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Isn't It About Time You Got the Credit?
Financial Planning
May 2001
Isn't It About Time You Got the Credit?
You've worked hard and carefully placed your money in tax-wise investments. In short, you've done everything you can think of to keep your money out of the hands of Uncle Sam, but he still seems to get a lot of your money every year. As you're signing the check to pay last year's tax bill, you are so frustrated you could scream, but you don't want to wake the kids up. So, you shake your head and mutter to yourself.
With most of your assets in growth vehicles and tax exempt funds, what more can you do? We have a suggestion. Have you ever thought about going into the Low-income Housing business?
No, we don't mean you need to start building apartment buildings, or low rent houses. You can get into the business by investing in any number of funds designed to develop and operate low-income housing projects that qualify for the Low-income Housing Tax Credit.
Depending on your sources of taxable income, funds that specialize in low-income housing projects that produce tax credits can accomplish two things for you.
First, you save money. We'll show you how a little later, but for now, keep in mind that the functional word in the tax saving feature of these funds is Tax Credit. That means, these funds are designed to provide you with credits you can use dollar for dollar against your income tax bill.
Second, by virtue of investing in projects that will throw off credits to you, as well as passive income or loss, you can fund a project that will provide housing to people who may otherwise not be able to afford it. We'll discuss the details in a moment. If this sounds like a pretty good deal, it can be. Let's look at this more carefully.
In 1986 the U.S. Congress established a program that grants tax credits to developers and owners of low-income housing projects. It provides each state with a credit of $1.25 ($1.50 in 2001 and $1.75 thereafter) multiplied by the population of that state. State housing authorities then approve the utilization of the credits on a project-by-project basis to make each project financially feasible.
For a project to qualify, at least 20% of the units in a project must be designated for rent to tenants with incomes at or below 50% of the median income in the geographic area as published by the Department of Housing and Urban Development. In the alternative, 40% of the units must be rented to persons with 60% of median area income. This, in effect, will cause these units to rent at lower than the market rate. Owners are required to maintain continued compliance with these requirements through annual recertification.
The offset for the lost revenue of the owners is the tax credit. The qualified cost for each unit rented to low-income persons is subject to a 9% credit for 10 years. Put another way, assuming you own the project for 10 years, you will receive a credit equal to 90% of the qualifying basis of the low-income rental units. Land is not included in the basis.
Let's take an example. Suppose you own 10% of a $5,000,000, 50 unit project and the land cost $1,000,000. Assume further that the project meets minimum requirements and 10 units, or 20% of the project, are rented to low-income tenants. Your credit would be calculated as follows:
Total project cost of $5 million less Land of $1 million equals $4 million total building costs. Total building costs of $4 million multiplied by the 20% of the project that qualifies for the credit equals $800,000 in qualified costs. Qualified costs of $800,000 multiplied by a credit rate of 9% equals $72,000 in credit per year. Your credit is $7,200.
The $7,200 credit is in addition to any tax benefit you may receive from operating losses created by the property. As an added benefit, unlike most other tax credits, none of the tax credit reduces the depreciable basis of the asset.
One final benefit is the availability of state tax credits. Some states allow credits against tax that may equal or exceed the value of the credits provided by the Federal government. Thus, you lower your federal and state tax bills.
The preceding example is just that, an example. Most funds that deal in this arena provide a much higher credit than the example. Many funds can provide returns of at least 10% and some funds can be even higher.
Let's see, you get what is probably a good, solid long-term investment, tax credits and you help mankind - doesn't sound to bad, does it? It isnt, but there can be one big hitch.
We said earlier that the sources of your income could have a big impact on whether you can benefit from this tax. This is because the Alternative Minimum Tax (AMT) does not recognize these credits.
Let's say your regular tax, after $10,000 in credits is $50,000 and, because of heavy state tax deductions and a lot of tax-free interest generated by private activity bonds, your pre-credit alternative minimum tax is $60,000. You will not be able to use any of the $10,000 in credits to reduce the alternative minimum tax. Therefore, your credits will have done you no good this year, but will create an indefinite AMT tax credit carry forward for the future.
Should you be stuck in this situation, there is always a secondary market for these investments where you may be able to sell enough of your investments to steer clear of the AMT.
As with all investments, investing in low-income housing projects may or may not be suitable for you. However, they can be a powerful income tax saving tool in your overall financial plan if properly utilized. Give us a call if you have any questions about their suitability for you. We can run the numbers and discuss the possibilities and help you make a realistic decision.
