Accounting, Audit & Tax Workshop For the Year Ended December 31, - - PowerPoint PPT Presentation

Massachusetts Housing Investment Corporation

Accounting, Audit & Tax Workshop For the Year Ended December 31, 2017

Presented By: Colleen D’Alfonso, CPA, Partner, Daniel Dennis & Company, LLC Karen Kent, CPA, Partner, Kevin P. Martin & Associates, P.C. Kenneth Lund, CPA, Managing Partner, Daniel Dennis & Company, LLC Christopher Pulick, CPA, Tax Director, Kevin P. Martin & Associates, P.C. November 29, 2017

1

Reporting Timelines – Opening Remarks Project Audits and Tax Returns: Drafts: Due March 1, 2018 Finals: The Later of March 15, 2018 or Within eight (8) calendar days of the date MHIC issues its “Go Final” letter.

2

Overall Agenda

• Audit Process
• Cost Certification Process
• Tax Process
• Year 15 and IRS Audit Guide
• Questions & Answers

3

Structure

IRS

State tax credit entity

Entity which requests and receives tax credits – typically a limited partnership/LLC which owns a housing project providing low income housing to qualified tenants

Operating Partnership

Allocation of credits

Financing $$$$$

$ $$$ The lender

Developer of LI HTC building

• r project - controls the operating

entity

1% GP

The Syndicator

negotiates the union between developers and investors

INVESTORS in the Fund

GP of Fund

Controls fund

Syndication fee

The Fund

• an investment

partnership

99% LP

I nvests $$$ (LP of Fund) Credits!! Low income housing Qualified Tenants I nvests $$$

4

Approach

MHEF Funds use the equity method of accounting for its investment in each project partnership.

5

Approach - Continued

Upper tier accountant will:

 review the draft audit and tax returns of each project partnership. require and/or request selected documentation as part of the review process.

6

Approach - Continued

Upper tier accountant will:

inquire and discuss items that may arise with MHIC and/or the lower tier accountant as needed. place reliance on the project partnership financial statements.

7

Audit Matters

–Please notify MHIC immediately if any

• f the following occur:
• Impairment
• Qualified Opinion/Disclaimer of Opinion
• Going Concern
• Restatement
• Amended Tax Returns
• Casualty Loss

8

Required Documentation – Year End Requirements

Required for ALL deals

– Signed Component Auditor Letter – Peer Review Report – Minimum Gain Calculation – Book to Tax Reconciliation – Qualified Occupancy Summary – Classifications of Loans – NR/QNR/R – Details of any special tax allocations (profit-loss- credits-liabilities

9

Required Documentation – Year End Requirements continued

Required for ALL First and Second Year Deals

– Cost Certification, if applicable – Draft 8609’s, if applicable – Working Trial Balance (GAAP & Tax) and Financial Statement grouping sheets

10

Required Documentation – Year End Requirements continued

Required for ALL First and Second Year Deals

– Fixed assets and fixed asset additions along with related depreciation (including calculations for asset impairment if applicable). – Deferred costs and related amortization. – Mortgage and loans payable along with related interest and confirmations. If no confirmations, please document how tested.

11

Required Documentation – Year End Requirements continued

Required for ALL First and Second Year Deals

– Partners equity showing changes in limited partner and general partner equity. – Revenue and expense analytical review. – Legal work paper and letter(s), if applicable – Management representation letter

12

Financial Statement Reporting/Accounting Pitfalls

• Material tenant accounts receivable
• Escrow/Reserve activity detail not

reconciled to third party statements

• Land included with building
• Construction payables included with

accounts payable

13

Financial Statement Reporting /Accounting Pitfalls - Continued

• Accruals – real estate taxes, utilities,

management fee, etc. not properly recorded

• Entity fees – calculation of incentive fees, asset

management fee, investor service fees etc. not properly performed and/or recorded

14

Financial Statement Reporting/Accounting Pitfalls - Continued

• Inclusion of entity expenses with
• perating expenses
• Development fee/soft debt interest non-

accrual

• Debt not reconciled to third party

statements

• Failure to record non-cash transactions
• Disclosure of guarantees

15

Financial Statements

Sample Financial Statements are included in the MHIC Tax Return and Audit Preparation Guide

16

Impairment

Impairment is the condition that exists when the carrying amount of a long-lived asset exceeds its fair value. An impairment loss shall be recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.

