Not-for-Profits and the Section 168(h) Election: Considerations in LIHTC Deal Structuring

By Will Bates, CPA

For-profit investors need to examine how a not-for-profit entity is involved in a potential deal structure, as it may create a tax trap referred to as a tax-exempt use property. This creates an unfavorable situation for investors because they won’t receive as much tax depreciation as they would without the not-for-profit partner’s involvement. If treated as a tax-exempt use property, the partnership is subject to unfavorable depreciation lives and methods. 

Fortunately, there is an escape mechanism provided in Section 168(h) of the tax code. If you make the Section 168(h) election, the partnership will benefit from more depreciation. However, the not-for-profit “blocker” corporation is then required to treat profit and distributions from the partnership as unrelated business taxable income. This could potentially create tax issues for the blocker corporation/not-for-profit.

Why would the General Partner want to give up its tax-exempt tax treatment?

Any such property is not eligible for bonus depreciation or depreciation under the most favorable depreciation method with shorter tax lives (MACRS instead of ADS). Also, some federal tax credits and state tax credits can be negatively impacted.

How do we make the Section 168(h) election and which entities make it?

Instead of the not-for-profit directly owning the General Partner (GP) interest in the real estate partnership, the not-for-profit typically will insert an LLC which is wholly owned by the not-for-profit to hold the GP interest.

This LLC then elects with the IRS to be taxed as a corporation, rather than be disregarded for tax purposes, by submitting IRS Form 8832 by mail. The election needs to be effective no later than the placed-in-service date of the property.

In addition, the newly formed LLC (now taxable as a corporation) must make a Section 168(h) election or else it will still be treated as an exempt entity by the IRS. This is a statement that is attached to the “blocker” entity’s return (during the taxable year for which the election is to be effective) as well as attached to the not-for-profit owner’s 990 return.

The trade-off in making the Section 168(h) election as previously mentioned is that distributions of capital and income received by the “blocker” entity are considered “unrelated business taxable income” and taxable at the corporate level. This trade-off can be mitigated in part with proper structuring.

Deal structuring in a Low Income Housing Tax Credit (LIHTC) partnership is not easy, and our team can provide expert guidance as well as accounting and tax solutions to meet your needs.

For additional considerations please reach out to Will Bates, CPA or contact the Real Estate Solutions Team at Mahoney to be of help to you in any way.

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