This article details an often overlooked solution for developers who are facing difficulty satisfying eligibility requirements because of construction or lease-up delays on multiple building projects financed with low-income housing tax credits (LIHTCs). The same solution also may offer relief to developers of certain LIHTC projects intended to qualify as scattered-site projects.

An LIHTC project that is delayed during construction or lease-up may have problems satisfying the minimum set-aside test of Code Sec. 42(g)(2) on a timely basis. The minimum set-aside test provides that a project will be a qualified low-income project only if either 40 percent of the units in the project are both rent-restricted and leased to tenants whose incomes are 60 percent or less of the area median income (AMI) or 20 percent of the units in the project are both rent-restricted and leased to tenants whose incomes are 50 percent or less of the AMI. A building will only qualify if the project that it is part of satisfies the minimum set-aside test by the end of the first year of the credit period. The credit period for any building is the taxable year in which the building is placed in service, or at the election of the developer, the succeeding taxable year.

If all of the buildings in a multiple-building project are placed in service over a two-year period and the minimum set-aside test is satisfied no later than the end of that two-year period, there's no problem—the project is a qualified project.

Significant problems may arise, however, when a project experiences construction or lease-up delays. For example, such a problem may arise if the buildings in a multiple building project financed with tax-exempt bonds are placed in service over a three-year period. In such a case, if the minimum set-aside test—taking into account the buildings are placed in service in the first two years—is not satisfied by the end of the second year, the project would not be a qualified LIHTC project. Similar problems may arise for multiple building projects that have received an allocation of LIHTCs where all buildings are placed in service within the required two-year period, but the project—taking all of the buildings into account—does not satisfy the minimum set-aside test as of the end of the second year.

Eligibility issues also may arise in projects intended to satisfy the scattered-site rule of Code Sec. 42(g)(7). In this case, the problem could arise simply because the owner doesn't realize that a scattered-site project is subject to different rules than a project located on a single site. Or, the problem could arise as a result of a change in the project. For example, assume that a mixed-use project starts out as a single-family subdivision situated on a single site, where each lot is contiguous to one or more other lots in the project. Because each of the lots in the project is proximate to at least one other lot, the project would constitute a single site and the scattered-site rules would not apply. This could change, however, if the specific lots included in the project change, for example because two of the lots that initially are part of the project are deemed to be unsuitable for some reason.

As a business matter, such a change may not be a problem. The seller of the property may be able simply to substitute two other lots. As a tax matter, however, this seemingly innocuous change in the project could result in the project not constituting a qualified project. The problem arises if the two substituted lots are not contiguous with any other lot in the project. This would change a single-site project into a scattered site project.

The issue is that Code Sec. 42(g)(7) provides that “buildings which would (but for their lack of proximity) be treated as a project for purposes of this section shall be so treated if all of the dwelling units in each of the buildings are rent-restricted and (within the meaning of paragraph (2)) residential rental units.” As a result, if 100 percent of the units in the project are not rent-restricted, the project would not qualify as a scattered-site project.

The solution to both the minimum set-aside test problem and the scattered-site problem is a single, relatively obscure, subsection of Sec. 42. Code Sec. 42(g)(3)(D) provides that “a project shall be treated as consisting of only 1 building unless, before the close of the 1st calendar year in the project period ... each building which is (or will be) part of such project is identified in such form and manner as the Secretary may provide.” Further, the instructions for Form 8609 indicate that multiple building projects are to be identified by checking “Yes” in line 8b of Part II of Form 8609 and by attaching a statement containing the information required in the instructions for line 8b. The instructions for line 8b include identifying the buildings that are included in the project.

Sec. 42(g)(3)(D) thus gives developers significant flexibility to elect which buildings are part of which project for LIHTC purposes. With respect to the minimum set-aside test problem described above, the developer can elect to treat each building as a separate project with its own minimum set-aside test. Or, the developer can elect to treat some of the buildings as one project and the remainder as a separate project. Basically, the developer can make elections regarding the number of projects and the number of buildings in each project as needed to ensure that each is a qualified project and to maximize credit delivery.

Similarly, with respect to the scattered-site issue described above, the developer can elect to treat each building as a separate project. Or, in the example provided, the developer can elect to treat the buildings on each of the two noncontiguous lots as two separate projects and the remaining contiguous units as a third project. In either case, the result would be that none of the developer's projects would be a scattered-site project. Rather than having to lease all units to low-income tenants at rent-restricted rates, each separate project would be a qualified low-income project as long as it satisfied the minimum set-aside test.

As a practical matter, changes to the number and composition of the projects will have to be coordinated with the state tax credit agency. Developers should contact the agency as soon as they identify the issue that would make the election under Code Sec. 42(g)(3)(D) beneficial to discuss the configuration of the projects that would be created by the election and to obtain the consent of the agency to this approach. Developers should also contact the tax credit syndicator to obtain their consent to the restructuring and verify the calculation of any credit adjuster liability in the event that tax credits are deferred.

Jerome A. Breed and William G. Driggers are partners and John R. Dalton is an associate in the Washington, D.C., office of Bryan Cave, LLP. Breed, Driggers, and Dalton specialize in the representation of investors, syndicators, and developers in transactions involving federal and state income tax credits, including the LIHTC, historic rehabilitation tax credit, New Markets Tax Credit, and renewable energy tax credit. Breed is vice president and a board member of the National Housing and Rehabilitation Association. For more information, call (202) 508-6000.