Late tax-exempt controlled entity election allowed

Plain-English summary

A corporation wholly owned by a nonprofit held an indirect interest in a partnership that developed low-income housing. The partnership agreement showed that the corporation always intended to elect under section 168(h)(6)(F)(ii) not to be treated as a tax-exempt entity, which would prevent part of the property from being classified as tax-exempt use property. The election was missed because the former accountant failed to prepare an upstream entity's return and Schedule K-1, while the nonprofit mistakenly believed the property would be placed in service in a later year and did not cause the corporation to file a return. After discovering the missing filing requirements, the parties promptly sought relief and prepared returns consistently with the intended election. The IRS found reasonable, good-faith reliance on tax professionals without hindsight or prejudice to the government. It granted 60 days to file the election statement and required copies with the tax-exempt shareholders' returns and other relevant returns.

Ruling snapshot

• Question: May the nonprofit-owned corporation make a late election not to be treated as a tax-exempt entity for the partnership property's depreciation rules?
• Outcome: Approved, with the election statement due within 60 days
• Key authorities: IRC § 168(h)(6)(F); Treas. Reg. §§ 301.9100-1, 301.9100-3, 301.9100-7T(a)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202350005                                             Third Party Communication: None
Release Date: 12/15/2023                                      Date of Communication: Not Applicable
Index Number: 9100.04-00
                                                              Person To Contact:
                                                              ------------------------, ID No. -----------------
--------------------------------------------------            Telephone Number:
-----------------------------------------------------------   --------------------
----------------------                                        Refer Reply To:
--------------------------------                              CC:ITA:B08
                                                              PLR-106766-23
                                                              Date:
                                                              September 20, 2023


       -
       -

                                                    Legend

                     Taxpayer                   = -----------------------------------------------------------
                                                  ------------------------
                     General Partner            = -------------------------------
                                                  ------------------------
                     Partnership                = ----------------------------------------
                                                  ------------------------
                     Nonprofit                  = -------------------------------------------------------------
                                                  -
                                                  ------------------------
                     General Partner            = ---------------------------------
                     Owner 1                      ------------------------
                     General Partner            = -------------------------------------------------------------
                     Owner 2                      ------------------------
                     Member                     = ----------------------
                                                  ---------------------------
                     Investor Limited           = -------------------------------------------------------------
                     Partner                      ----------
                                                  ------------------------
                     Paragraph A                = -------------------------------------------------------------
                                                  -----------------------------------------------------------
                     Paragraph B                = -------------------------------------------------------------
                                                  ----------------------------------------------
                     LP Agreement               = -------------------------------------------------------------
                                                  -------------------------------
                     Accountant                   -------------------------------------------
                     A%                         = ---
                     B%                         = ----
                     C%                         = ---
PLR-106766-23                                  2

                    D%                 =   --------
                    E%                 =   ---
                    F%                 =   ---
                    Property           =   ------------------------------------
                    Location           =   -----------------------
                    Former             =   --------------------------
                    Accountant
                    Date 1             =   ---------------------
                    Date 2             =   ----------------------
                    Date 3             =   ------------------------------
                    Year 1             =   -------
                    Year 2             =   -------
                    Year 3             =   ------



Dear ------------------:

This ruling responds to Taxpayer’s request for a letter ruling dated Date 1. Specifically,
Taxpayer requests an extension of time under sections 301.9100-1 and 301.9100-3 of
the Income Tax Regulations, to make a timely election under § 168(h)(6)(F)(ii) of the
Internal Revenue Code (Code) to Taxpayer, a tax-exempt controlled entity under
§ 168(h)(6)(F)(iii).


                                           FACTS

According to the affidavits and additional information provided to us, Taxpayer has
represented that the facts are as follows.

Taxpayer, a C corporation, uses the calendar year as its annual accounting period and
the accrual method as its overall method of accounting. Taxpayer was formed to serve
as a member of General Partner. General Partner is a limited liability company and is
the general partner of Partnership. Taxpayer is wholly owned by Nonprofit.

General partner uses the calendar year as its annual accounting period, and the cash
method as its overall method of accounting. Partnership uses the calendar year as its
annual accounting period and the accrual method as its overall method of accounting.

Taxpayer owns A% of General Partner, and General Partner owns B% of Partnership.
The remaining C% of General Partner is owned by General Partner Owner 1, a
disregarded S corporation wholly owned by General Partner Owner 2. General Partner
Owner 2 is a disregarded S corporation wholly owned by Member.
PLR-106766-23                                  3

Investor Limited Partner owns the remaining D% of Partnership. Partnership was
formed exclusively to provide housing facilities for persons of low and moderate income,
or for persons whose income does not exceed limits established in § 42 of the Code. In
furtherance of this, the purpose of Partnership was to construct, develop, improve,
maintain, own, and operate Property located in Location.

Pursuant to Paragraph A of the LP Agreement effective as of Date 2, upon the final sale
of Property owned by the Partnership, the balance of net cash shall be distributed E% to
General Partner and F% to Investor Limited Partner. Of the E% of the balance of net
cash distributed to General Partner, A% shall be distributed to Taxpayer. As such, the
final allocation to Taxpayer does not remain the same during the entire life of
Partnership.

