By Gordon Goldie and Matthew Kosciow, Plante Moran
Tax Increment Financing (“TIF”) is an incentive program authorized by a variety of state statutes that allows municipalities to promote economic development of designated areas and/or property types. TIF subsidies are funded by the increase in tax revenue (e.g., property tax, sales/use tax) within a designated TIF district due to the economic activity generated by the developments. The developer will receive reimbursement for eligible expenditures (e.g., public infrastructure, sewer expansion) over a period of time pursuant to a promissory note and/or reimbursement agreement.
A recent Internal Revenue Service (IRS) Chief Counsel Advice Memorandum clarified key points on the tax treatment of TIF reimbursements received by a developer in connection with the construction of infrastructure improvements. However, the CCA leaves several questions unanswered.
Tax reporting of TIFs
The taxpayer in the CCA was subdividing land and selling parcels to home builders and commercial developers. The taxpayer acquired land with the intention of creating a mixed-use development, but the taxpayer was required to provide public infrastructure to gain approval for development plans. The municipality created a special improvement district, which provided reimbursement for the taxpayer’s infrastructure expenditures. At the conclusion of the taxpayer’s development activities, the special district issued promissory notes to the taxpayer with a stated interest rate and maturity date (bond anticipation notes).
The taxpayer elected under Revenue Procedure 92-29 to treat all payments made for public infrastructure improvements as common improvements and allocated the improvement costs among the developed lots.
Following completion of the development, the taxpayer began selling lots and receiving payments of principal and interest pursuant to the bond anticipation notes. The taxpayer treated the receipt of principal amounts under the notes as reductions to the basis of the lots that were subsequently sold after the year of repayment.
The analysis of CCA 201537022 concluded that:
- Reimbursable expenditures made for infrastructure improvements should be treated as common improvements and included in the basis of the properties within the development.
- Reimbursements for infrastructure improvements made pursuant to a TIF note should be treated as reductions to the basis of the underlying properties held by the taxpayer at the time of the reimbursement.
- To the extent that the taxpayer already disposed of all of the improved property, the reimbursements for infrastructure improvements are ordinary income.
Points of consideration
The guidance provided by the CCA raises several important questions, including the following:
Application of Section 118
The CCA treated the reimbursement of infrastructure costs as a reduction of basis (or an inclusion in taxable income after all property has been sold). However, in the case of a corporate taxpayer (as was the case in the CCA), could receipt of contributions to capital by a nonshareholder be excluded from taxable income under Section 118?
Costs other than infrastructure improvements
The CCA focused on facts involving TIF reimbursement of public infrastructure improvements. However, TIFs may be used to finance a variety of expenditures. Should the tax treatment of a TIF used to finance depreciable property differ considering the basis adjustment outlined in the CCA may be difficult to administer?
Alternatively, the TIF-eligible costs could be included in the basis of the underlying property with a corresponding zero basis receivable being recorded. Under such approach the taxpayer would recognize TIF reimbursements as taxable income. The TIF-eligible costs could also be included in the basis of a receivable rather than including such amount in the basis of the depreciable property and reimbursements would reduce the receivable. Under such approach, the taxpayer would generally not recognize income on the receipt of the TIF reimbursements, but at the expense of excluding the eligible costs from the basis of the underlying property. For development projects that involve property eligible for tax credits (e.g., historic rehabilitation tax credits), the zero basis receivable treatment would likely maximize the credits.
Sale of the TIF note
The facts presented in the CCA involved the taxpayer continuing to hold the note and receiving all related payments from the municipality. What if the taxpayer sold the TIF note — would the TIF note be a capital asset, and how would the taxpayer determine its basis in the TIF note?
TIFs are a common and important form of public financing for real estate development projects, but they differ depending on the state and municipality. The recent CCA provides some guidance, but additional questions remain unanswered depending on the facts of the particular development project.
Gordon Goldie is a partner and Matthew Kosciow a senior tax manager with Plante Moran, a tax, consulting and wealth-management firm with locations in Illinois, Michigan and Ohio, as well as internationally.