Sometimes, being fiscally responsible as a Tax Credit property means doing simple things, like reducing overhead and using losses effectively. Then there are the complicated steps that make a marginal, yet significant difference over the life of your project, like the 168(h) election.
What is the 168(h) Election?
Section 168(h) of the IRS Tax Code allows profit flowing into a not-for-profit entity to be treated as unrelated business taxable income, rather than the default tax exempt status.
It may seem backwards, but making this election means the property gets to take advantage of a more favorable depreciation deduction on the building (MACRS, as opposed to ADS), including bonus depreciation.
The 168(h) election is permanent, and must be filed with both the GP’s and not-for-profit entity’s first tax return. Failure to make the election during the first year or to submit the tax return on time will force the property to take the less beneficial depreciation deduction.
How do I Take the 168(h) Election?
When both the not-for-profit and the GP for the property submit their first-year tax returns, simply attach a statement that says you want the GP to be taxed as a corporation, and all profit be included as unrelated business income under section 168(h)(6)(F)(ii).
If this is your organization’s first time joining a partnership for a LIHTC property, there are other forms needed to establishing the correct partner structure, which means you should consult with your CPA or attorney to strategize and make sure every step of the process is completed correctly. This process involves creating a taxable “blocking” entity that the not-for-profit wholly owns in order to take the 168(h) election.
Structure of Partners
In a typical General Partner (GP) / LP relationship, the GP owns something like 1% of the property and is responsible for managing, maintaining, and upgrading the property as needed. The LP funds the majority of the property and gains tax benefits from it.
LPs gain better tax benefits from not-for-profit GPs when the GP is taxable. To make the not-for-profit taxable, the organization sets up an LLC (or an S corporation) that is wholly owned by the not-for-profit. It then elects to have this entity taxed as a corporation by filing IRS Form 8832. Only now is the GP/LLC/LP relationship ready to take the 168(h) election.
First-Year Tax Filing
With the first tax return both the GP and not-for-profit file, include the statement of election. There are no additional forms needed to make the 168(h) election, and you cannot change this status once it has been processed.
Assuming the return is filed before the deadline and the statement is formatted correctly, your property will be structured and taxed to maximize the benefits of tax credits!
Tax Reform Effect on 168(h)
With the passing of the Tax Cuts and Jobs act in 2017, a key change was made to the Tax Code that diminished the usefulness of the 168(h) election. Previously, the default depreciation time for buildings was 40 years. That meant a lower depreciation expense each year, and fewer tax credits. Under the election, this time is reduced to 27.5 years, greatly increasing the cost per year and tax benefits for the LP.
However, under tax reform, the default depreciation for buildings is now only 30 years, making the difference between the 168(h) election smaller, but still beneficial.
The most common reason LIHTC properties fail to make the 168(h) election is because of simple oversight. The first year owning and managing a property includes a lot of work, which means some things simply fall through the cracks.
The other reasons the 168(h) election may not happen is because organizations may confuse which ownership tier requires the election, or that the entity wholly owned by the non-profit requires a corporate tax return.
The process to make the 168(h) election isn’t simple, so it helps to have expert guidance as you go about it. The CPAs at Lemler Group are always here to help you make the most of your LIHTC property and ensure everyone involved can achieve their goals. Contact us online or give us a call today to start the conversation.