Partnership acquired land and began constructing Property in Year 1. Partnership
completed its construction of Property in Year 2.

Under the general rule of § 168(h)(6)(F)(iii), because Taxpayer is wholly owned by a
tax-exempt entity, absent an election, Taxpayer would be considered a "tax-exempt
controlled entity" within the meaning of § 168(h)(6)(F)(iii), and therefore, due to the non-
qualified allocation as noted in Paragraph A of LP Agreement, a portion of Property
would be considered "tax-exempt use property."

However, under § 168(h)(6)(F)(ii), Taxpayer had the ability to elect not to be treated as
a tax-exempt entity for purposes of § 168(h)(6), thereby avoiding having any portion of
Partnership Property from being considered "tax exempt use property."

It was always Taxpayer's intention to make the election under § 168(h)(6)(F)(ii), so as to
not be treated as a tax-exempt entity for purposes of § 168(h)(6). This is evidenced by
Paragraph B of LP Agreement, wherein the partners of Partnership agreed that General
Partner 'warrants and represents that it will cause Taxpayer to make, on its tax return,
the election described in § 168(h)(6)(F)(ii) of the Code.’

Partnership filed its Year 2 tax return with Former Accountant, and first placed property
in service in Year 2. Due to its election under § 163(j)(7)(B) to be an electing real
property trade or business, Partnership computed its depreciation deduction for
residential rental property utilizing the Alternative Depreciation System (ADS).
Partnership computed its depreciation deduction for all other property utilizing the
General Depreciation System (GDS) and it claimed bonus depreciation on this property.

Partnership's utilization of GDS for depreciation and its claim to bonus depreciation
were methods that Partnership could properly have used if the § 168(h)(6)(F)(ii) election
had been validly made by Taxpayer.

In their normal course of business, Former Accountant would typically prepare tax
returns for Member and affiliated entities, including any tiered relationship tax returns if
PLR-106766-23                                 4

required. Member expected Former Accountant to prepare the Year 2 tax return for
General Partner. Due to an administrative oversight of filing requirements, Former
Accountant did not prepare a tax return for General Partner. As a result, a Year 2
Schedule K-1 for General Partner was not prepared or furnished to Taxpayer.
Additionally, Nonprofit believed all property was to be placed in service in Year 3 rather
than Year 2. General Partner inadvertently did not provide correspondence to Nonprofit
regarding the buildings being placed in service in Year 2.

Because Taxpayer did not receive a Schedule K-1 and Nonprofit was unaware that
Property was placed in service during Year 2, Nonprofit did not cause for Taxpayer to
file an initial tax return for the tax year ending Date 3, as it did not believe Taxpayer had
a filing requirement.

Accountant was engaged by both General Partner to prepare the tax return for General
Partner and Nonprofit to prepare the tax return for Taxpayer for Year 2 upon discovery
of the missing filing requirement for General Partner and Taxpayer. Realization of the
missing filing requirement for General Partner and Taxpayer was made after the filing
deadline. Therefore, a valid § 168(h)(6)(F)(ii) election could not be made through a
timely filed Year 2 tax return for Taxpayer. Following LP Agreement, Accountant is
preparing the tax returns as if a valid § 168(h)(6)(F)(ii) election is going to be made by
Taxpayer.

Upon discovering this failure to file a timely return, Taxpayer, through Nonprofit,
engaged Accountant to prepare this Request for Letter Ruling seeking an extension of
time in which to make the § 168(h)(6)(F)(ii) election.

                                   LAW AND ANALYSIS

Section 168(h)(6)(A) provides that, for purposes of § 168(h), if any property that is not
tax-exempt use property is owned by a partnership having both a tax-exempt entity and
a nontax-exempt entity as partners, and any allocation to the tax-exempt entity is not a
qualified allocation, then an amount equal to such tax-exempt entity's proportionate
share of such property shall be treated as tax-exempt use property.

Section 168(h)(6)(F)(i) provides generally that any tax-exempt controlled entity shall be
treated as a tax-exempt entity for purposes of §§ 168(h)(5) and (6). Section
168(h)(6)(F)(iii)(I) provides that a tax-exempt controlled entity is any corporation if 50
percent or more (in value) of the stock is held by 1 or more tax-exempt entities.
Because Nonprofit owns more than 50 percent in value of Taxpayer's stock, Taxpayer is
a tax-exempt controlled entity under that section. As such, Taxpayer is eligible to make
the § 168(h)(6)(F)(ii) election.

Under § 168(h)(6)(F)(ii), a tax-exempt controlled entity may elect to not be treated as a
tax-exempt entity. Such an election is irrevocable and will bind all tax -exempt entities
holding an interest in the tax-exempt controlled entity.
PLR-106766-23                                5


Under § 301.9100-7T(a)(2)(i) of the Procedure and Administration Regulations
(Regulations), an election under § 168(h)(6)(F)(ii) must be made by the due date of the
tax return for the first taxable year for which the election is to be effective.

