Introduction and IRS Guidance
“I’ve already lost my property, will I lose tax credits, too?”
Whether it is a kitchen fire that destroys a unit or a hurricane that takes out an entire apartment community, property damage events result in casualty loss. As far as major disasters, a review of the last three years FEMA data shows that there were 79 areas affected by declared disasters in 2015 and there were 102 in 2016. As of late October, 2017, there were 124 such areas, mostly resulting from storms and wildfires. These events potentially affect or destroy many, many affordable housing units. On top of these major disasters, there are other losses that result from more localized events, such as the kitchen fire mentioned above. Owners, agents and investors may be forced to review the impact of casualty loss on their tax credits while a unit, building or property is off line after an event. Considering all the above, it seems a good time to review IRS guidance on casualty loss as it applies to tax credit properties. What happens to the credits while the property is down? Also, will the additional penalty of tax credit recapture result? The answers will depend on how quickly the loss is restored and whether the loss resulted from a presidentially declared disaster or a lesser event. We will discuss these issues in four parts.
Part 1: Definition of casualty loss and where we find IRS guidance
Part 2: Casualty loss related to a presidentially declared major disaster
Part 3: Casualty losses that do not relate to a declared disaster
Part 4: IRS provisions designed to assist victims of major disasters
Definition of casualty loss. A casualty loss is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Property damage is not considered a casualty loss if the damage occurred during normal use, the owner willfully caused the damage or was willfully negligent, or if it was progressive deterioration such as damage caused by termites. Major storms, flooding and wildfires often result in casualty loss. Leaking pipes that eventually result in mold and property destruction and gradual deterioration of parking lots due to seasonal weather heaving are NOT examples of casualty loss.
Usually, a building will be subject to tax credit recapture if, as of the close of any tax year after the first year in the compliance period, the qualified basis of the building is less than it was as of the close of the prior tax year. Qualified basis is reduced when individual units or a building is (1) not housing tax credit-qualified residents, or (2) the residents are not paying program appropriate rent, or (3) the units are not habitable and not reasonably up to HUD’s Uniform Physical Conditions Standards (UPCS) or local code. The third item is where property damage events potentially affect tax credits. However, an exception to the general rule exists if the reduction in qualified basis results from a casualty loss, and the loss is replaced or reconstructed within a reasonable period, as determined by the IRS. As we will see, the exact length of this reasonable period must be below a maximum established by IRS guidance, and is further delegated to the state tax credit agency in the case of major disasters. The maximum period itself is also different for declared disasters and other casualty losses.
Question: Where do I find IRS guidance on casualty loss?
Answer: At first, guidance on casualty loss relating to declared disasters was issued for specific major disasters. However, after a series of individualized disaster instructions, in 2014 guidance applicable to all future major disasters declared on or after 8/21/14 was issued in Revenue Procedure 2014-49. Additional relevant history can be tracked in the following documents:
IRS Publication 547
Chief Counsel Advice Memorandum (CCAM) 200134006
Rev Proc 95-28 (for disasters declared on or after 1/1/95)
Rev Proc 2007-54 (for disasters declared on or after 7/2/07)
The Sec. 42 LIHC Audit Technique Guide
Next time: Can I really avoid the loss of credits after casualty loss because of a major disaster? And more!