Accounting Guidance Update for Investments in Qualified Affordable Housing Projects
On January 15, the Financial Accounting Standards Board (FASB) issued a new Accounting Standards Update (ASU), Investments – Equity Method and Joint Ventures (Topic 323), Accounting for Investments in Qualified Affordable Housing Projects. The new update is intended to give investors in qualified affordable housing projects the option of electing to account for their investments under the proportional amortization method under certain conditions. The ASU applies to investments by a reporting entity in a flow-through limited liability entity that manages or invests in qualified affordable housing projects qualifying for the Low-Income Housing Tax Credit (LIHTC). The update does not extend to other types of tax credit investments.
Under the ASU, a limited liability investor entity meeting certain conditions may elect a proportional amortization method to account for its investment in a qualified affordable housing project. The option addresses the presentation of LIHTC investments in the income statement to better reflect their economic substance.
Using the proportional amortization method, investor entities recognize amortization on the initial cost of the tax credit investment in proportion to anticipated total tax credits and benefits over the life of the investment. The entity recognizes the amortization as a component of income tax attributable to continuing operations. The proposed amendments require recurring disclosures about investments in LIHTC projects, in an effort to help financial statement users understand the nature of the entity’s investments and their effects on the reporting entity’s financial position and results of operations.
To qualify for the accounting election, an investor entity is allowed to use other tax benefits, e.g., tax deductions from operating losses of the investment, as well as currently allowed tax credits to calculate the investor’s projected yield on the investment. The update broadens the availability of an accounting alternative for LIHTC investments from a limited partner to a limited liability entity in an affordable housing project. FASB prohibits the reporting entity from exercising significant influence over the operating and financial policies of the limited liability entity. Lastly, the investor entity must determine the tax credits allocable to it are probable to be available, versus guaranteed by a creditworthy entity under current GAAP.
The ASU is effective for public business entities for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. For all entities other than public business entities, the amendments are effective for the annual period beginning after December 15, 2014, and interim periods within annual reporting periods beginning after December 15, 2015. Early adoption is permitted.
Investments in qualified affordable housing projects through flow-through limited liability entities have different risks and rewards than traditional equity investments. Unlike traditional equity investors, investors in qualified affordable housing projects seek a majority of their return through the receipt of tax credits and other tax benefits instead of the underlying operating cash flows and appreciation of the investee. Typically held by limited liability partnerships, LIHTC entities usually are not consolidated, and investors generally account for them as equity investments.
To investors, accounting for LIHTC investments under the proportional amortization method provides a better understanding of returns from such investments than the equity or cost method. The equity method of accounting for investments in tax credits results in separate reporting for the investment’s performance and related tax credits. Investors report the investment’s performance in pretax income and the tax credits in after-tax (net) income. Because investors do not report the tax credits as a component of the investment’s performance, they often report pretax losses, despite the investment performing as intended and yielding an after-tax net benefit to the investor. Investors accounting for LIHTC investments at cost results in a similar income statement presentation. In contrast, a reporting entity with LIHTC investments that qualify for the proportional yield method will have no pretax losses to recognize in the financial statements for investments.
Under current GAAP, a reporting entity that invests in a qualified affordable housing project is subject to different eligibility criteria to elect to account for the investment using the effective yield method. With this ASU, FASB has replaced the effective yield method with the proportional amortization method.
Here is a summary of the five conditions required for a reporting entity investing in qualified affordable housing projects through a limited liability entity to elect to use the proportional accounting method.
|Condition||Current U.S. GAAP Effective Yield Method to Account for the LIHTC Investment||ASU 2014-01 Proportional Amortization Method to Account for the LIHTC Investment|
|Availability of Tax Credits||The availability—but not necessarily the realization—of the tax credits allocable to the investor is guaranteed by a creditworthy entity through a letter of credit, a tax indemnity agreement or another similar arrangement.||It is probable that the tax credits allocable to the investor will be available.|
|Investor’s Projected Yield||The investor’s projected yield based solely on the cash flows from the guaranteed tax credits is positive.||The investor's projected yield based on the cash flows from the tax credits and other tax benefits is positive.|
|Investor Structure||The investor is a limited partner in the affordable housing project for both legal and tax purposes, and the investor’s liability is limited to its capital investment.||The reporting entity is a limited liability investor in the limited liability entity for both legal and tax purposes, and its liability is limited to its capital investment.|
|Investor Influence||No criteria||The investor does not have the ability to exercise significant influence over the operating and financial policies of the limited liability entity.|
|Investor Benefit||No criteria||Substantially all of the projected benefits are from tax credits and other tax benefits, e.g., tax benefits generated from the operating losses of the investment.|
A reporting entity should evaluate its eligibility to use the proportional amortization method based on facts and conditions that exist at the time of the initial investment. The reporting entity should re-evaluate the eligibility to use the proportional amortization method if there is a change in the nature of the investment or in the relationship with the limited liability entity. In determining whether an entity meets the conditions, FASB decided the entity should not consider other transactions between the reporting entity and the limited liability entity, provided that certain conditions are met.
Measurement of the Tax Credit Investment
Under the proportional amortization method, the entity amortizes the initial cost of the investment over the period in which it receives tax credits and other tax benefits. Amortization is calculated as the initial investment balance less any expected residual, multiplied by the percentage of tax credits of any benefits allocated in the current year to total anticipated tax credits and benefits over the life of the investment. Under a practical expedient, the initial investment cost could be amortized in proportion only to the tax credits, if doing so would produce a measurement substantially similar to the measurement that would result from considering both tax credits and other tax benefits received. In general, when tax credits are the primary source of economic benefit, the investor entity should amortize using the pattern of tax credits.
The investor should exclude any expected residual value of the investment from the proportional amortization calculation. Cash received from operations of the limited liability entity or sale of the property, if any, should be included in earnings when realized or realizable.
Disclosure requirements include information to enable users of financial statements to understand the nature of qualified affordable housing project investments, the effect of the measurement of qualified affordable housing project investments and the related tax credits on an entity’s financial position and results of operations, including the amount of deferred tax assets arising from such investments. Disclosure requirements apply to all reporting entities that invest in qualified affordable housing projects, regardless of which accounting method is used.
The decision to apply the proportional amortization method of accounting is an accounting policy election that should be applied consistently to all qualifying affordable housing project investments rather than to individual investments. An entity should apply the amendments on a retrospective basis using the requirements for accounting changes in U.S. GAAP. Early adoption is permitted as of the beginning of the fiscal year of adoption for financial statements not yet issued. The ASU permits a reporting entity that uses the effective yield method to account for its LIHTC investments entered into prior to the date of adoption of the proposed amendments to continue to apply the effective yield method for those LIHTC investments.
An entity not electing the proportional amortization method of accounting should account for investments in qualified affordable housing projects as an equity or cost method investment.
FASB requested that the staff perform research on the applicability of this update to other types of tax credit investments in addition to qualified affordable housing projects.