Financing Affordable Assisted Living With Tax Credits
 
September 1, 1999
 
Kristin A. DeKuiper- Boston

Financing assisted-living projects with low-income housing tax credits offers exciting opportunities for cooperation between the health care industry and the affordable housing industry to develop effective solutions to meet the needs of low-income elders. The two industries share a common goal of finding cost-effective ways to permit low-income seniors to age with dignity and to provide the support they need for maximum independence. The low-income housing tax credit (the Tax Credit) provides an attractive source of equity financing for affordable assisted living projects. The intersection of the housing and health care industries in this cooperative effort, however, creates numerous structuring issues, most of which arise from the ambiguous nature of the assisted living concept itself.

Assisted living facilities have both housing and service components. From the perspective of the Tax Credit Program, it is important that assisted living projects be structured and characterized as housing. The service component of these projects, however, can complicate the housing characterization by invoking a regulatory overlay that smacks of health care and necessitates use of health care funding sources such as Medicaid.

Qualification of an Assisted Living Facility as Residential

Rental Property for Purposes of the Tax Credit Program

For purposes of the Tax Credit, in order to be a "qualified low income housing project" a project must be "residential rental property." Residential rental property" for purposes of the Tax Credit program has the same meaning as "residential rental property" for the purposes of the tax-exempt private activity bond rules. Tax-exempt bonds are another source of financing for affordable assisted living projects.

Although a project must be "residential rental property" to qualify for the Tax Credit, regulations under the Tax Credit program provide that "the furnishing to tenants of services other than housing (whether or not the services are significant) does not prevent the units occupied by the tenants from qualifying as residential rental property eligible for credit." If non-housing related services are provided, however, charges for services that are not optional generally must be included in gross rent for purposes of determining whether the rents charged meet the low-income rent restrictions imposed by the Tax Credit program. The Tax Credit regulations provide that "a service is optional if payment for the service is not required as a condition of occupancy. For example, for a qualified low-income building with a common dining facility, the cost of meals is not included in gross rent for purposes of [the Tax Credit Program] if payment for the meals in the facility is not required as a condition of occupancy and a practical alternative exists for tenants to obtain meals other than from the dining facility."

The Tax Credit regulations also provide that if continual or frequent nursing, medical or psychiatric services are provided, it is presumed that the services are not optional and the building is ineligible for the credit, as is the case with a hospital, nursing home, sanitarium, life-care facility or intermediate care facility for the mentally and physically handicapped. Accordingly, although it is clear that significant services other than housing may be provided to Tax Credit projects, without disqualifying the facility as a qualified low income housing project, continual or frequent nursing, medical or psychiatric services are prohibited.

Revenue Ruling 98-47

In 1997, the Service issued Private Letter Ruling 974007, which concluded that an assisted-living facility did not qualify as residential rental property for purposes of the tax-exempt bond financing rules. The ruling appeared inconsistent with the authority under the Tax Credit program regarding characterization of an assisted living facility as residential rental property and caused consternation in the assisted-living industry. The ruling addressed whether an assisted living project was a "qualified residential rental project," in which event the project could have been financed with tax-exempt private activity bonds. Due to unique factual circumstances, the taxpayer preferred to have the bonds characterized as Section 501(c)(3) bonds, which may not be used to finance qualified residential rental projects, but can be used to finance health care facilities. The ruling supported the taxpayer's position and found that the facility in question was a health care facility, not residential rental housing.

The ruling surprised practitioners because it seemed inconsistent with another 1997 ruling that approved as residential rental housing a facility that included only microwave ovens in units where required for the safety of the elderly residents, without addressing the level of services provided. Moreover, although the ruling addressed bond-financed projects, it also caused concern about its potential applicability to Tax Credit-financed assisted-living projects. Industry groups, such as the National Association of Bond Lawyers, requested that the Internal Revenue Service (the IRS) clarify the ruling and, in particular, to produce guidelines for tax-exempt, bond-financed, assisted-living projects that are consistent with authority already developed under the Tax Credit program.

In Revenue Ruling 98-47, the IRS clarified its position on characterization of assisted living facilities as residential rental property for purposes of both the tax-exempt bond rules and the Tax Credit program, citing the authority under the Tax Credit program as the appropriate standard for determining whether a facility is residential rental property for purposes of the tax-exempt bond rules as well.

Revenue Ruling 98-47 described a campus (Complex M) containing three buildings offering housing units on a non-transient basis to individuals of retirement age or older. Each building offered a different level of services to its residents.

The ruling described the increasing complexity and sophistication of services available as one moved from building to building. The basic services available to the residents in the first building were limited to laundry; housekeeping; regular daily meals in the common dining areas; 24-hour, monitored emergency call service using call buttons and two-way communication devices located in each room of a unit; planned social activities; and scheduled transportation to various sites in the vicinity including commercial areas, shopping centers, hospitals and doctor's offices.

Residents of the second building also received typical assisted-living services such as: assistance by medication management technicians in medication management and intake; maintenance of detailed medication records; consultation with a nurse as needed about health concerns and medication plans; assistance by non-medically certified aides each day during waking hours in activities of daily living that include getting in and out of bed and chairs, walking, using the toilet, dressing, eating and bathing; and routine checks by staff members to insure the residents' general well-being. The ruling specifically noted that some residents of the second building had incapacitating infirmities that require continual assistance, but do not require continual or frequent nursing, medical or psychiatric services.

Only in the third building were continual or frequent skilled nursing care, medical or psychiatric services provided.

