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September 13, 2013 EITF Meeting – Update on Issue 13-B Accounting for Investments in Qualified Affordable Housing Projects (Hope for Other Tax Credit Programs)


9/24/13

On April 17, 2013, the Financial Accounting Standards Board (FASB) issued a Proposed Accounting Standards Update (ASU or the Exposure Draft (ED)), Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (the proposed Update). (See previous CohnReznick alert on this topic). The ED reflects a consensus reached by the Emerging Issues Task Force (EITF or Task Force) on its project Issue No. 13-B, "Accounting for Investments in Qualified Affordable Housing Projects".  The ED is expected to address many of the concerns associated with the current accounting for affordable housing project investments. 

Subsequent to the issuance of the ED and as part of the accounting standards setting process, the FASB received numerous comment letters on the ED by various parties (industry trade associations, preparers, syndicators, developers). Based on the comments received on the ED and other outreach programs, the FASB staff presented suggested changes on the ED to the EITF Task Force at the September 13, 2013 EITF meeting.

Background of Current Accounting for Investments in Qualified Affordable Housing Projects

The Low Income Housing Tax Credit (LIHTC or affordable housing tax credit) is a federal tax program designed to encourage investment from the private sector in the construction and rehabilitation of low income housing. The program allows third-party investors who invest in affordable housing projects to receive the benefits of the tax credits allocated to an affordable housing tax credit property entity. An investor generally receives the benefits of the tax credits by making an equity investment in the entity that owns the affordable housing tax credit property. 

Current accounting for investments in affordable housing projects is set forth under ASC 323-740 (formerly EITF 94-1) issued in May of 1995. The guidance provides that an entity investing in a qualified affordable housing project or LIHTC investment can elect to account for that investment using the effective yield method if all of the requisite conditions are met. If an investor’s investment qualifies for the effective yield method, then the tax credits received from the investment (net of amortization of the investment) are presented in the income statement within income taxes. Investments that do not meet all of the conditions of the effective yield method are required to be accounted for using either the equity method or the cost method. 

The current requirements to qualify for the effective yield method are difficult to meet and very few LIHTC investments qualify for use of the effective yield method. As a result, most investments in affordable housing projects are accounted for using the equity method. The concern with the equity method, or the cost method for that matter, is the resulting income statement geography. Under the equity method and the cost method, the investor’s earnings on the investment, which is usually a loss due to depreciation charges, is reported as a pre-tax loss while the resulting tax credits and other tax benefits related to those losses are reported separately as a component of the income tax provision. This leaves investors explaining why they made an investment that appears to be losing money when, in reality, it is performing as expected. In contrast, under the effective yield method, the amortized cost of the investment is netted against the tax credits and presented as a component of the income tax provision.

EITF Discussion and Proposed Changes to the ED

In an effort to address the above noted concerns with the current accounting around LIHTC investments, the proposed accounting Update is expected to allow more LIHTC investments to qualify for the effective yield method. The FASB received seventy-three (73) comment letters on the ED. Based on the comments received, the FASB staff developed suggested changes and modifications to the original ED accounting guidance. The FASB staff presented their findings and suggested changes to the EITF Task Force at their September 13, 2013 meeting. 

Overall the public comments received were supportive of the proposed changes to the current accounting for LIHTC investments, but questioned a number of key issues in the ED in an effort to make the proposed accounting more operable in practice. In summary, a majority of respondents requested the FASB to reconsider the conditions required to apply the effective yield method, requested that an alternative amortization method for LIHTC investments be used, and also supported that the effective yield method guidance be applied to similar types of tax credit investments such as New Market Tax Credit (NMTC), Historic Tax Credits (HTC), and Renewable Energy Tax Credits (RETC). 

The main topics discussed during the EITF meeting regarding the accounting for LIHTC investments focused on the following categories: Scope of the guidance, Measurement of the investment, Disclosures, Transition and Early Adoption, Effective Date, and Other Tax Credit Investments.

Scope of the Proposed Accounting

The proposed accounting guidance in the ED requires that in order to present the amortization of a qualified investment (along with the allocated tax credits) within the investor’s income tax line item in their financial statements, the investment must meet the following conditions:

  1. It is probable that the tax credits allocable to the investor will be available.
  2. The investor retains no operational influence over the investment other than protective rights, and substantially all of the projected benefits are from tax credits and other tax benefits (for example, tax benefits generated from the operating losses of the investment).
  3. The investor’s projected yield based solely on the cash flows from the tax credits and other tax benefits is positive.
  4. The investor is a limited liability investor in the affordable housing project for both legal and tax purposes, and the investor’s liability is limited to its capital investment.
     

