Not-For-Profit Treatment

It is obvious through the redesign of the Form 990 that the IRS is concerned about the involvement of nonprofit entities in organizational structures and the transactions going on within those structures.  Schedule R is where related organizations and various related party transactions are required to be reported on Form 990.  A great deal more information is now required on the Schedule R and it is important to understand what the IRS is looking for in order to meet their requirements.

The newly redesigned Form 990 has six parts.  Parts I through IV require you to identify the following types of related parties:  disregarded entities, tax-exempt organizations, partnerships and C or S corporations and trusts.  Part V is for information on transactions with related organizations and part VI requires information on unrelated organizations that are taxed as partnerships through which the organization conducted more than five percent of its activities.

The first major hurdle in completing Schedule R is determining who is related to you!  According to the Schedule R instructions, there are five types of relationships that can cause two organizations to be related.  The first type of relationship is “parent,” which is an organization that controls the filing organization.  The next type of relationship is “subsidiary,” which is an organization controlled by the filing organization.  A third type of relationship in the same territory with parent and subsidiary relationships is “brother/sister” relationship, which is when two organizations are controlled by the same person(s).  All three of these types of relationships are based on “control,” which is defined differently in the 990 instructions depending on what types of organizations are involved.

Control of a nonprofit organization is determined if one or more persons (individuals or organizations) have the power to remove and replace a majority of the nonprofit organization’s directors or trustees.  Another way to be considered a controlling organization is if a majority of the members have the power to elect a majority of the nonprofit’s directors or trustees.  There are two different ways this power can be exercised by an organization.  If one or more of the parent organization’s officers, directors, trustees, or agents have such power over a nonprofit, then the parent organization is deemed to control the nonprofit.  The other way an organization can be deemed to control a nonprofit is if a majority of the nonprofit’s directors or trustees are directors, trustees, officers, employees, or agents of the parent organization.

Control of a stock corporation is simply defined as one or more individuals or organizations owning more than 50% of the stock of the corporation.  Control of a partnership or limited liability company is not quite as simple, but it does also include a comparable 50% rule.  One or more persons control a partnership if they own more than 50% of the profits interest or capital interest in a partnership or limited liability company.  A person can also be deemed to control a partnership or limited liability if they are a managing partner, managing member or general partner and that entity has three or less managing partners, managing members or general partners.  This rule stands without regard to which partner or member actually has the most control.

Similar to partnerships and corporations, one or more persons control a trust if they own more than 50% of the beneficial interests in the trust.  The control rules as they relate to the different types of entities also include indirect control, i.e. if organization A controls organization B and organization B controls organization C, then organization A also controls organization C.  The Section 318 rules apply for determining constructive ownership of a corporation.

There are some different rules within the Schedule R instructions for exempt organizations that are involved in group exemptions.  A group exemption is sometimes granted by the IRS for a group of organizations who are tax exempt if they are affiliated with a central organization, then each organization does not have to apply for exemptions individually.  For Schedule R purposes, central organizations and subordinate organizations of a group exemption are not required to be listed as related organizations.  For a group return, the central organization must attach a list of the subordinate organizations included in the group return.  Also, the central organization must include in their Schedule R the related organizations of all the subordinate organizations except for organizations included within their group exemption or organizations that they know to be included in another group exemption.  Similarly, an entity that is or is not part of a group exemption, is not required to list a related organization that is included in a group exemption.

In addition to parent, subsidiary and brother/sister relationships, there are two more types of relationships for Schedule R reporting purposes – supporting/supported and sponsoring organization of a voluntary employees beneficiary association (VEBA).  Organizations treated as supporting or supported organizations under the section 509 Private Foundation rules must report each other as related organizations.  An organization that contributes 10% or more of the contributions or payments made to a section 501(c)(9) VEBA during the tax year is considered to be a sponsoring organization of a VEBA and related.

After clearing the first hurdle of determining who is related to you and completing the first four parts of the Schedule R, then you have to determine what transactions you are required to report on part five.  The first line of part five is relatively simple; it is the second line of part five that gets more complex.  In line one, you are to check the box if the filing organization engaged in any of the listed transactions.  The listed transactions encompass just about every type of transaction you could imagine.  One of the listed transactions is transfer of cash or property to/from related organizations and this includes any conveyance of funds or property not already listed, whether or not for consideration.

