Housing & Tax Consultants, LLC was formed in 2004 to provide consulting services to Owners, Developers and Managers of multi-family low-income housing projects operated through Government agencies such as Housing and Urban Development (HUD) and United States Department of Agriculture Rural Housing Service(RD). These programs are considered some of the most successful government/private ventures. They’re are designed to aid low-income individuals with housing assistance. While the rents for the properties are Government financed. They are owned and operated by individuals in the private sector. This unique ownership structure allows individuals with passive/rental income to deduct the depreciation generated through the partnerships.
Although a small number of the earlier projects (those done in the 1970’s) were designed as general partnerships, the vast majority were formed as limited partnerships. For purposes of this discussion, we will concentrate on the limited partnership structure. The typical limited partnership has a general partner, who handles the day to day operations and is responsible for partnership obligations and limited partners, who are the passive investors and are not obligated on the debts (see figure 1). In many cases, the partnerships are formed as two-tier partnerships, meaning that in the place of the limited partners is another partnership (see figure 2).
Under these programs, private sector investors would provide 5% or more of the initial capital and the government would contribute the balance, either through direct loans or loan guarantees over a long period of time (typically 30-50 years). Most of these programs were put together as limited disbursement programs and are typically referred to as passive loss projects.
Based on the prevailing tax code, investors were allowed to depreciate the buildings over a shorter term than the mortgage, which allowed the limited partnership to create taxable losses. In some cases, the owners were able to utilize accelerated depreciation to amplify the losses in the early years. For the most part, these losses come from depreciation deductions. The bad news is that these same losses also produce a negative capital account.
For all practical purposes, depreciation is only a borrowed deduction. It is not a permanent deduction and must be paid back at some time. This does not mean that passive loss projects are bad or that the investors made a mistake by getting involved. In fact, the investors got significant tax advantages by deferring taxes owed to the government for fifteen to twenty years through these passive losses. The default method used by the government to “recapture” these deferred taxes is through “Phantom Income”.
Once the project’s depreciation is used up, they start to generate Phantom Income. While passive losses are incurred in the earlier years, Phantom Income exists throughout the life of the mortgage. Phantom Income only becomes noticeable once the depreciation has been exhausted and since its primary component is the principal portion of the mortgage, it tends to increase as the projects age. Hence the reference: the “Leaky Tax Shelter”..
Solutions and Services
Our founders have been working on solutions to these issues since 1992 and have developed several “Strategies for Tax Relief” to assist people in handling problems created by aging projects. These strategies consist of “Special Allocation”, “Bargain Sale”, Sales and Transfers, Offer-In-Compromise, Re-Syndication, LP Purchase, and GP Brokerage.
As mentioned earlier, Housing & Tax Consultants, LLC works with Owners, Developers and Managers of multi-family projects. Each of these groups has differing objectives and sometimes they may be at odds with the other participants. Our associates have considerable experience in bringing the parties together to solve these issues.
Whether you are an aging limited partner who wants to deal with estate planning issues or Phantom Income; a management company who wants to acquire general partnership interests and buy projects or is ready to retire and wants to sell their general partnership interests; a developer who wants to build new projects or re-syndicate older projects through an acquisition/rehab; or an investor that is looking to acquire limited partnership interests for the tax losses, we can help.
We have a project analysis service to help determine which options are most appropriate for your circumstances. To explore these options, just click on our contact page and send us an email or feel free to call us.