Court Opinion

ID: 9942299
Source: CourtListenerOpinion
Date Created: 2024-02-20 20:02:09.186476+00
Date Added: 2024-06-11T13:47:55.637888
License: Public Domain

United States Tax Court

                             162 T.C. No. 3

 23RD CHELSEA ASSOCIATES, L.L.C., RELATED 23RD CHELSEA
        ASSOCIATES, L.L.C., TAX MATTERS PARTNER,
                         Petitioner

                                   v.

           COMMISSIONER OF INTERNAL REVENUE,
                       Respondent

                              —————

Docket No. 22382-19.                           Filed February 20, 2024.

                              —————

             C, a partnership, constructed a residential rental
      property in New York City during 2001 and 2002.
      Construction was financed by a loan from the New York
      State Housing Finance Agency (HFA). The HFA funded
      the loan by raising $110 million in bonds, some of which
      were tax exempt under I.R.C. § 103. C claimed low-income
      housing credits (LIHCs) under I.R.C. § 42 for tax years
      2003 through at least 2009. In calculating the yearly
      credit, C included in the property’s “eligible basis” (as
      defined in I.R.C. § 42(d)) a portion of the various financing
      costs it incurred in connection with the HFA loan,
      including bond fees that the HFA passed on to C.

             In a notice of final partnership administrative
      adjustment for tax year 2009, R determined that C should
      not have included any of the financing costs in eligible
      basis. R accordingly proposed to reduce C’s LIHC for tax
      year 2009 and also proposed an increase in tax under the
      credit recapture provisions of I.R.C. § 42(j) with respect to
      tax years 2003–08.

            Held: The term “adjusted basis” in I.R.C. § 42(d)(1)
      has the meaning given to it in I.R.C. § 1011(a), and

                           Served 02/20/24
                                           2

       accordingly the uniform capitalization rules of I.R.C.
       § 263A apply.

               Held, further, all financing costs, including bond
       fees, incurred “by reason of” the taxpayer’s construction of
       residential rental property, see Treas. Reg. § 1.263A-
       1(e)(3)(i), and before the end of the first year of the credit
       period, see I.R.C. § 42(d)(1), are includible in eligible basis
       for purposes of the LIHC. This is true whether or not the
       bondholders are exempt from federal income tax under
       I.R.C. § 103 on the bond interest.

             Held, further, R’s proposed adjustments are not
       sustained.

                                     —————

James P. Dawson and Alan S. Cohen, for petitioner.

Frederick C. Mutter and Mimi M. Wong, for respondent.

                                     OPINION

       COPELAND, Judge: On September 30, 2019, the Commissioner
of Internal Revenue (Commissioner) issued a notice of final partnership
administrative adjustment (FPAA) for tax year 2009 to Petitioner,
Related 23rd Chelsea Associates, L.L.C., the tax matters partner (TMP)
for 23rd Chelsea Associates, L.L.C. (23rd Chelsea). This case is a
partnership-level action under the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA), 1 based on a timely Petition filed by the TMP. In
the FPAA the Commissioner determined that 23rd Chelsea overstated
the “eligible basis” of its residential rental property for purposes of the
section 42 low-income housing credit (LIHC). See I.R.C. § 42(d)(1).
Accordingly, the Commissioner proposed decreasing the LIHC credit
amount claimed by 23rd Chelsea for tax year 2009 by $20,079 (i.e., the

        1 TEFRA, Pub. L. No. 97-248, §§ 401–407, 96 Stat. 324, 648–71, codified at

sections 6221 through 6234, was repealed for returns filed for partnership tax years
beginning after December 31, 2017. Unless otherwise indicated, statutory references
are to the Internal Revenue Code, Title 26 U.S.C. (I.R.C. or Code), in effect at all
relevant times, regulation references are to the Code of Federal Regulations, Title 26
(Treas. Reg.), in effect at all relevant times, and Rule references are to the Tax Court
Rules of Practice and Procedure. Some dollar amounts are rounded.
                                             3

amount allocable to the alleged overstatement of eligible basis). The
Commissioner also proposed a recapture amount of $49,568, reflecting
the portion of the credits claimed in tax years 2003 through 2008
allocable to the alleged overstatement. See I.R.C. § 42(j).