Section 301.9100-1(a) of the Regulations provides that the Commissioner of Internal
Revenue has discretion to grant a reasonable extension of time to make a regulatory
election. Section 301.9100-1(b) defines the term "regulatory election" as including any
election the due date for which is prescribed by a regulation. The election allowed by
§ 168(h)(6)(F)(ii) election is a regulatory election.

Sections 301.9100-1 through 301.9100-3 provide the standards that the Commissioner
will use to determine whether to grant an extension of time to make a regulatory
election. Section 301.9100-3(a) provides that requests for extensions of time for
regulatory elections (other than automatic extensions covered in section 301.9100-2)
will be granted when the taxpayer provides evidence (including affidavits) to establish
that the taxpayer acted reasonably and in good faith and the grant of relief will not
prejudice the interests of the government.

Under section 301.9100-3(b), a taxpayer is deemed to have acted reasonably and in
good faith if the taxpayer requests relief before the failure to make the regulatory
election is discovered by the Service, or reasonably relied on a qualified tax
professional, and the tax professional failed to make, or advise the taxpayer to make,
the election. However, a taxpayer is not considered to have reasonably relied on a
qualified tax professional if the taxpayer knew or should have known that the
professional was not competent to render advice on the regulatory election or was not
aware of all relevant facts.

In addition, section 301.9100-3(b)(3) provides that a taxpayer is deemed not to have
acted reasonably and in good faith if the taxpayer—

      (i)     seeks to alter a return position for which an accuracy-related penalty has
              been or could be imposed under section 6662 at the time the taxpayer
              requests relief, and the new position requires or permits a regulatory
              election for which relief is requested;

      (ii)    was fully informed in all material respects of the required election and
              related tax consequences but chose not to make the election; or

      (iii)   uses hindsight in requesting relief. If specific facts have changed since
              the original deadline that make the election advantageous to a taxpayer,
              the Service will not ordinarily grant relief.
PLR-106766-23                                 6

Section 301.9100-3(c)(1) provides that the Commissioner will grant a reasonable
extension of time to make the regulatory election only when the interests of the
Government will not be prejudiced by the granting of relief.

Section 301.9100-3(c)(1)(i) provides that the interests of the government are prejudiced
if granting relief would result in a taxpayer having a lower tax liability in the aggregate
for all taxable years affected by the election than the taxpayer would have had if the
election had been timely made (taking into account the time value of money).

Section 301.9100-3(c)(1)(ii) provides that the interests of the government are ordinarily
prejudiced if the taxable year in which the regulatory election should have been made or
any taxable year that would have been affected by the election had it been timely made
are closed by the period of limitations on assessment under section 6501(a) before the
taxpayer’s receipt of a ruling granting relief under this section.

                                      CONCLUSION

Based on the facts and information submitted and the representations made, we
conclude that Taxpayer has acted reasonably and in good faith, and that the granting of
relief would not prejudice the interests of the government. From the materials
submitted, including the affidavits submitted by Taxpayer and other relevant parties, it is
clear that Taxpayer at all times intended to make a § 168(h)(6) election. Upon
discovering its failure, Taxpayer promptly sought an extension of time to file the
election.

Based on the materials submitted, our office concludes that Taxpayer’s failure to make
the § 168(h)(6) election with its original return for Year 2 was inadvertent and based
upon its reliance on tax professionals. In addition, Taxpayer is not using hindsight in
requesting relief. Moreover, Taxpayer requested relief before the failure to make the
election was discovered by the IRS. Taxpayer has acted reasonably and in good faith.
Finally, the interests of the Government will not be prejudiced by the granting of relief
under § 301.9100-3.

Accordingly, based solely on the facts and information submitted, and the
representations made in the ruling request, we grant Taxpayer an extension of 60 days
from the date of this ruling to file the election statement with the appropriate service
center containing the information required in § 301.9100-7T(a)(3) for the election to be
effective for Year 1. Taxpayer must attach a copy of this letter to the election statement.
Further, the letter ruling should be attached for all subsequent returns (and amended
returns) for all taxable years to which this ruling is relevant. In addition, pursuant to §
301.9100-7T(a)(3)(ii), a copy of the election statement should be attached to the
Federal tax returns of the tax-exempt shareholders of Taxpayer.

This ruling is based upon facts and representations submitted by Taxpayer and
accompanied by a penalty of perjury statement executed by an appropriate party. This
PLR-106766-23                                  7

office has not verified any of the material submitted in support of the request for a ruling.
However, as part of an examination process, the Service may verify the factual
information, representations, and other data submitted.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. We express no opinion regarding the tax treatment of the instant transaction
under the provisions of any other sections of the Code or regulations that may be
applicable, or regarding the tax treatment of any conditions existing at the time of, or
effects resulting from, the instant transaction.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                       Sincerely,



                                       Erika C. Reigle
                                       Senior Technician Reviewer, Branch 8
                                       Office of Chief Counsel
                                       (Income Tax & Accounting)



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