The IRS recently ruled that a private foundation’s proposed acquisition of 100% of a low-income housing project would not subject the foundation to either excess business holdings tax or unrelated business income tax. See PLR 201603032.
The taxpayer (the “Foundation”) requesting the ruling was a private foundation under the Internal Revenue Code (the “Code”). The Foundation’s purpose was to finance, own, and operating affordable housing. The Foundation owned an interest in a limited liability company (the “Operating Entity”) that operated a low-income housing project. The Operating Entity was receiving low-income housing tax credits with respect to the project. The Operating Entity was owned by the Foundation, an investor (the “Investor Member”), and a special member related to the Investor Member (the “Special Member”). The Investor Member and the Special Member offered to sell their interests in the Operating Entity to the Foundation for less than fair market value.
Generally, a private foundation established under section 509(a) of the Code is exempt from Federal income tax. However, exempt organizations are subject to tax on any “unrelated business taxable income”. In addition, if a private foundation operates a business enterprise, the private foundation is subject to an excise tax under section 4943(a) of the Code.
If a tax-exempt entity engages in activities other than those related to its exempt purpose, the tax-exempt entity may jeopardize its own tax-exempt status. In Revenue Procedure 96-32, the IRS established a safe harbor for organizations that provide low-income housing. Under the safe harbor, an organization is considered charitable (for purposes of the tax-exemption under section 501(c)(3) of the Code) if the organization shows that a certain percent of the housing units are occupied by low-income residents, the units actually are occupied by poor and distressed residents, and the housing is affordable to the residents.
As a result of the proposed transaction, the Operating Entity would become a disregarded entity wholly owned by the Foundation. Accordingly, the activities of the Operating Entity would be attributed to the Foundation. The IRS concluded that the Operating Entity satisfied the safe harbor due to the number and status of the residents housed by the Operating Entity. In addition, the Operating Entity’s activities would contribute to fulfilling the Foundation’s charitable purposes. Consequently, the activities of the Operating Entity would not be an unrelated trade or business of the Foundation. Income from the activities of the Operating Entity would not generate unrelated business taxable income or be subject to the excise tax because the Operating Entity’s activities are charitable (as established by satisfying the safe harbor) and related to the exempt purposes of the Foundation.
Real estate professionals who are involved in low-income housing transactions should be aware of this ruling. Specifically, if there is to be a sale of a low-income housing project, the parties should ensure that the purchasing entity (generally a tax-exempt entity) is able to satisfy the safe harbor of Revenue Procedure 96-32.
In addition, note that the Foundation requested that the IRS rule that the section 42 low-income housing tax credits allocated to the Operating Entity would not be subject to recapture due to the sale of membership interests in the Operating Entity. However, the IRS declined to rule on this issue. Accordingly, real estate professionals should look for future guidance from the IRS governing this issue.
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