       The parties submitted this case fully stipulated for decision
without trial, pursuant to Rule 122.          After concessions by the
Commissioner (as described below), the issues for our decision are
(1) whether, for purposes of the LIHC, the eligible basis in a qualified
low-income residential building includes financing costs 2 related to the
issuance of bonds (whether taxable or tax-exempt) 3 whose proceeds were
lent to the taxpayer as financing for the construction of the building and
(2) if not, whether section 42(j) requires a credit recapture from the
taxpayer that included such financing costs in its eligible basis in prior
tax years. These are questions of first impression for our Court.

                                      Background

       The following facts are based on the pleadings and the parties’
First Stipulation of Facts, including the attached Exhibits. Both 23rd
Chelsea and the TMP are Delaware limited liability companies with a
principal place of business in New York, New York.

I.      Building Construction

       23rd Chelsea was formed on June 6, 2000. Between June 2000
and March 2001, 23rd Chelsea purchased real property and
development rights on West 23rd Street, New York, New York. On or
about June 1, 2001, 23rd Chelsea began construction to develop the
property into a 313-unit 4 multifamily residential apartment complex
called the Tate, including recreational facilities, a business center, and

         2 The parties refer to the financing costs included in 23rd Chelsea’s calculation

of eligible basis as “bond fees.” However, that calculation includes costs not directly
related to the bonds (e.g., loan issuance costs), so for clarity this Opinion refers to such
costs collectively as “financing costs.”
        3 Hereinafter, bonds whose interest payments are not taxable to the
bondholders under section 103 are referred to as “tax-exempt bonds,” and bonds whose
interest payments are not excludable under section 103 are referred to as “taxable
bonds.”
       4 There is some evidence in the record that 314, rather than 313, units were

constructed. This discrepancy does not affect our disposition of the case.
                                      4

retail space. Construction lasted approximately 14 months, and the
Tate was placed in service on August 13, 2002.

       The Tate’s construction was funded entirely by a 31.5-year, $110
million loan from the New York State Housing Finance Agency (HFA).
The HFA raised these funds through two bond issuances, the first on
May 31, 2001, composed of 31.5-year bonds, and the second on July 1,
2002, composed of 30.4-year bonds. The 2001 issuance comprised
$26 million of tax-exempt bonds and $27.5 million of taxable bonds. The
2002 issuance comprised $73 million of tax-exempt bonds. Of the
proceeds from the 2002 issuance, $16.5 million was used to redeem a
portion of the outstanding 2001 taxable bonds, and the rest was remitted
to 23rd Chelsea.

       As a condition of initiating the loan, the HFA required
23rd Chelsea to agree to certain restrictions on the eventual tenant mix
(by income level) and the rental rates for low-income tenants. These
restrictions were designed to (among other things) preserve the tax-
exempt status of the tax-exempt bonds and qualify the Tate for the
LIHC. The HFA also required 23rd Chelsea to fully secure the loan and
related repayment obligations by obtaining a letter of credit from
Bayerische Hypo-und Vereinsbank AG (Hypo Bank) (or another bank
acceptable to the HFA). 23rd Chelsea duly obtained a letter of credit
from Hypo Bank, which agreed to lend 23rd Chelsea up to $54.1 million
between May 31, 2001, and May 31, 2006, solely for the purpose of
making principal or interest payments on the loan financed by the
HFA’s 2001 bond issuance. A subsequent letter of credit from Hypo
Bank, dated July 1, 2002, increased 23rd Chelsea’s credit limit to
$111.2 million (to also reflect the 2002 bond issuance). 23rd Chelsea
never drew on either letter of credit.

