Reviewing the Development Budget
The PJ underwriter reviews the development budget (uses) to evaluate whether it contains reasonable estimates for all of the project development costs. In general, these development costs are the same for a project, regardless of the funding source. However, there are some differences in the development budget for a HOME-LIHTC project of which the PJ should be aware:
- There may be some costs in an LIHTC project that a PJ might not normally see in a HOME- assisted project.
- There may be some costs in a HOME project that might not otherwise be in an LIHTC- assisted project.
- Presentation of the budget may differ because of LIHTC cost eligibility.
- Certain costs may be higher in a tax credit project than in other HOME-assisted projects.
LIHTC Costs that Are Not Found in a HOME Project
Housing tax credit projects can be complex, and the owner needs to engage the services of a variety of experts in order to successfully execute a housing tax credit deal. The PJ should expect to see the following costs in a project that has LIHTC equity funds. These costs are not typically present in a project that is funded only with HOME:
- Syndication Fees. Usually, the owner pays a syndicator to serve as a broker between the equity investor and the developer. This is referred to as the syndication fee. The syndicator might pool several projects into one equity fund, so that investors share the risk among several projects. Syndication is key to securing investor equity to the tax credit project.
- Tax advisors. Owners and investors rely on the advice of tax advisors to ensure the project complies with the IRS rules, so as not to jeopardize the tax credit.
- LIHTC application fees. Most states impose LIHTC application fees, to offset the costs of reviewing and processing LIHTC applications. In some states, there is a different fee structure for for-profit and nonprofit developers.
- Organizational fees. This is the cost to create the new ownership entity (Limited Liability Corporation or Limited Partnership) for the project.
These costs are standard costs in LIHTC deals, and they should be reflected in the development budget. The PJ should consult with the state to assess the cost-reasonableness of these fees; the state’s QAP may also provide guidance on the expected cost of these fees.
HOME Costs that Are Not Found in an LIHTC Project
There are a number of HOME requirements that are not LIHTC requirements. When reviewing a development budget, particularly for a project that was initially conceived as a tax credit project or that has already received an allocation of tax credits, the PJ should be sure that the budget reflects these HOME-related costs, as applicable:
- Davis-Bacon prevailing wage for projects with twelve or more HOME-assisted units
- Lead-based paint treatment for projects that include a pre-1978 building
- Environmental clearance requirements
- Relocation costs for any project that includes a property that is currently occupied
- Energy efficiency improvements required by the International Energy Conservation Code.
All of these costs are eligible HOME costs. Some of these costs may be eligible in the LIHTC basis, such as Davis-Bacon prevailing wages and lead-based paint treatment costs. These costs are related to the construction and building and can, therefore, be depreciated. Some of these other costs may or may not be eligible in the LIHTC basis, depending on the specific type of the cost and whether the cost(s) can be depreciated for income tax purposes. The project sponsor should consult with its tax attorney or tax credit advisor to make this determination. The following section of this chapter discusses eligible LIHTC costs in more detail.
Presentation of LIHTC-Eligible and Ineligible Costs
LIHTC cost eligibility is important for determining how many tax credits can be allocated to a project. The general principle underlying LIHTC cost eligibility is that a cost must be eligible to be depreciated for income tax purposes in order to count toward LIHTC basis. Therefore, eligible costs are referred to as “in LIHTC basis,” and ineligible costs are “outside LIHTC basis” (that is, the costs are not eligible to be included in LIHTC calculations which determine the amount of tax credits that can be issued). These items are driven by IRS rules about depreciation. There are no limits on how the equity in an LIHTC project can be spent once basis is established and tax credits are allocated (equity can pay for costs that are outside of the basis). This is significantly different than the HOME Program – HOME funds can be spent only on eligible costs for HOME-assisted units.
The development budget for an LIHTC project is often presented so that the costs are identified as “in basis” or “outside of basis.” For instance, when LIHTC funds are involved in a project, the development budget usually separates the land and building costs because construction costs are in basis (LIHTC-eligible), but land is outside of LIHTC basis (not LIHTC-eligible).
In general, the PJ does not need to review whether or not this delineation is accurate because the state reviews this component of the project. If the project has not yet secured a tax credit allocation, however, it is helpful for the PJ to have a basic understanding of what is inside and outside of basis because if the owner calculates the eligible basis incorrectly, it impacts its projection of how much tax credits the project can secure and this impacts how much HOME funding the project needs. Using the example of splitting the land and building cost, if the state has accepted the land/building split proposed by the developer, the PJ does not need to question this split and the inclusion in basis further. However, if the tax credits have not yet been requested, the PJ should understand the reasoning behind the split, so that it can assess if the tax credits anticipated by the developer are realistic.
Exhibit 2-3 identifies the standard line items in a development budget, and identifies if these are eligible costs under the HOME Program, and whether they are in or outside of LIHTC basis.
Exhibit 2-3: HOME Eligible Costs and LIHTC Eligible Basis
Certain fees may be higher for a HOME-LIHTC project than they are for a HOME-only project, including developer fees and attorney fees. These higher costs may be reasonable, depending on the project and the market, and should be expected because an LIHTC project is more complex than a typical deal and requires a high level of expertise and more time to put the deal together. The PJ may want to consult with the state to determine the cost reasonableness of these higher costs.
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