units in the building [IRC §168]. Being able to include this cost has a direct bearing on the amount of credit the site owner can claim each year. As such, a developer fee represents payment for the developer’s services and at least a portion of the fee is includable in eligible basis.
Issue #53 focuses attention on the following four basic developer fee guidance and audit issues to consider when examining the developer fee for an LIHTC site: character of the services to be provided; services actually provided; reasonableness of the fee amount; and method of payment.
Examples of Includable Fees
According to Issue #53, developer services typically associated with the IRC Section 42 buildings and includable in eligible basis include, but are not limited to:
- Negotiating agreements for architectural, engineering, and consulting services, the construction of the low-income housing (including interiors) or improvements includable in eligible basis, and the furnishing of the associated supplies, materials, machinery, or equipment.
- Applying for and maintaining all government permits and approvals necessary for the construction of the project and securing the certificates of occupancy (or other equivalent documents) when completed.
- Complying with the requirements imposed by insurance providers during construction.
- Providing oversight, including inspections during the course of construction and approving eventual payment for the services rendered.
- Implementing the taxpayer’s decisions made in connection with the design, development, and construction of the project.
Examples of Fees Not Includable
The following are developer services highlighted as not associated with the IRC Section 42 buildings, and, therefore, these costs are not includable in eligible basis. Typical services include (but are not limited to):
- Acquiring the property site. Specific activities may include locating suitable sites, performing economic and feasibility studies, market studies, and negotiating the purchase price.
- Maintaining contracts, books, and records sufficient to establish the value of the completed project.
- Advising the owner regarding available sources of financing, such as federal, state, or local subsidy programs, as well as commercial financing. The developer may also negotiate the terms of the financing with lenders or secure financing.
- Partnership costs. Services associated with the partnership’s organization and syndicating partnership interests are not includable in eligible basis.
- Application fees and other costs associated with securing an allocation of IRC Section 42 credit are not includable in eligible basis.
- Post-development costs such as completing the initial leasing of the rental units. Typical costs include (but are not limited to) hiring on-site managers and trained staff, advertising, maintaining model units, and providing ongoing management of the day-to-day operations of the project after the initial lease-up.