      Of the $110 million of bond proceeds ultimately lent to
23rd Chelsea, it spent $107,444,441 by December 31, 2003, including
$5,745,837 in financing costs stemming from the bond issuances.

II.   Calculation of Eligible Basis

       23rd Chelsea claimed an LIHC with respect to the Tate of
$593,961 in each tax year from 2003 through at least 2009. See infra
note 10. The partnership calculated this credit using an eligible basis
(as defined in section 42(d)) of $93,165,121, determined as follows:
$60,792,972 of “hard” construction costs (including material and labor
for concrete, masonry, plumbing, electrical, etc.); $1,218,320 of financing
                                           5

costs; $9,654,186 of other “soft” costs (architecture and engineering fees,
insurance payments, etc.); and a 30% increase pursuant to section
42(d)(5)(C), 5 which increases the LIHC for buildings in areas with a high
concentration of low-income residents or a high poverty rate, see
§ 42(d)(5)(C)(ii), or high construction, land, and utility costs, see
§ 42(d)(5)(C)(iii). The Tate’s hard costs included $1,204,362 of union
dues and pension contributions, paid by 23rd Chelsea on behalf of
workers for one of its construction subcontractors.

     The financing costs consisted of the following components and
amounts:

                                                                    Amount Included
                                                        Total
  Component                  Description                            by 23rd Chelsea in
                                                       Amount
                                                                      Eligible Basis
                  Paid to Hypo Bank in
Origination Fee                                       $841,696          $193,232
                  connection with letter of credit

HFA Financing     Paid to HFA in connection with
                                                       880,000            26,789
Fee               loan agreement

                  Paid to New York State
                  Department of Taxation, on
NYS Bond Fee                                           698,250            16,524
                  HFA’s behalf, in connection
                  with bond issuances

Rating Agency     Paid to reimburse HFA for
                                                        3,000               55
Fee               obtaining bond ratings

Multi-Year        Paid to HFA in connection with
                                                        25,000             956
Processing Fee    loan agreement

Underwriter       Paid to bank that underwrote
                                                       253,000            6,768
Fee               and remarketed the bonds

Underwriter       Paid to reimburse underwriting
                                                        17,109             461
Expenses          bank for expenses

                  Paid to reimburse HFA for bond
Trustee Fee                                             7,000              128
                  trustee’s fee

Printing and      Paid to reimburse HFA for
                                                        6,000              110
Binding Costs     producing bond documents

        5 This citation is given for tax year 2003, the first year of the Tate’s credit

period. The provision is currently codified at section 42(d)(5)(B).
                                            6

Hypo Bank          Paid to Hypo Bank in
                                                         81,200       79,892
Servicing Fee      connection with letter of credit

HFA Servicing      Paid to HFA in connection with
                                                         75,793       74,572
Fee                loan agreement

HFA                Paid to HFA in connection with
                                                         60,000       2,295
Application Fee    loan agreement

Engineer           Paid to engineers retained by
Consultants        Hypo Bank and HFA in                 113,574      111,744
Cost               connection with letter of credit

                   Paid to Hypo Bank in
Appraisal Fee                                            17,500       4,017
                   connection with letter of credit

                   Paid to reimburse HFA and
Financial
                   Hypo Bank for financial adviser       30,000       4,018
Adviser Fees
                   fees
Letter of Credit   Paid to Hypo Bank in
Commitment         consideration for its extending      693,000      681,835
Fee                the letter of credit
                   Paid in connection with a
                   guaranty, required by Hypo
                   Bank and made by a company
Guaranty Fee                                             77,000         —
                   related to 23rd Chelsea, of any
                   draws on Hypo Bank’s letter of
                   credit
                   Paid to title insurer engaged for
Title Insurance                                         390,024       14,924
                   bond issuances
                   Paid in connection with
Refinancing
                   refinancing the HFA loan in         1,476,691        —
Costs
                   2003
 Totals                           —                    $5,745,837   $1,218,320

The parties stipulated that 23rd Chelsea incurred the amounts shown
in the “Total Amount” column for the purposes listed in the
“Description” column (i.e., the parties agreed that the fees and expenses
listed in the table were 23rd Chelsea’s financing costs incurred related
to the issuance of the HFA bonds that funded 23rd Chelsea’s loan).