Two types of transactions with a “controlled entity” are required to be listed on the second line of part five.  For this part of Schedule R, the Section 512(b)(13) definition of a controlled entity is used.  The first type of transaction that must be disclosed is the receipt or accrual of interest, annuities, royalties or rent from a controlled entity regardless of the amount.  The second type of transaction required to be listed is any transaction described in lines 1b through 1r of part V (which is essentially any other type of transaction) with a controlled entity if the amounts between the filing entity and the controlled entity exceed $50,000.  The IRS appears to be the most interested in the receipt of interest, annuities, royalties or rent because these are potential sources of unrelated business income.  From the perspective of the affordable housing industry, it seems that part V of Schedule R would be the most cumbersome for management companies or any upper tier type of entity that would be considered to have controlled entities.

The Schedule R reporting requirements can be a large burden in the affordable housing industry.  Not only do management companies and upper tier entities have a significant amount of responsibility in reporting related party transactions, but all entities in the industry have to be vigilant about identifying and reporting related entities.

 Email Jessica or connect via LinkedIN to learn more!

Jessica Cooper is a tax manager at Dauby O’Connor & Zaleski, LLC 

Opportunities and Obstacles

There are multiple opportunities and obstacles facing affordable housing projects during their life span.  One of the more complex decisions is to determine how and when to exit the project.  There are several items to consider when making this determination in order to effectively and efficiently exit the project with the least amount of legal and tax ramifications. The first step in the process is to review and become familiar with all of the legal documents associated with the project including the partnership agreement, loan documents, development agreements, and other restrictive covenants.  These agreements give a baseline as to what, if any, constraints the project will face at the time of disposing either the property or the partnership interest. Analyzing the debt structure of the project and any discrepancies with the original underwriting is imperative.  The earlier discrepancies in the life span of the project can be identified the better.  It is essential to determine the type of debt on the project and what limitations are associated with the debt.  If there is a substantial amount of debt on the project, then a determination needs to be made regarding the payment or forgiveness of this debt prior to end of the project.  However, as every deal is different, refinancing the project prior to exiting might also be a viable solution. Once a determination is made that an exit strategy is warranted, then the strategies associated with that strategy may range from a complete sale of the property itself to just having one or more of the partners selling their specific interest.  Depending upon the strategy taken, the exit taxes, from a federal, state and local perspective may be substantially different. With the various agreements, covenants, financing sources, physical and market conditions of the project, it is never too early to begin planning for the disposition of an affordable housing project. If you would like more specific information on this topic, please contact us.

Nancy Morton is a member at Dauby O’Connor & Zaleski, LLC. Nancy has been in the practice of public accounting for over 18 years, having worked with the international accounting firms of Arthur Andersen and Deloitte & Touche prior to joining Dauby O’Connor & Zaleski, LLC in December 2001.

Getting Ready for the Annual Audit

The annual audit of your property’s financial statements is a chore few people relish.  The journey and the outcome of the audit are dependent on your preparation.  The following are some basic guidelines to follow in preparing for the annual audit:

Plan

The critical element in a successful audit from the standpoints of both the auditor and the owner/manager is planning prior to year end.  Communicate the following:

• The required timing of the deliverables – the draft and final audit.
• Use of electronic data – many of today’s auditors document and store their work within specialized software.  How does this impact you?
• Any material change in the project’s financial structure – new debt, equity,ownership changes, etc.
• Operational issues that affected the property during the year – occupancy problems, owner advances, legal proceedings, occurrences of fraud, and capital improvements.
• Preliminary audit procedures – insist that as many procedures as possible be done prior to year end.  Internal control testing, test of transactions and compliance work should be substantially completed prior to year end so that the primary focus of the audit after year end relates to verifying the financial statement numbers.  Any material issues should be addressed and resolved prior to year end making the audit go smoothly.

