NYC Housing Tax Credit Portends Penalties for Some Developers

The New York legislature late last month passed a bill that would allow affordable housing developments in New York City to receive a property tax break for up to 40 years.

State and local tax professionals looking to add value for their clients in the real estate arena need to carefully consider the full impact of this new law, known as 485-x, to ensure compliance and account for the economic advantages and disadvantages it presents.

Running the Numbers

In an optimistic world, 485-x will generate substantial interest from developers who hear that very large rental projects satisfying the 485-x requirements are eligible for a 40-year property tax exemption.

They may also want to take advantage of the elimination of the 12 Floor Area Ratio cap (an old New York zoning rule that generally limits the size of purely residential buildings to 12 floors) for new affordable housing developments.

Taken in isolation, these benefits may seem like a thumb on the profitable side of the scale. But they come with strict requirements that mean financial figures must work out for your client before any project can move forward.

The 485-x tax break has stringent wage requirements for construction workers, for example, that peak for the largest developments in desirable areas of New York City such as Manhattan below 96th Street and the Williamsburg and Williamsburg East neighborhoods in Brooklyn.

The portion of the development that must be devoted to affordable housing also rises with the development size, reducing the marginal benefits of building bigger in better areas by limiting the number of market-rate units that can be built in the areas that command the highest rental prices.

These affordability requirements, as well as building service employee wage requirements, are ongoing for the life of the exemption. There’s also the issue that any development that receives benefits under 485-x can’t receive an abatement or exemption “under any other law.”

Advisers also must give thoughtful consideration to the other market forces at play. Interest rates remain relatively high and may be for an extended period of time. Office vacancy rates continue to grow and commercial real estate value continues to fall, decreasing viability of new commercial projects.

In contrast, New York’s rental rates have recovered from their pandemic lows and soared to new heights as residential vacancy rates have plummeted to 1.4%. Despite interest rates remaining relatively high, these broader market forces as a whole suggest that an eager market exists for developers who can deliver new residential units at a reasonable price.

These factors all weigh on the profitability of potential projects and present an opportunity for advisers to assist with complex, but necessary, financial modeling to help clients. That way, they’ll be well-equipped to engage lenders and enlist joint-venture partners to share risks and rewards.

Staying Compliant

If your client moves forward with a 485-x project, you should continue to stay involved to keep them from inadvertently triggering a penalty provision that could result in a fine (which will be calculated by the Department of Housing Preservation and Development), require payment of the property taxes that would otherwise have been owed on the development, and/or preclude your client from being eligible to receive 485-x benefits on future projects.

Three compliance areas worthy of particular attention are construction wage requirements, meeting contract requirements from minority and women-owned businesses, and satisfying ongoing unit affordability requirements.

This third issue is particularly nuanced, as the affordability requirements are calculated as a percentage of area median income, adjusted for family size. Your client will therefore need your guidance in building and maintaining a compliance system for each development project to stay organized.

Audits likely will be stringent, given the heavy criticism that was leveled at 421-x projects from government and public advocacy groups alike for not delivering very much housing for the cost of the tax break. Mundane items such as quality record-keeping and tracking statistics such as the prevailing rates of wages and area median income will therefore be important.

There are many opportunities for foot faults, and you need to be familiar with them to best advise your client on potential risks. Keeping your client in compliance could be as simple as setting up alerts to ensure you stay current on statistical changes and then holding periodic meetings with your client to review and update their compliance system.

If your client won’t own and manage the building after construction wraps up, make sure that any transactional documents explicitly protect your client from any future recapture or penalty events.

Outlook

Ultimately, 485-x offers new opportunities to developers facing a difficult market for new construction. Whether this program meaningfully improves New York’s housing shortage will take years to answer. But we can safely say today that deciding whether a developer should use the benefits available under this new law requires careful consideration amid complex economic and compliance factors.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Adam P. Beckerink is head of Duane Morris’ state and local tax group, representing multinational corporations and high-net-worth individuals in tax disputes, controversies, and litigation with revenue authorities in the US.

Dakota Newton is an associate in Duane Morris’ state and local tax group. He represents mid-size and multinational entities in transactional and large controversy matters.

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