17

Impairment

Examples of Triggering Events:

• A significant decrease in the market price of a long-

lived asset

• A significant adverse change in the extent or manner

in which a long-lived asset is being used or in its physical condition

• A significant adverse change in legal factors or in the

business climate that could affect the value of a long- lived, including an adverse action or assessment by a regulator

18

Impairment

Examples of Triggering Events – Continued

• An accumulation of costs significantly in excess of the

amount originally expected for the acquisition or construction of a long-lived asset.

• A current-period operating or cash flow loss combined

with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset.

• A current expectation that, more likely than not, a

long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

19

Impairment

• Recoverability Analysis:

– Carrying value vs. sum of undiscounted cash flows – If the carrying value of the asset exceeds the sum of the undiscounted cash flows, the asset is impaired and must be written down to fair value.

20

Impairment

• Fair Value – Some Considerations:

– Value of the tax credits – Value of the future expected cash flows – Original underwriting projections – Appraisals

21

Management Responsibilities

• Financial Statements are the

responsibility of the organization’s management.

• Financial Statements should be in

accordance with GAAP.

• Management is responsible for ensuring

internal controls are in place and

• perational

22

Management Responsibilities

• Books are maintained on the accrual

basis of accounting

• All transactions including cash and non-

cash are recorded in the general ledger and reconciled at year end

• Development and operating activity are

consolidated and reconciled

23

Management Responsibilities

• Maintenance of supporting

documentation

• Any new debt, debt modifications or

restructurings are properly accounted for and supported by signed documents

24

Management Responsibilities

• Responsible for compliance with laws

and regulations and for making the auditor aware of those requirements

• Completion of accurate qualified
• ccupancy summaries for all LIHTC

properties (including 100% deals)

25

Auditor Responsibilities

• Timely Service
• Reasonable deadlines for information

requested

• Reasonable staff continuity
• Independence
• Partner involvement
• Compliance with audit requirements

26

Auditor Responsibilities

• Express an opinion on the financial

statements based on audit results

• Preparation of tax returns based on

information provided by management

27

Auditor Expectations

• Staff availability/cooperation
• Supporting schedules
• Information provided timely
• Forms and checklist completion
• Knowledge of and responsibility for

financial statement preparation and GAAP

28

Project Sponsors – Accounting and Auditing Updates that MAY be Applicable to Your Financial Statements

• Accounting for Leases

 Requiring leases to be capitalized (i.e. on the statement of financial position)  The lessee recognizes a Right of Use (ROU) asset and liability for lease contracts (other than short-term leases)  The ROU assets represents the lessee’s right to use the leased asset for the lease term; the liability represents the lessee’s obligation to make lease payments.  Effective fiscal years beginning after December 15, 2019

29

Project Sponsors – Accounting and Auditing Updates that MAY be Applicable to Your Financial Statements

• Presentation of Financial Statements of Not-for-Profit Entities

Replaces reporting model that has existed for 20 years Changes: Net Asset Classifications (3 categories to 2) Expanded Disclosure for: Underwater Endowments Board-designated Net Assets Transparency and Utility of Liquidity Information Functional Expenses Presentation of Investment Expenses (net with investment return) Choice of Cash Flow Presentation (direct vs. indirect)  Effective for fiscal years beginning after December 15, 2017

30

Project Sponsors – Accounting and Auditing Updates that MAY be Applicable to Your Financial Statements

• PROPOSE

D GUIDANCE

I

n Aug ust 2017, F ASB propose d c ha ng e s to g ra nt a nd c ontribution

a c c ounting

Ne w fra me wo rk to de te rmine whe the r a c o ntrib utio n is c o nditio na l o r

unc o nditio na l

De sig ne d to he lp o rg a niza tio ns e va lua te if a tra nsa c tio n sho uld b e

a c c o unte d fo r a s a c o ntrib utio n o r a n e xc ha ng e

Apply to a ll o rg a niza tio ns tha t ma ke c o ntrib utio ns o f c a sh a nd o the r

a sse ts, inc luding b usine ss e nte rprise s

 If finalized, the effective date would coincide with the new revenue standard.

31

Project Sponsors – Accounting and Auditing Updates that MAY be Applicable to Your Financial Statements

• Accounting for Revenue Recognition – Topic 606

 The revenue recognition standard affects all entities—public, private, and not-for-profit—that have contracts with customers, except for certain items, which include leases accounted for under FASB ASC 840, Leases; insurance contracts accounted for under FASB ASC 944, Financial Services—Insurance; most financial instruments, and guarantees (other than product or service warranties).  The new revenue recognition standard eliminates the transaction- and industry-specific revenue recognition guidance under current GAAP and replaces it with a principle-based approach for determining revenue recognition.  Effective for annual reporting periods beginning after December 15, 2018.