Support and Take Ownership of Your Numbers

It is very important that a review of the financials prior to your auditor’s arrival is performed and any adjustments to the respective accounts are made.  Take ownership and have pride in your financial statements.  At year end, an auditor needs support for the numbers in your financial statements.  Bank statements and subsidiary ledgers must be reconciled to the general ledger.  Prepare an audit package that includes at a minimum support for each item on the project’s balance sheet, gross potential rent reconciliation and management fee calculation.  The following are examples of items contained in a typical audit package:

1. Cash – reconciliation and related bank statements;

2.Accounts receivable and prepaid rent – subsidiary ledger and related reconciliations (if applicable);

3. Prepaid insurance – calculation with copies of paid insurance invoice(s), policies, and certificate of insurance from provider;

4. Fixed assets – schedule of fixed assets by cost, accumulated depreciation and current year depreciation.  Provide a description and supporting documentation of any additions during the year (i.e., paid invoices);

5. Accounts payable – subsidiary ledger and/or listing of outstanding expenses and related reconciliation (if applicable).  For those invoices not processed prior to close, yet relate to the current period under audit, record the accrual and maintain a listing to ensure inclusion of expenses in the appropriate period;

6. Accrued real estate taxes – calculation with copies of current (or prior) paid real estate tax invoice(s);

7. Security deposit liability – subsidiary ledger and/or listing of security deposits by tenant and related reconciliation (if applicable);

8. Mortgage and related accounts – copies of monthly mortgage statements including escrow and replacement reserve activity, and calculation of accrued interest.  Typically an auditor sends a mortgage confirmation requesting this same information from the financial institution servicing your debt;

9. Rental income – calculation of gross rent potential, and schedule of vacancy/occupancy by month during the year;

10. Management fee – calculation of management fee during the year; and

11. Permanent documents – copies of new agreements, such as management agreements, loan documents, HAP contract renewals, etc.

This list is not all-inclusive.  Discuss the items needed for your annual audit with your auditor to ensure you are fully prepared for his/her arrival.

Know Your Property

 Your financial statements tell the story about where your property is financially and how it got there.  Your auditor needs to understand this story before the audit report can be issued.  Compare current year financials to the budget and to the prior year financials.  Be prepared to explain material variances as the auditor will be asking about these.

Communications with Regulatory Agencies

You have them and your auditor wants to know about them.  Was a REAC inspection performed at your property?  Did you receive comments on your prior year financial statements?  A copy of these communications from and to a regulatory agency should be provided to your auditor so all issued are addressed accordingly prior to issuing your audit report.

Staff Accessibility

Given the crucial time of your annual audit, you need to not only prepare prior to your auditor’s arrival, but you and your staff (at management office and on-site) also need to be accessible to them throughout the audit process.  It is extremely important for questions to be answered in a timely manner.  The quicker the response, the quicker the audit is completed.

Accommodate Your Auditor

Although this is listed as #6, this is by far the most important.  Ensure your auditor has adequate space to work, the coffee is ready in the morning and donuts are provided every other day.  All kidding aside, discuss with your auditor any accommodations that he/she needs prior to his/her arrival.  For example, is Internet access required?  How many staff is the auditor bringing?  Where will the auditor be located in your office (i.e., conference room, vacant office)?  Just like you, your auditor needs a good working environment to perform your audits.

Follow these basic steps and the audit process should be relatively painless and your audits should be completed in a timely manner.

Jeff Lathrop is a principal at  Dauby O’Connor & Zaleski, LLC. Jeff has specialized in the multifamily housing real estate industry for the past seven years.  Jeff is very experienced with audits that adhere to the Department of Housing and Urban Development (HUD), Low Income Housing Tax Credits and Rural Economic and Community Development guidelines.
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As many Mark to Market (M2M) project owners know by now, their projects are required go through many more painful levels of review than any other HUD project.  M2M projects are required to first have an annual financial statement audit completed by a CPA, financials are then reviewed by REAC and HUD, and most recently OAHP has added an additional level of surplus cash review by MBI.  These various levels of reviews, and the financial impact to the project if all regulations are not followed, has led many owners to be very conservative with any payments made from these projects.

One payment which has led to many discussions and debates is the repayment of the Capital Recovery Note.  Not understanding the requirements around this Note payment leads many to delaying repayment and not receiving the full return on investment or even making payments which are unauthorized and could cause reimbursement to the project.

First, we need to understand how the Note is being amortized and when it becomes due.  Typically these Notes are approved for repayment on a monthly payment amortized over 10 years assuming certain preconditions are met.  The key is that HUD will not allow any more payments then those based on the initial monthly amortized payment schedule.  Most importantly, if the project does not meet the preconditions established for repayment and the monthly payments are not made the loan will not accrue any additional interest.  The missed payments can be made once the preconditions for repayment are met and there is sufficient cash flow for payment; however, delayed payments ultimately result in a decreased return on the Note as additional interest does not accrue as the payments are waiting to be made.

