Change in Tax Rates and Qualified Affordable Housing Project Investments
The Tax Cuts and Jobs Act passed in December 2017 lowers the corporate income tax rates starting in 2018. Entities with qualified affordable housing project investments (LIHTC investments) will need to evaluate the impact the change in tax rates has on their accounting for such investments. Generally, accounting for LITHC investments is performed using one of three methods: the proportional amortization method, the equity method, or the cost method. The proportional amortization method was made available as an alternative in 2014 by the issuance of Accounting Standards Update 2014-01 Accounting for Qualified Affordable Housing Project Investments (ASU 2014-01).
The most common impact on the statement of financial position of a change in tax rates for any entity is the required adjustment of deferred tax assets and liabilities accounted for under Topic 740, Income Taxes. LIHTC investments, however, should not be confused with deferred tax assets. Nevertheless, a reduction in the corporate tax rate applicable to most entities holding LIHTC investments could result in an adjustment to the investment in certain circumstances because the change in tax rates affects the primary benefits received from a LIHTC investment.
Generally, the primary benefits received from a LIHTC investment consist of the low-income housing tax credits (the “tax credits”) and the other tax benefits resulting from tax-deductible losses based on the net investment amount consisting of the original investment less any expected residual value to be received upon disposition of the investment (the “other tax benefits”). The tax credits generally will be unaffected by a change in corporate tax rates. However, the other tax benefits likely will decrease because of the decrease in tax rates.
As a result, the change in tax rates will impact the accounting for LIHTC investments in two ways: 1) the net investment will need to be evaluated for impairment, and 2) annual accounting and the amortization of the net investment will be impacted if the proportional amortization method is used. These two areas are addressed further below.
Since remaining other tax benefits generally would be reduced by the reduction in tax rates, impairment would exist if the carrying amount of the investment is greater than the total remaining benefits expected to be received on the investment. To make this determination, the carrying amount of the investment would be compared to the total of the remaining tax credits, the remaining other tax benefits and any residual value expected to be received upon disposition of the investment. If the reduction in tax rates caused the total remaining benefits expected to be received to be less than the carrying amount of the LIHTC investment, then an impairment adjustment would need to be recognized. Because the remaining tax credits have not been reduced, we do not expect any impairment to result from the reduction in tax rates for LIHTC investments accounted for under the proportional amortization method. However, impairment could exist in some situations where LIHTC investments are accounted for using the equity method.
The impact of the decrease in tax rates on the subsequent annual accounting for a LIHTC investment is most significant for investments accounted for using the proportional amortization method. Under the proportional amortization method, the initial LIHTC investment balance less any expected residual value is required to be amortized based on the percentage of actual tax credits and other tax benefits allocated to the investor in the current period divided by the total amount of such items expected to be received over the life of the investment.
The initial estimate of the denominator in the above fraction is established at inception of the investment. A subsequent reduction in tax rates reduces the remaining other tax benefits, which reduces the denominator.
The guidance in ASC 323-740 related to application of the proportional amortization method does not address how a subsequent change in tax rates should be reflected. As a result, it is possible that accounting interpretations regarding how to reflect a reduction in tax rates could differ. We have presented two options below, Option 1 and Option 2, explaining how a reduction in tax rates could be reflected under the proportional amortization method. We believe Option 1 is preferable.
Based on our consideration of the guidance in ASC 323-740, and assuming no impairment adjustment is required as a result of the reduction in tax rates, we believe the change in the denominator caused by the reduction in other tax benefits represents a change in estimate which should be accounted for prospectively. Previous amortization of the LIHTC investment would not be changed. Prospective remaining amortization of the LIHTC investment would be based on a revised fraction based on the percentage of actual tax credits and other tax benefits allocated to the investor in the current period divided by the total amount of such items expected to be received over the life of the investment as adjusted to reflect the reduced other tax benefits. The effect will be an increased rate of amortization in comparison to the remaining tax benefits received. This approach is consistent with other scenarios involving changes in estimates, such as depreciation and amortization.
An alternative approach would be to recognize a catch-up adjustment to previous amortization amounts using the revised denominator. Such a catch-up adjustment is designed to maintain a constant effective yield on the investment, which is similar to how LIHTC investments qualifying for the effective yield method were required to be accounted for before the Financial Accounting Standards Board (FASB) issued ASU 2014-01, in January 2014, which amended Topic 323 Investments-Equity Method and Joint Ventures, including section ASC 323-740 Income Taxes (ASC 323-740), and eliminated the effective yield method of accounting for LIHTC Investments. The effect will be recognition of additional amortization in the year the catch-up adjustment is made.
Entities may encounter situations where one of the above alternatives is considered more appropriate under the proportional amortization method. However, because ASC 323-740 does not specify how a change in tax rates should be reflected under the proportional amortization method, the impacts of each approach should be evaluated before an approach is chosen.
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