WASHINGTON - The Internal Revenue Service's safe harbor standard on low-income housing is too strict and could have disastrous effects on federal housing programs and organizations seeking tax-exempt status, the Resolution Trust Corp. and housing groups are warning.

The RTC and housing groups issued the warnings in comment letters that they recently submitted to the IRS.

They said the safe harbor is more strict than tax laws and other federal agency standards that deal with low-income housing.

They urged the IRS to either reconsider the safe harbor or significantly modify it to include, among other things, a special exception for housing groups that want to participate in federal low-income housing programs.

Under the safe harbor standard, which the IRS sent to its agents last October and published in Notice 93-1 in January, an organization building or acquiring housing would qualify for tax-exempt status if at least 75% of the units were made available to families earning 60% or less of an area's median income. The remaining 25% of the units would have to be set aside for "persons at the lower end of the economic spectrum."

The safe harbor standard is not supposed to be a requirement. Instead, it is intended as a test that agents can apply in determining whether an organization would qualify for tax-exempt status, according to the IRS.

But in a lengthy comment letter, the National Low Income Housing Coalition told the agency that "we have already received reports from members of IRS agents applying the safe harbor as a substantive test and denying applications based solely on the anticipated income profile of the groups' housing projects."

In addition, the coalition said, "charitable givers have denied funds to groups for projects that fail to meet the safe harbor test; prospective home owners seeking loans through a community loan fund have been turned down because their incomes exceed the proposed safe harbor; and a state issuing agency declined to proceed with a 501(c)(3) bond issue because the units it was proposed for did not meet the proposed safe harbor."

The coalition said that if the IRS adopts the safe harbor standard "without appropriate, strong and clear guidelines as to its use," it "will have a chilling, negative effect on nonprofits."

The RTC warned that the safe harbor standard "would impose a severe hardship" on organizations seeking to qualify for its Affordable Housing Disposition Program because it is stricter than the low-income standard used by the program.

Under the RTC program, which was established in 1989, nonprofit organizations get both a first right to buy RTC properties and favorable financing terms if they meet certain requirements. One of the requirements is that at least 20% of the units is made available to individuals with incomes below 50% of the area's median income level and at least 15% of the remaining units is made available to persons with incomes below 80% of area median income.

The RTC told the IRS that if nonprofit organizations are required to meet the stricter IRS safe harbor standard, they will be forced to offer much lower prices for the purchase of RTC properties and the RTC will "not be able to promote both economic integration and ensure the economic viability of the properties."

There is "no policy justification" for requiring stricter definitions of low income under the section of the tax code that governs nonprofit organizations, the RTC said.

The law firm of Russo, Cox & Russo in Tucson told the IRS that the safe harbor standard could cause major problems for a local industrial development authority's pending purchase of 20 multifamily residential housing projects held by the RTC. The industrial Development Authority of the County of Pima, in Arizona, plans to purchase the properties and sell them to nonprofit organizations, some of which have tax-exempt status and some of which have applied for a tax exemption.

"If the nonprofits are required to comply with Notice 93-1. it is unlikely that the cash flow from the rental income of the project will be sufficient to pay operating and maintenance expenses, much less be sufficient to pay the debt service on the loan utilized to fund the purchase price." Russo Cox said.

The National Council of State Housing Agencies also warned that the safe harbor standard could force nonprofit organizations to develop low-income projects, that are not economically viable.

The council said the safe harbor standard "contradicts tax law provisions" that allow tax-exempt bonds to be used to finance new residential rental projects that provide either 20% of the units to persons at or below 50% of area median income or 40% of the units to persons at or below 60% of area median income.

Other organizations pointed out that the Department of Housing and Urban Development's standard for low income is only 80% of area median income.

The council, however, said it is most concerned that the safe harbor standard will be used in a manner that threatens the tax-exempt status of existing nonprofit housing organizations and the bonds that they have issued.

The IRS said, in Notice 93-1, that organizations that had obtained IRS letters granting them tax-exempt status could continue to rely on those letters, as long as they had not "materially changed their organization or operation."

Despite this statement, the housing council said, "it is difficult, without further clarification, to avoid misinterpretations regarding whether the safe harbor will be used in other situations," such as reviews or audits of existing tax-exempt organizations.

The council said that some housing finance agencies ~have been advised" that they should require organizations that already have tax-exempt status and that are trying to obtain tax-exempt financing to either make sure their housing project meets the new safe harbor or seek clarification from the IRS that the failure to meet the safe harbor will not trigger a loss of their tax exemption.

"It is crucial that the exempt status of nonprofits ... not be called into question solely because of the new safe harbor," the council said. "Any challenge to their status could disrupt the bond market and severely damage the agencies and nonprofits involved in legitimately exempt activities."

The Statewide Alliance of Tenants, which represents low-income tenants in federally subsidized rental housing in California, told the IRS that the safe harbor could hurt tenant organizations by making it impossible for them to get tax-exempt status.

A number of organizations said that the IRS safe harbor contradicts long-standing policies set by Congress and federal agencies.

"Congress has repeatedly recognized the importance of mixed-income projects," the National Low Income Housing Coalition said. "Numerous federal housing assistance programs encourage the development of such projects to achieve goals of economic, social, and racial integration."

Some of the groups, such as Chicanos Por La Causa, a nonprofit social service organization in Arizona, asked the IRS to reconsider the safe harbor.

Others, including the Resolution Trust Corp. and the housing coalition, asked the IRS to either carve out an exception from the safe harbor standard or create a separate safe harbor for organizations seeking a tax exemption to participate in federal low-income housing programs.

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