ASSET MANAGEMENT
REZNICK RESPONDS
10 Percent Test Not Graded on Curve
BY TERENCE KIMM
AFFORDABLE HOUSING FINANCE • April 2008
The information presented here is intended
solely for informational purposes and
should not be construed as accounting advice
from the author or Reznick Group. Reznick
Responds is published four times a year, so be
sure to send accounting questions that you
would like to have addressed in this column to
terry.kimm@reznickgroup.com.
Reznick Group has more than 25 years of
experience providing accounting, tax, and
business advisory services to clients nationwide.
The expertise of the firm is broad, ranging
from real estate and management advisory
services to auditing and tax preparation.
Ranked among the top 20 public accounting
firms in the nation, Reznick Group is on the
move—continuing to grow nationally, expanding
its services, and building upon its leadership
as industry experts.
Terence Kimm, CPA, is a principal with
Reznick Group and co-head of the Real
Estate Consulting Group in the Bethesda,
Md., office, where he works with developers
and syndicators in structuring low-income
housing, historic, and New Markets tax credit
transactions./p>
Q: We have traditionally
developed low-income
housing tax credit (LIHTC)
tax-exempt bond deals. In
early 2007, we submitted
our first 9 percent competitive LIHTC
application. Our application was successful,
and we received a reservation letter.
Subsequently, on Dec. 31, we received a
carryover allocation. One of the conditions
of our carryover allocation was
meeting the 10 percent test by June 30,
2008. What is the 10 percent test?
A: If a project is not placed in service by
the end of the calendar year in which
the LIHTC allocation was received, the project
must qualify for a carryover allocation.
There are two federal requirements for a
valid carryover allocation. The first is that
by the latter of either the date that is six
months after the date that the allocation
was made, or the close of the calendar year
in which the allocation was made, the basis
in the project must meet specific criteria. It
must exceed 10 percent of the “reasonably
expected” basis in the project as of the end
of the second calendar year following the
year of allocation. This is sometimes
referred to as the 10 percent test. The second
statutory test is that the project must
then be placed in service by the end of the
second calendar year following the year of
allocation. Therefore, in order to have a
valid carryover allocation, you must have
incurred at least 10 percent of your project’s
reasonably expected basis by June 30,
2008, and the project must be placed in service
by Dec. 31, 2009.
Q: What happens if we don’t meet the
10 percent test by June 30, 2008?
Do we have some wiggle room?
A: If you fail either of the previously
mentioned two requirements, your
project will not have a valid carryover allocation.
Without a valid carryover allocation,
your investor and lender will most likely
revoke their commitments, effectively
killing the deal. This is why the 10 percent
test is sometimes referred to as a threshold
test. Although your state housing finance
agency (HFA) allows the full six months to
meet the test, others are not as generous.
An HFA may be more restrictive than the
federal rules when it comes to administrating
the allocation process within its state.
Q: How do we demonstrate to the HFA
that we have met the test?
A: Most HFAs will require you to submit
a carryover allocation application.
Included in this will be a certification
from an attorney or certified public accountant
that the taxpayer has incurred more
than 10 percent of its reasonably expected
basis in the project.
Q: What does reasonably expected
basis mean, and how is the 10 percent
test calculated?
A: The 10 percent test is a fraction calculated
as follows. The numerator is
the taxpayer’s adjusted basis in land and
depreciable property that is reasonably
expected to be part of the project as of the
measurement date determined by the HFA.
The denominator is the taxpayer’s adjusted
basis in land and depreciable property that
is reasonably expected to be part of the project
as of the close of the second year following
the year of allocation. Note that the
description of neither the numerator nor
the denominator mentions eligible basis.
Therefore, costs related to any commercial
component of the project are includable in
both. Additionally, any basis boost as a
result of the project being located in a qualified
census tract or difficult development
area is ignored. Stated more simply, the
numerator is the taxpayer’s basis in land
and depreciable property incurred as of the
measurement date, and the denominator is
the taxpayer’s expected basis in land and depreciable property
at completion of construction.
Q: Do we actually have to have paid for an item to
include it in the numerator?
A: It depends on the method of accounting utilized for
income tax purposes by the taxpayer meeting the test. If
the taxpayer is a cash basis taxpayer for income tax purposes,
all costs included in the numerator must actually be paid. If the
taxpayer is an accrual basis taxpayer for income tax purposes,
then the income tax rules related to economic performance will
determine when a cost can properly be accrued. Most LIHTC
entities are accrual basis taxpayers. Fees for services rendered
are generally allowable costs for accrual basis taxpayers; however,
the services must actually have been performed. This
brings me to one of the most common problems I have
incurred when evaluating 10 percent tests. The taxpayer receiving
the carryover allocation must be the taxpayer meeting the
10 percent test. All project invoices, contracts, and cancelled
checks should be in the name of that taxpayer that received the
carryover allocation. If contracts are not in the name of that
taxpayer, there should be an assignment and assumption
agreement transferring the contracts to that taxpayer. If invoices
and canceled checks are not in the name of the taxpayer that
received the carryover allocation, there should be a reimbursement
agreement between the payer and that taxpayer.
Q: What other common problems have you run across
that we should avoid?
A: For various reasons, the following items have sometimes
raised 10 percent test issues:
• Land acquisition, especially related party purchases and
purchase money notes;
• The inclusion of a portion of the development fee will
require certain documentation;
• Financing fees can be complex, especially if you have the
same construction and permanent lender;
• Fees paid to governmental entities have certain rules
with regards to economic performance that must be respected;
and
• Purchasing and storing materials prior to the beginning
of construction will require advanced planning and documentation.
In summary, the planning process for meeting the 10 percent
test should begin well before the due date of the report to
the HFA. Providing your accountant with a schedule of the
estimated costs incurred and the reasonably expected basis
well in advance of the due date will allow them to do a quick
analysis of reasonableness of incurred costs, provide you with
a list of what backup documentation will be required, point
out any potential problem areas, and allow for the timely completion
when due. The time for surprises is now and not right
before the 10 percent test is due.
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