Until next month, invest wisely and have a great May, and happy Mother's Day to all the mothers reading this article.
With most of your assets in growth vehicles and tax exempt funds, what more can you do? We have a suggestion. Have you ever thought about going into the Low-income Housing business?
No, we don't mean you need to start building apartment buildings, or low rent houses. You can get into the business by investing in any number of funds designed to develop and operate low-income housing projects that qualify for the Low-income Housing Tax Credit.
Depending on your sources of taxable income, funds that specialize in low-income housing projects that produce tax credits can accomplish two things for you.
First, you save money. We'll show you how a little later, but for now, keep in mind that the functional word in the tax saving feature of these funds is Tax Credit. That means, these funds are designed to provide you with credits you can use dollar for dollar against your income tax bill.
Second, by virtue of investing in projects that will throw off credits to you, as well as passive income or loss, you can fund a project that will provide housing to people who may otherwise not be able to afford it. We'll discuss the details in a moment. If this sounds like a pretty good deal, it can be. Let's look at this more carefully.
In 1986 the U.S. Congress established a program that grants tax credits to developers and owners of low-income housing projects. It provides each state with a credit of $1.25 ($1.50 in 2001 and $1.75 thereafter) multiplied by the population of that state. State housing authorities then approve the utilization of the credits on a project-by-project basis to make each project financially feasible.
For a project to qualify, at least 20% of the units in a project must be designated for rent to tenants with incomes at or below 50% of the median income in the geographic area as published by the Department of Housing and Urban Development. In the alternative, 40% of the units must be rented to persons with 60% of median area income. This, in effect, will cause these units to rent at lower than the market rate. Owners are required to maintain continued compliance with these requirements through annual recertification.
The offset for the lost revenue of the owners is the tax credit. The qualified cost for each unit rented to low-income persons is subject to a 9% credit for 10 years. Put another way, assuming you own the project for 10 years, you will receive a credit equal to 90% of the qualifying basis of the low-income rental units. Land is not included in the basis.
Let's take an example. Suppose you own 10% of a $5,000,000, 50 unit project and the land cost $1,000,000. Assume further that the project meets minimum requirements and 10 units, or 20% of the project, are rented to low-income tenants. Your credit would be calculated as follows:
Total project cost of $5 million less Land of $1 million equals $4 million total building costs. Total building costs of $4 million multiplied by the 20% of the project that qualifies for the credit equals $800,000 in qualified costs. Qualified costs of $800,000 multiplied by a credit rate of 9% equals $72,000 in credit per year. Your credit is $7,200.
The $7,200 credit is in addition to any tax benefit you may receive from operating losses created by the property. As an added benefit, unlike most other tax credits, none of the tax credit reduces the depreciable basis of the asset.
One final benefit is the availability of state tax credits. Some states allow credits against tax that may equal or exceed the value of the credits provided by the Federal government. Thus, you lower your federal and state tax bills.
The preceding example is just that, an example. Most funds that deal in this arena provide a much higher credit than the example. Many funds can provide returns of at least 10% and some funds can be even higher.
Let's see, you get what is probably a good, solid long-term investment, tax credits and you help mankind - doesn't sound to bad, does it? It isnt, but there can be one big hitch.
We said earlier that the sources of your income could have a big impact on whether you can benefit from this tax. This is because the Alternative Minimum Tax (AMT) does not recognize these credits.
Let's say your regular tax, after $10,000 in credits is $50,000 and, because of heavy state tax deductions and a lot of tax-free interest generated by private activity bonds, your pre-credit alternative minimum tax is $60,000. You will not be able to use any of the $10,000 in credits to reduce the alternative minimum tax. Therefore, your credits will have done you no good this year, but will create an indefinite AMT tax credit carry forward for the future.
Should you be stuck in this situation, there is always a secondary market for these investments where you may be able to sell enough of your investments to steer clear of the AMT.
As with all investments, investing in low-income housing projects may or may not be suitable for you. However, they can be a powerful income tax saving tool in your overall financial plan if properly utilized. Give us a call if you have any questions about their suitability for you. We can run the numbers and discuss the possibilities and help you make a realistic decision.
Until next month, invest wisely and have a great May, and happy Mother's Day to all the mothers reading this article.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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