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

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 thetest?

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 isthe 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.