32

Cost Certification Process

The purpose of the cost certification is to establish the actual total costs incurred by the taxpayer in order that the Total Development Cost, Depreciable Basis, Historic Tax Credit Basis, and Low-Income Housing Tax Credit (“Tax Credit”) Basis may be determined for purposes of preparing the IRS Form 8609, Low Income Housing Credit Allocation Certification. The costs must be within the parameters established by the respective state Housing Finance Agency (HFA). For example in:

• Massachusetts - Department of Housing and Community

Development (DHCD)

• Connecticut - Connecticut Housing Finance Agency (CHFA)

33

Cost Certification Process

Each state has its own cost certification format. Each state has its own review and approval process. Each state has its own process as to the preparation of the 8609’s.

34

Cost Certification Process

Knowing the respective HFA’s requirements is critical to a successful and timely cost certification. Establish, early on, an understanding with your CPA of the cost certification timing and expectations. Communicate with MHIC as to the cost certification timing and if any issues arise that may delay the timing. MHIC requires review of the draft cost certification and draft 8609(s) with the Part II elections penciled in for their review and approval prior to signing.

35

Cost Certification - Overview

36

Cost Certification – Books and Records

• Accrual basis of accounting
• Recording of predevelopment costs
• General ledger chart of accounts is

consistent with the sources and application

• f funds
• Allocation of development costs
• Development and operating activity is

consolidated

• Permanent file documents

37

Cost Certification – CPA Documents

• Offering memorandum/Letter of understanding/Property fact sheet

– document describing the project in detail, such as, name, location, financing, funding, required reserves, etc. used to establish understanding among developer, syndicator and investor)

• Tax opinion and Tax credit application
• LIHTC initial allocation and carryover allocation letters
• Financial forecast
• Development budget (sources and uses of funds)
• Partnership/LLC agreement (Original and Amended)
• Development fee agreement
• Purchase and sale agreement (acquisition of land/property) and

acquisition settlement sheet

38

Cost Certification – CPA Documents

• Financing agreements: mortgages and notes payable; mortgage

commitment letter including construction financing; soft debt notes and agreements

• Government grants, if applicable
• Land use restriction agreement/regulatory agreement
• Architect Agreements
• Construction contract and copies of approved change orders
• Cost of commercial space
• Site improvements
• Furniture, fixtures and equipment
• Summary trial balance including development and operations on an

accrual basis

39

Cost Certification – CPA Documents

• Pre-development costs are recorded gross
• Non-cash activity is recorded
• General ledger detail including development and operations
• Allocation of development costs detailing capitalized versus

expensed and methodology used to allocate costs

• Unit Information - unit basis and square footage basis
• Development payable detail listing
• Invoices available as requested
• Requisitions – available as requested
• Detail draws schedule for all sources of funds including date, amount

received and accrued interest, if any.

40

Eligible/Non-Eligible Costs

Eligible Basis Generally Includes:

• Building Acquisition
• Construction Costs
• Soft costs: architect, legal, permitting, clerk of the works, survey, etc.
• Refrigerators, stoves, air conditioners
• Parking lots, roads “closely associated” with use of the building
• Grading and landscaping “closely associated” with the use of the

building

• Capitalized interest including amortization of loan costs
• Local impact fees

41

Eligible/Non-Eligible Costs

Eligible Basis Generally Does Not Include:

• Cost of land
• Loan costs and fees
• Bond issuance fees
• State Housing Compliance Fees
• Marketing/Advertising
• Reserves required by lender
• Parking, roads, grading, and not integral to the building
• Landscaping not adjacent to the building (trees along property line not eligible)
• Organization and syndication costs
• Rent-up costs
• Development fees allocable to land acquisition and other in-eligible project costs
• Construction Contingency (contingency should be reclassified by client to actual

natural category)

• Cost Certification Fee

42

Projections

• Underwritten projections represent the

investment expectation.

• Cost certification summarizes the actual results

when the building has been completed.

• Compare the cost certification to the

projections.

• If cost certification is not materially consistent

with the underwritten projections, then the differences should be understood as questions may arise.