Many of the comment letter responses believed the criteria in requirement #2 would limit the number of tax investments that would qualify for the accounting. Respondents believed that that the proposed condition of “no operational influence” would be too restrictive and is inconsistent with the fundamentals of equity accounting. Based on the comments received, the EITF reached a tentative decision that criteria #2 above would be modified from requiring an investor to retain no “operational influence over the investment other than protective rights”, to now requiring that an investor retains no “substantive participating rights in the investment.” The changes to criteria #2 are shown below (deletions are struck trough and additions are underlined).

The investor retains no operational influence over substantive participating rights in the investment other than protective rights, and substantially all of the projected benefits are from tax credits and other tax benefits (for example, tax benefits generated from the operating losses of the investment).

Many of the comments received from the respondents indicated that the requirement that “substantially all of the projected benefits” be from tax credits and other tax benefits should be clarified or revised. In many instances a LIHTC investment structure involves other arrangements between the investor and the limited liability entity. As such, the FASB is also proposing to add guidance to the final standard that certain other arrangements and transactions between the investor and the limited liability entity (for example bank loans) should not preclude an entity from applying this guidance provided that all three of the following are true: (1) the primary business purpose of the reporting entity is to enter into these types of transactions, (2) the transactions are entered into at market rates commensurate to rates offered to other counterparties with similar credit quality, and (3) the reporting entity does not acquire substantive participating rights as a result of these transactions.

The original proposed Update did not specify when the conditions to elect the effective yield method should be evaluated – at the time of the initial investment or reevaluated throughout the life of the investment. The FASB staff is proposing to issue additional clarifying guidance that the investment criteria and conditions would be evaluated at the time of initial investment or upon occurrence of an event that changes the nature and design of the investment entity.

The FASB is also suggesting that the final standard include clarifying language that a reporting entity should test the LIHTC investment for impairment if changes in facts and circumstances indicate that it is no longer probable that the tax credits allocable to the investor will be available.

Measurement of the Investment – Amortization

In the original ED, the FASB requested feedback on whether the effective yield method was an appropriate method to account for qualified affordable housing investments. A majority of the comments received suggested that using the effective yield method was overly complex and instead supported a proportional or ratable amortization method. Based on the feedback received the FASB is recommending to revise the proposed accounting Update to change the method of amortizing a qualified LIHTC investment from the effective yield method to a proportional amortization method.  In using a proportional amortization method, the cost of the investment would be amortized each reporting period in proportion to the tax credits and other tax benefits received. Also, consistent with the original proposed Update, the resulting amortization should be recognized as a component of income taxes attributable to continuing operations.

Finally, the Task Force reached a tentative conclusion that LIHTC investments would be presented on the investor’s balance sheet as a deferred income tax asset, instead of as an investment.

Other Tax Credit Investments

An overarching question is whether other types of tax investments made primarily for the purpose of receiving tax credits (e.g. NMTC, HTC, RETC) would meet the conditions in the proposed Update and therefore apply the same accounting. A significant number of respondents (as well as the FASB staff) noted that those types of tax credits have structures and characteristics similar to the LIHTC.  As such, a tentative decision was reached that the scope of this project should be expanded to other types of tax investments. However, the FASB stated that not all of the currently proposed criteria may be appropriate for all tax credit investments. The FASB staff believes that the additional facts and circumstances of other types of tax investments should be considered by the EITF before the scope of the LIHTC guidance is expanded to other tax investments. A recommendation was made to add a separate project to research and evaluate whether the proposed guidance should be extended to other types of tax credit investments. 

Disclosures

Based upon the feedback received, the majority of respondents to the proposed Update generally agreed with the proposed disclosures. The FASB staff suggested one change to the disclosures and is proposing to remove the example disclosure related to whether the qualified affordable housing project is current subject to any regulatory reviews and the status of such reviews.

Transition, Early Adoption, and Effective Date

The proposed guidance would be applied retrospectively with early adoption being permitted. The effective date for all entities would be effective for fiscal years, and any interim periods within those years, beginning after December 15, 2014.

The Next Steps

The EITF will perform additional outreach and research to determine the potential impact of the above noted changes and are expected to revisit the topic during the EITF’s November meeting. The proposed changes to the original ED could be significant and, as a result, some of the Board members suggested the proposed accounting guidance for investments in qualified affordable housing projects may need to be re-exposed as a new ED.


What Does CohnReznick Think?
If the ED is re-exposed, CohnReznick believes that it is unlikely that the proposed accounting will be finalized at the EITF’s November meeting. Additional work is still required regarding finalization of the amortization model. Changing the classification of the investment to that of a deferred tax asset and expanding the scope of the accounting to other types of tax credits represent significant new considerations, which ultimately could slow down finalization of the accounting.


Contact:

For specific questions regarding the EITF’s meeting, please contact your CohnReznick engagement partner for assistance or Michael Beck, CohnReznick’s National Director of Audit and Accounting at 404-847-7728.


Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.


 

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