Section of Taxation Publications
  VOL. 60
NO. 2

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Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.

Bradley Myers*

* Assistant Professor of Law, University of North Dakota School of Law; University of California, Los Angeles, B.S., 1983, M.S., 1987; University of Oregon School of Law, J.D. 1993; New York University, LL.M., 1994


Availability of affordable housing is a long standing social issue in the United States. The primary system adopted by Congress to create new stocks of affordable housing is the availability of the Low-Income Housing Tax Credit (LIHTC) under section 42 of the Code. A significant aspect of the LIHTC program in both practice and design is the participation of nonprofit entities as owners and developers of the affordable housing projects developed using the LIHTC. Unfortunately, the LIHTC program also requires nonprofits that develop projects to enter into business relationships with for-profit partners.

The Service has long opposed the participation of tax exempt entities in traditionally for-profit economic arenas. The general resistance has taken the form of the imposition of the Commerciality Doctrine, which prevents nonprofits from engaging in activities that are commercial in nature, as well as the rule that any substantial noncharitable purpose will prevent an entity from qualifying as tax exempt. Congress largely dealt with the issue of nonprofits engaged in purely commercial ventures through the adoption of the unrelated business income tax (UBIT). Opposition by the Service in this area, however, has mostly resulted in limitations on the activities that tax exempt entities can engage in on their own behalf. The LIHTC program, on the other hand, brings nonprofits into the more troubling area of joint venture relationships with for-profit entities.

The development of partnerships between tax exempt entities and for-profit businesses and individuals has proven particularly troublesome for the Service. The issue is not that the activities of these ventures are insufficiently tied to the nonprofit’s purpose; they usually are. Besides, any unrelated activities, even when conducted through a joint venture, would be subject to UBIT. The problem is that joint venture partners owe a fiduciary obligation to watch out for one another’s interests. This must be reconciled with one of the basic obligations borne by tax exempt entities: that no part of their net earnings may inure to the benefit of any private shareholder or individual. A nonprofit that dedicates itself to protecting the interests of its joint venture partners may end up ensuring the financial return of that partner even though doing so may diminish its ability to satisfy its tax exempt purposes.

It has always been necessary to interpret the private inurement prohibition carefully. Tax exempt entities can have employees who receive salaries, even quite high salaries. They can also enter into basic agreements, such as rental contracts or purchase agreements, that result in for-profit businesses and individuals receiving a share of the earnings of the tax exempt entity. The Service has consistently drawn a distinction between third party agreements to provide goods and services and third party agreements to jointly operate an enterprise. The ban on private inurement has always been something a bit more nebulous than just preventing individuals from receiving net earnings of the organization. It assumes a corporate model, where the organization operates, pays its bills, and has some level of profit remaining. It is this profit that may not inure to private individuals, but must be reinvested in the tax exempt activities of the organization.

Despite Service concern and resistance to partnerships between nonprofit and for-profit entities, Congress has embraced the concept through the adoption of the LIHTC, which envisions and even mandates partnerships between nonprofits and for-profit investors. The program has proven quite effective in reaching its goals of providing new low-income housing.

Despite Congressional approval, the Service has continued to raise valid concerns regarding the relationships between tax exempt entities and their for-profit partners. The original position of the Service was that nonprofits could never engage in joint venture activities with a for-profit interest. Although the Service appears to have conceded that tax exempt entities must be allowed to engage in joint ventures, it has done so only with the caveat that the nonprofit must control the joint venture. The question is whether the LIHTC program can be amended in a way that will retain the positive aspects which have won Congressional approval while satisfying the concerns of the Service and ensuring the LIHTC program’s continued vitality and public support.

This Article proposes a change to the structure of LIHTC transactions which should satisfy the concerns of the Service that nonprofits maintain control over housing projects, while at the same time satisfying investors that their money is not at any greater risk. An assumption of this Article is that participation of nonprofits in the development and ownership of property is to be greatly encouraged. Part II of this Article discusses the history of the development of the control standard for assessment of nonprofit participation in joint ventures. Part III summarizes and describes the LIHTC and the syndication system that serves as the primary vehicle for use of the credits. Part IV reviews the history of Service treatment of nonprofits involved in low-income housing development using the LIHTC. Finally, Part V discusses a proposal to separate use of the LIHTC and, significantly, the losses generated by the operation of the projects, from ownership of those projects.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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