43

Summary

• Communication
• Books and Records in Order
• Know the project
• Know HFAs requirements
• Know MHIC requirements

– Review of draft cost certification – Review of draft 8609(s) with Part II elections penciled in for MHIC’s review and approval prior to signing

44

Tax Returns

45

Tax Return – Due Dates

• Partnerships

– Return due 3/15

• Corporations

– Return due 4/15

46

Tax Return

• Prefer K-1’s on tax basis
• If on GAAP basis, provide

a tax basis footnote

47

Tax Pitfalls

• Capitalizing 100% of interest,

taxes and insurance into rehab basis

• Failure to maximize credits:

– Focus on building with fewest market tenants first – Fill entire building first – Consider moving market rate tenants to other buildings

48

Tax Pitfalls - Continued

• Not looking at operating statement when preparing

cost certification to see if there are capitalizable costs paid for out of operations to increase tax credit basis

• Not meeting expected lease-up
• Not tracking qualified occupancy (i.e. lower of area
• r units
• Failure to timely plan, prepare and complete cost

certification

49

Tax Pitfalls - Continued

• Failure to timely secure 8609’s from the

housing finance agency

• Electing improper elections on Section II of

the 8609 (i.e. set a-side election)

• Improper liability allocation
• Improper cut-off of qualified expenditures for

HTC

50

Minimum Gain

– Minimum Gain is the excess of nonrecourse liabilities which are secured by the partnership property over the adjusted tax basis of the property – Rules prescribed under 704(b) limit the losses allocated to limited partners to their capital contributions, their previous share of income and losses plus their share of minimum gain. – Pre-emptive Reallocation

51

Occupancy Issues

• Minimum set-aside requirement

– 40-60 rule – 20-50 rule

• Client must meet set-aside requirements by

year end or project will not qualify for that year’s tax credits (deferral)

• Set aside requirements apply throughout the

compliance period (15 years)

52

Deferred Developer Fees

One of the most significant issues encountered in low income tax credit cases stems from the inclusion or general allowance

• f developer fees in the reported eligible basis
• f the respective real estate projects.

53

COD Income

• Debt Modification that must be tested

for COD income

– Change from recourse to non recourse or vice versa – Change in payment expectation – Different asset securing nonrecourse debt – Change in obligator on a recourse debt

54

Year 15 Issues

– When to Exit

• Tax Credit Compliance ends on the last day of the 15th

year since the credits were first claimed on the tax return

• May be different for different buildings
• Need to be thinking about Year 15 issues long before Year

15 – strategy should be decided in year 13, prepared for in year 14 and executed in year 15

– COD Income – Lender Consents – Assignment and Assumption Agreements – Formation of New entities

55

Year 15 Issues

– Know the property

• Is cash flow sufficient to sustain it?
• What are the anticipated changes, such as a loss of a subsidy?
• Is the property in good shape, what are the capital needs?
• What’s the current market, what’s the market projected to be

– Know the stakeholders, what do they want?

• Residents
• Investors
• Lenders
• Allocating agencies

56

Year 15 Issues

– Know what your documents say you can do and cannot do.

• Is there a purchase option?
• Is there a “Right of First Refusal” (ROFR) (Section 42

requirements?

• How are the proceeds to be split?
• Are there disposition fees?
• What issues are negotiable?
• Investor Income Issues
• Assignment and Assumption Issues

57

Year 15 Issues – When to Exit

– Many Options

• Sponsor acquires property and continues operations,

assuming all existing debt.

• Sponsor acquires and rehabs through re-syndication and/or

refinancing – new entities

• Sponsor acquires and sell to third party
• Partnership sells to third party
• Homeownership (lease-purchase, condos)
• “Qualified contract”
• Remember “exit taxes” – tax return due date
• Remember an audit may still be required –

– Know your regulatory agreement.

58

IRS Audit Guide

– Released in September 2014 by the IRS, revised August 2015 – To assist IRS examiners audit taxpayers, usually partnerships

• wning IRC 42 housing projects

– The new Audit Technique Guide does not replace, but rather complements, the Form 8823 Guide, which was written to assist state housing finance agencies evaluate partnerships for compliance with LIHTC program requirements and report noncompliance to the IRS

8823 Guide Audit Technique Guide 344 Pages 200 Pages Auditor

59

IRS Audit Guide

– Chapter 4, First year certification – Chapter 5, Extended use agreement – Chapter 6, Nonprofit set-aside – Chapter 8, Eligible basis – Chapter 12, Applicable fraction – Chapter 15, Credit adjustment – Chapter 16, Credit recapture

60

Question and Answer

61

The End Thank You!

62