Most states still do not have legal precedent for dealing specifically with Sec. 42 properties. Among the states that can rely on case law, there's no uniformity as to how to value the properties for assessment purposes. Cases usually revolve around which income to use in the valuation equation - the restricted rents or the market rents - and/or whether to assign any value to the tax credits. An examination of three cases decided in 2003 demonstrates the point.

In The Greens of Pine Glen case, which took many years to come to an final judgment, the North Carolina Supreme Court overturned a ruling by the state's Court of Appeals. The Supreme Court held that Sec. 42 properties should be valued using an income approach and market rents, not restricted rents. The Court found:

"...taxpayer's contractual agreement to section 42 rent restrictions meant The Greens at Pine Glen no longer earned the market rate in rents. Taxpayer voluntarily entered into such an agreement because of the substantial tax credits it received in return. Taxpayer could have built these apartments for rental on the open market, but it chose to be in the business of affordable housing in order to take advantage of the various federal and state incentives. Its participation in the section 42 program created another way to finance taxpayer's building project because the sale of the tax credits generated funds that taxpayer used to construct The Greens at Pine Glen. Therefore, taxpayer's participation in section 42 housing represented a business and economic decision ..."

The taxpayer in The Greens at Pine Glen had argued that the rent restrictions were akin to governmental regulations, like zoning regulations, which diminished the property's value. The Court, however, called the rent restrictions "freely entered contractual covenants" and said "...taxpayer cannot adjust the value of their property by engaging in contractual agreements that reduce the income potential of their property below the fair market value."

Taking what appears to be an exactly opposite position, the Arizona Tax Court, in the Cottonwood Affordable Housing case, said that a property's value should be determined from its restricted income potential, without regard to low-income housing tax credits (LIHTCs). The Court held that while LIHTCs do provide an incentive for an investor or developer to invest in and construct these low income housing projects, they are also a disincentive for a current owner to sell, and provide little or no incentive for a new buyer to purchase, the property. Thus, the Court found that they add little, if anything, to the long-term value of the property.

To summarize its rationale for this decision, the Arizona court opined that:

" ... the restrictions imposed under the LIHTC program have a direct and immediate effect upon marketability and must be taken into account. Substantial rent restrictions have been placed on the property for a minimum term of fifteen years. Logic and common sense dictate that long term rental restrictions imposed upon rental property, either by contract or state or federal regulation, have a significant impact on the value of the property. A willing buyer, knowing that there is a restriction as to the amount of rent that can be charged, would pay less for a low income housing project than for a regular commercial apartment complex. The property should not be valued as though a buyer would not consider the restrictions. A valuation for an LIHTC project, determined under any of the standard appraisal methods, that does not take the deed restrictions into account will not result in a determination of fair market value for that property."

In Tennessee, assessors took yet another tack in valuing a Sec. 42 property owned by Spring Hill, L.P. There, they employed an income approach utilizing the restricted rents, but then added back to the property's value the discounted present worth of the total tax credits to be received in each of the 10 years. In affirming this methodology, the Tennessee Court of Appeals, in the Spring Hill case, concluded that the LIHTCs relate directly to the real property. They were not an intangible benefit, severable and sold to third parties, as the taxpayer argued, and they were properly included in the valuation equation. the Court went on to say that the assessors had properly balanced both the value-enhancing factor of the LIHTCs and the value-reducing effect of the restricted rents. Thus, they arrived at a value that reflects the property's sound, intrinsic and immediate value.

In the Spring Hill case, both the taxpayer and friends of the court pleaded with the Court to consider what they felt to be the very serious public policy implications that would fcollow from including LIHTcs in the property's value. The Court essentially relegated its response to this question to a footnote, where it said: "The legislature is the appropriate body to determine public policy on this issue."

But if you are prescient enough to have developed your Sec. 42 property in states like Alaska, Colorado, Florida, Illinois, Iowa, Pennsylvania and Wisconsin, you don't have to worry about the effects of a court case. Those states have specific statutes that prohibit the inclusion of LIHTCs in the value equation.

State Legislation Can Clear the Waters

For those owners of Sec. 42 properties in states that do not have a court case fuling on the specific circumstances of Sec. 42 developments, the waters appear muddy enough to justify a test case before the courts. There are obvious differences between Sec. 42 projects and market-rate apartment complexes or developments using other government subsidy programs, such as Sec. 236 or Sec. 515. These differences would serve as a foundation for arguing that the Sec. 42 properties should be valued on the basis of only their actual income and expenses, with no factor included for LIHTCs. In all states that don't already have laws on the books to give a break to Sec. 42 properties, though, owners should work toward a legislative solution. Appropriate legislation is the ultimate solution, bringing all laws across the country into harmony.

Wayne A. Tenenbaum is Of Counsel to the law firm Neill, Terrill & Embree, L.C., the Kansas and Nebraska member of American Property TAx Counsel, the national affiliation of property tax attorneys. He can be reached at wtenenbaum@ntelaw.com.