Rev. Rul. 80-54

1980-1 C.B. 43, 1980-9 I.R.B. 6.

                       Internal Revenue Service
                                 Revenue Ruling

           INVESTMENT INTEREST; NET LEASE PROPERTY; CONTRACT WITH HUD

                            Published: March 3, 1980

SECTION 163.--INTEREST

  Investment interest; net lease property; contract with HUD. The owner and operator of an apartment complex received direct payments under a contract with the Department of Housing and Urban Development (HUD), under section 8 of the National Housing Act, for providing low income housing. The net lease provisions of section 163(d)(4)(A)(ii) of the Code do not apply and the income and expenses from such units are not subjected to the interest limitations imposed by section 163(d)(1).

ISSUE

  Under the circumstances described below, are certain apartment units owned and operated by the taxpayer property subject to the net lease provisions of section 163(d)(4)(A) of the Internal Revenue Code?

FACTS AND LAW

  The taxpayer, an individual, is the owner and operator of an apartment complex.  Pursuant to section 8 of the National Housing Act, as amended, 12 U.S.C.A. section 1701 (Supp. 1978), the taxpayer entered into a five year contract with the Department of Housing and Urban Development (HUD) with regard to a certain number of apartments in the complex.

  Section 8 of the Act provides for direct payments to apartment owners providing housing for low income families.  The assistance payments are equal to the maximum monthly rent, based on schedules established by HUD of the fair market rental for similar dwelling units in the market area, less an amount varying between 15 and 25 percent of the family's monthly income.

  Section 8 of the Act further provides that the maximum monthly rent shall be revised annually to reflect changes in the fair market rentals.  Special additional adjustments may be granted, when approved by the Government, to reflect increases in the actual and necessary expenses of owning and maintaining the rental units if the increases have resulted from substantial general increases in real property taxes, utility rates, or similar costs. The owner must demonstrate that the general increases have caused increases in the owner's operating costs that are not adequately compensated for by automatic annual adjustments.

  The contract between the taxpayer and HUD provides that the Government has not assumed any obligation for the amount of rent payable by any family or the satisfaction of any claim by the owner against any family other than for security and utility deposits. The contract further provides that if a family vacates its unit (other than as a result of action by the owner that is in violation of the contract or any applicable law), the owner shall receive housing assistance payments in the amount of 80 percent of the contract rent for a vacancy period not exceeding 60 days.  In addition, the contract provides a maximum Government payment each year subject to provisions allowing for amendment of this amount.

  For each taxable year in question the sum of the taxpayer's deductions with respect to the apartment units covered by the contract with HUD that are allowable solely by reason of section 162 of the Code will not be less than 15 percent of the rental produced by these apartment units.

  Section 163(d) of the Code provides a limitation on the amount of investment interest that may be deducted by a taxpayer other than a corporation.  Interest on funds borrowed in connection with property subject to a net lease is considered investment interest and, therefore, is subject to the limitation.  A lease is considered a net lease under section 163(d) if the taxpayer's trade or business expenses with respect to the property, which are deductible solely by reason of section 162, are less than 15 percent of the rental income from the property, or if the taxpayer is guaranteed, in whole or in part, against loss of income.

HOLDING

  Because for each taxable year in question the sum of the taxpayer's deductions with respect to the apartment units covered by the contract with HUD that are allowable solely by reason of section 162 of the Code will not be less than 15 percent of the rental income and because the taxpayer is neither guaranteed a specified return nor guaranteed in whole or in part against loss, the net lease provisions of section 163(d)(4)(A) of the Code do not apply.

  Therefore, the income and expenses from the apartment units covered by the contract with HUD are not subject to the interest limitations imposed by section 163(d)(1) of the Code.

Rev. Rul. 80-54, 1980-1 C.B. 43, 1980-9 I.R.B. 6.