IRS Letter Ruling Breaks New Ground Regarding Income Test

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Tax Credit Advisor, October 2009: A New Orleans developer has received a private letter ruling from the Internal Revenue Service that breaks new ground regarding a key income test under the federal new markets tax credit program. The ruling also suggests new opportunities for historic rehabilitation tax credit developers.

Dated August 31 and not yet made public, the letter ruling was received by an entity organized by HRI Properties to develop a three-building, mixed-use project in downtown Jackson, Miss. The King Edward/Standard Life project, now under construction, is using federal new markets and historic tax credits and involves the rehabilitation of three historic buildings on contiguous parcels in the same block.

The King Edward building is being renovated into a 186-room hotel and 64 apartments. The Standard Life building, a 1929 Art Deco office skyscraper, is being renovated into 72 residential units. The Hines Motor Company building is being redeveloped into a parking garage that will serve tenants and users of the entire development. The project will also include some commercial space. (For details, see Tax Credit Advisor, June 2009, p. 23.)

Hal Fairbanks, Director of Acquisitions of HRI Properties, expects the King Edward and parking garage to be completed toward year-end, and the Standard Life building by mid-2010.

The IRS ruling provides that the three buildings may be treated as one for purposes of determining whether the NMTC program’s commercial income test is satisfied. Under the program, a real estate project isn’t eligible for the NMTC if more than 80% of its gross income comes from residential rental property (i.e. at least 20% of the income must stem from commercial uses). This 20% commercial income test must be met on a building-by-building basis. The new letter ruling permits this test to be met project-wide for the Jackson project through use of the “integrated unit test.”

Among the key facts in the Jackson case are the buildings are located on contiguous parcels of land, and share a common plan of ownership, development, financing, and operation.

Fairbanks welcomed the IRS’ letter ruling. He noted that because of the lack of clarity on the issue, the initial closing for the project included just the King Edward and Hines Motor buildings. He said there was reluctance by others to the closing and development of the Standard Life building at the same time. “The CDEs [community development entities] working with us were uncomfortable without a private letter ruling or legislative clarification of this test,” he noted.

He said the favorable private letter ruling now permits the mixed-use project to be developed according to original plans, rather than having to make adjustments to make sure that the King Edward and Standard Life buildings each have enough commercial space to meet the 20% test separately.

Fairbanks suggested that the ruling also portends favorably for multiple-building historic tax credit projects, where all the buildings are adjacent to one another. He noted that to date, many tax lawyers haven’t been comfortable treating adjacent buildings as part of one project for purposes of the historic credit unless the buildings are physically connected, such as by a newly constructed corridor. The ruling, he noted, indicates a physical connection isn’t necessary.

Fairbanks said the ruling also means that existing buildings in multiple-building NMTC projects can be redeveloped for their natural and most suitable purpose (e.g., office, residential), rather than having, say, to cram commercial uses into a residential building to meet the 20% test.

An IRS private letter ruling can only by relied on by the taxpayer that receives it, and can’t be cited as precedent by others. Such rulings, though, indicate the Service’s interpretation of particular federal statutory and regulatory tax provisions.

(Private letter ruling: http://www.housingonline.com/ Documents/TCA Issues/ruling09.pdf)