The Importance of Monitoring Tax Capital Accounts in Affordable Housing Partnerships
Monitoring tax capital accounts is important in any partnership, but it is especially critical in affordable housing partnerships. Internal Revenue Code Section 704 requires the maintenance of capital accounts and establishes rules governing the allocation of partnership income, losses, and tax credits. Affordable housing projects are particularly attractive to investors because they offer the opportunity to utilize Low-Income Housing Tax Credits (LIHTCs) and benefit from allocated partnership losses.
Properly tracking tax capital accounts helps ensure that investors can fully utilize the losses and credits as intended, maximizing the tax benefit associated with their investment. In addition, maintaining accurate records enables partners to identify and address potential issues before they become significant. Proactive monitoring helps avoid costly surprises, supports compliance with tax regulations, and contributes to the long-term success of the project.
Why Capital Accounts Matter
Investors typically participate in affordable housing partnerships to receive LIHTC credits and benefit from losses that may offset other taxable income. However, if an investor’s tax capital account becomes negative before the end of the credit period, limitations under the partnership agreement and applicable tax rules may affect the allocation of losses and credits that can be utilized. In many affordable housing partnerships, investors are generally allocated losses and credits more heavily than other partners which leads to tax capital accounts declining rapidly. Continuous monitoring of the accounts is essential.
When a partner’s capital account becomes negative, losses and credits may be reallocated to another partner in accordance with the partnership agreement and applicable tax rules. Regular monitoring of tax capital accounts helps identify potential issues and allows time for strategies to be implemented to avoid unexpected surprises. Steps can often be taken to avoid large tax liabilities and ensure LIHTCs can be utilized.
Avoiding Unexpected Surprises
A tax capital account projection should be included as part of the closing process of affordable housing projects. Regular monitoring of the projection can help ensure the capital accounts are in line with what investors are expecting and allow for planning to avoid unexpected outcomes. It is especially important in 4% tax-exempt bond transactions and rehabilitation projects because these developments typically generate less equity than traditional 9% LIHTC projects. The capital accounts are likely to decline even more rapidly without proper monitoring.
Investors generally exit affordable housing partnerships at the end of the LIHTC compliance period. If tax capital accounts were not monitored, an investor may end up with a large tax liability upon disposition of their partnership interest due to a negative capital account. Partnership agreements should include provisions that address capital account deficits so investors can avoid unexpected surprises at disposition. There are also planning strategies that can be implemented to spread losses out to ensure LIHTCs and allocated losses can be utilized.
McKonly & Asbury, LLP is a leader in accounting and tax services for affordable housing developments. Our team has the specialized knowledge that is required when preparing audits and taxes for affordable housing entities. To learn more about these services, be sure to visit our Affordable Housing page, or contact our team.
About the Author
Maegan Cassel is a Manager with the firm. She is a member of the firm’s Tax Segment, primarily working with clients in affordable housing and family-owned businesses providing tax services for pass-through entities, corporations, and… Read more