Revenue Ruling 98-47 stated that the guiding principle for determining whether a facility should be defined as residential rental property or a health care facility is not how it is labeled, but whether the nature and degree of services provided make the facility in substance a residence or a health care facility. Applying this analysis to the facilities discussed in the ruling, the ruling concluded that the first and second buildings were residential rental property, and that only the third building would not qualify for tax-exempt, private-activity bond financings or Tax Credits because of its medical orientation.

Revenue Ruling 98-47 is consistent with prior authority under the Tax Credit program but has also significantly clarified the IRS's position on assisted-living Tax Credit projects as well as tax-exempt, bond-financed projects.

Drawing the Line - When Does the Package of Services

Become Too Much Like a Health Care Facility?

For purposes of determining whether a Tax Credit project qualifies as residential rental housing, the most important consideration is drawing the line between (i) the case where "continual or frequent nursing medical or psychiatric services are provided" and the facility is therefore analogous to a "hospital, nursing home, sanitarium, life care facility or intermediate care facility for the mentally and physically handicapped," in which case it is presumed that the services are not optional and the building is ineligible for the Tax Credit, and (ii) the case where the line can be drawn on the side of a facility that provides much less medically oriented services, which may be designed to assist the frail elderly in activities of daily living, but which do not rise to the level of continuously supervised skilled medical care. For this purpose, whether a facility is regulated by the health department in a particular state is not determinative. States regulate assisted-living facilities in various ways, and some states with an extremely residential/non-medical assisted-living statute may nonetheless delegate supervision of assisted-living facilities to the health department. The focus should be on the nature of the services permitted or required in an assisted living facility, not on the regulatory authority to whom enforcement is delegated.

Both existing Tax Credit authority and Revenue Ruling 98-47 lead to the conclusion that it is preferable to avoid a facility that, either as a result of licensing requirements or as a result of choosing permitted services within the range of licensing requirements, accentuates the availability of immediate and continual medical services and/or provides skilled nursing care on a regular basis. Again, the focus of the analysis should not be on the particular state's regulatory scheme, but on the actual nature of the services provided to and required by residents. It should be noted that in PLR 9814006, a single room occupancy (SRO) facility that offered optional supportive services was not disqualified as residential rental property even though there was a 24-hour staff person on duty and provision for holding and dispensing medication by the facility.

The Juxtaposition Between Funding the Assisted-Living Service

Component and the Rent Restrictions of the Tax Credit Program

Once an assisted-living project has been structured so that it can be characterized as housing under the Tax Credit program, care must be taken to structure the service component to avoid adverse impact on the Tax Credit program's rent restrictions and Tax Credit basis. As noted above, the general rule is that any services that are not truly optional must be included in a low-income tenant's gross rent in calculating whether the rent restriction test is satisfied. If a service package is designed to be "optional," the tenant must truly have a "practical alternative" to services offered through the facility. This means that the tenant must be able to reject services offered by the facility either because he or she does not need them or because they can be secured realistically through other available providers. Thus, in facilities oriented towards frail elders who require assistance with one or more activities of daily living, it is important that the assistance required by residents be of a nature that reasonably can be secured from other community-based providers.

Several states permit the use of Medicaid to fund the service component of assisted-living projects for qualifying tenants. This is often accomplished through a Section 1915(c) "home and community-based services" waiver. Medicaid funding can only be used to fund the service component and may not be used for housing, although for this purpose meal preparation and service (but not the cost of food) may be considered a service rather than part of room and board.

Because Medicaid is a federal program, it could be deemed a federal grant, which would have an adverse impact on Tax Credit basis. Federal-source grants must be excluded from Tax Credit basis if they are made with respect to the building or the operation of the building. Certain federal subsidies (specifically those provided under Section 8 or Section 9 of the United States Housing Act of 1937) are excepted from this rule, but Medicaid is not among them. Because Medicaid funding is programmatically restricted to funding the service component of assisted living, however, it should not be deemed to be made with respect to the building or its operation and therefore should not adversely affect Tax Credit basis. Important to this reasoning is successfully structuring the project so that the service component is truly optional, so that it cannot be argued that services provided by the building operator are integral to the operation of the building itself. This argument may be further supported if the services are provided not by the building owner, but by contractual arrangement with an independent service provider.

Another programmatic feature of Medicaid's home and community-based waiver is that it is available only to individuals who would be eligible for placement in a nursing home if they applied. This is because the waiver is intended to reduce nursing home costs by providing frail elders the support they need to live in a less-acute setting as long as possible. In this respect, the programmatic goal is similar to the goal enunciated in the Tax Credit program's exception from the gross rent calculation of supportive service payments made under a program designed to enable residents of residential rental property to remain independent and avoid placement in a nursing home. The same goal is implied by the Tax Credit program's authority for significant supportive services other than housing as long as they do not rise to the level of continual or frequent nursing, medical or psychiatric services.

However, the Medicaid waiver requirement that beneficiaries be eligible for nursing home care can be problematic if the eligibility level requires assisted living residents to be in need of a level of continual or frequent nursing or medical services that would lead one to conclude that such services are not optional. If residents require this level of care, the facility could lose its characterization as housing under Tax Credit authority. If the state regulatory scheme uses a housing model for assisted living, moreover, requiring residents to need a high level of medical care could make placement in an assisted-living facility inappropriate from a state regulatory perspective.

Structuring assisted-living projects for low-income seniors to advantageously combine the resources of the Tax Credit program and the health care industry is an exciting challenge. As solutions are found to the many difficulties of working at the intersection of two different industries, new models should emerge that will help address the problems of aging with creativity and compassion.