Second, it is just as important to understand the preconditions which are required for repayments to be made so we are not delaying and decreasing our rate of return on the Note.  These preconditions for repayment consist of the following:

1. All project expenses have been paid
2. All required payments have been made on the Mortgage Restructuring Note and on any 1st mortgage;
3. The most recent REAC physical inspection score is 60 or above;
4. There are no outstanding HUD audit or management findings; and
5. The owner is not in default under any of the key governing documents such as the Regulatory Agreement.

In summary all these points lead to the requirement that the project must be in a Surplus Cash position based off of the HUD Surplus Cash Calculation to make any payments on the Note.  The majority of practitioners have adopted a philosophy of not paying any payments on the Note till the yearend Financial Statement Audit is completed to confirm the project is in a Surplus Cash position to make the payments, or they are completing a Monthly Surplus Cash calculation to support every monthly payment

Finally, there are many specific reporting requirements for classification of the outstanding balance of this Note within the Audited Financials and Surplus Cash Calculation which I recommend confirming with you CPA and the following resource provided by HUD:http://www.hud.gov/offices/hsg/omhar/mhrowner.cfm.

Ryan Strutz is a manager at  Dauby O’Connor & Zaleski, LLC.

The IRS has notified tax-exempt organizations that the Modernized eFile (MeF) system will not be available from January 1, 2012 through February 29, 2012 for electronic filing of Form 990, Form 990-EZ, Form 990-PF, or Form 1120-PL.  The notice provides for an automatic extension until March 30, 2012 unless the 990 return has already been extended twice.  For those 990′s with final dates of Janary 17, 2012 or February 15, 2012, relief from late filing penalties will be granted if the return is e-filed by March 30, 2012.

Click here to view the press release.

Click here to view Notice 2012-4.

On November 18^th, 2011, HUD‘s Fiscal Year 2012 budget was signed into law which provides for Section 8 Project Based Rental Assistance (PBRA) at levels that will allow for full funding of all contracts.  In a letter to all multifamily project owners, Janet M. Golrick, Acting Deputy Assistant Secretary for Multifamily Housing Programs, announced HUD’s plan to slow the growth of PBRA expenditures.  This plan includes the following policy changes:

1. The use of project residual receipts funds to reduce rental assistance payments.
2. Housing assistance payment contract renewals under Option 4 and annual rent adjustments will be limited to OCAF increases if proposed rents exceed market rent.
3. Proposed rents exceeding 110% of Small Area Fair Market Rents will require rent comparability studies.

Per Golrick, these policy changes will be formally announced in an upcoming Housing Notice, implemented in 2012 and will be continued and likely expanded in 2013.

Click here to view the letter in its entirety.

On December 14, 2011, Congressmen Pat Tiberi (R-OH) and Richard Neal (D-MA) introduced H.R. 3661 a bill which would permanently extend the flat 9% Credit rate and create a flat 4% Credit rate for allocated Credits.  The bill currently has 7 cosponsors including: Vern Buchanan (R-FL); Emmanuel Cleaver (D-MO); Joseph Crowley (D-NY), Jim Gerlach (R-PA); Bill Pascrell (D-NJ); Charles Rangel (D-NY); and Lee Terry (R-NE).  Additionally, Senators Maria Cantwell (D-WA) and Olympia Snowe (R-ME) introduced S. 1989 which is the Senate version of the same legislation.  The Senate version currently has 9 cosponsors including: Jeff Bingaman (D-NM); Scott Brown (R-MA); Benjamin Cardin (D-MD); Susan Collins (R-ME); Mike Crapo (R-ID); John Kerry (D-MA); Robert Menendez (D-NJ); Bill Nelson (D-FL); and Bernard Sanders (I-VT).

For more information, visit The Affordable Housing Tax Credit Coalition’s website by clicking here.

For each of the past 10 years, DOZ has sponsored at least 3 families to provide food, clothes, and gifts through the United Way of Central Indiana.  The program, United Christmas Service, was established in 1952.  Caseworkers from more than 170 partner organizations refer qualified families to the United Christmas Service each year.  In 2010, more than 28,500 people received food, clothing and gifts.  In 2011, DOZ spread the Christmas spirit by sponsoring 3 single-parent families.  For more information on the United Christmas Service, click here!