       The HFA either directly or indirectly required 23rd Chelsea to
pay each component of the financing costs—other than the Refinancing
Costs—as a condition of the HFA’s issuing and maintaining the loan.
(For instance, although the HFA did not directly require 23rd Chelsea
to pay an origination fee to Hypo Bank, the HFA required 23rd Chelsea
                                             7

to secure a letter of credit from Hypo Bank, which in turn required an
origination fee.) 23rd Chelsea included each component of the financing
costs in eligible basis only to the extent that it deemed that component
to relate to both (1) the portion of the real estate composed of residences
and common areas and (2) costs incurred during the construction period
(approximately June 1, 2001, to August 13, 2002). Therefore, 23rd
Chelsea first reduced each cost component by 1.61%, the percentage of
the bond proceeds allocated to the health club and retail space. It then
removed all fee amounts paid (or deemed paid) for services occurring
after the construction period. For many of the cost components, this
second step involved prorating lump-sum payments over the months
during which the HFA loan, the bonds, and/or the Hypo Bank letter of
credit remained (or were projected to remain) outstanding, then tallying
only the amounts prorated for the months of the construction period.
23rd Chelsea’s computation of eligible basis includes only financing
costs that were paid before the Tate was ever placed in service.

       In 2004, 23rd Chelsea presented to the HFA an independently
audited final cost certification, which included a detailed calculation of
eligible basis. (That calculation explicitly included in eligible basis a
portion of the financing costs totaling $1,218,320, as detailed in the table
supra pp. 5–6.) The HFA was responsible for allocating to the Tate no
greater amount of LIHC than an amount “necessary for the financial
feasibility of the project and its viability as a qualified low-income
housing project.” See I.R.C. § 42(m)(2)(A). The HFA was also
responsible for specifying the maximum qualified basis 6 that 23rd
Chelsea could use for computing its LIHC. See I.R.C. § 42(h)(7)(D). The
HFA did not dispute 23rd Chelsea’s calculation of eligible basis,
qualified basis, or LIHC amount.

III.    The FPAA

       In the FPAA the Commissioner determined that 23rd Chelsea’s
eligible basis in the Tate included neither the $1,204,362 of union dues
and pension contributions (paid on behalf of one of 23rd Chelsea’s
subcontractors) nor the $1,218,320 of financing costs that 23rd Chelsea
had included. The Commissioner therefore proposed decreasing the
LIHC credit amount claimed by 23rd Chelsea for tax year 2009 by
$20,079, i.e., the amount of the claimed credit allocable to the alleged

         6 Qualified basis is a specified percentage of eligible basis. See infra pp. 10–11.

Therefore, the HFA was effectively responsible for specifying the Tate’s maximum
eligible basis.
                                      8

overstatement of eligible basis. The Commissioner also proposed, under
section 42(j), recapturing $49,568 of the credits taken for tax years 2003
through 2008.

       The Commissioner now concedes that 23rd Chelsea properly
included the full amount of the union dues and pension contributions in
eligible basis. 7 Therefore, we must decide only whether $1,218,320 of
the financing costs was properly included—and, if some or all of that
amount was not, whether 23rd Chelsea is subject to the credit recapture
provisions of section 42(j). As discussed below, the Commissioner has
offered two arguments to support his determination that the financing
costs (including bond fees) were not includible in eligible basis: one
relevant to all the costs and one limited to those costs allocable to the
tax-exempt bonds. Our ultimate holding does not rest on the distinction
between taxable and tax-exempt bonds.

                                 Discussion

I.     Jurisdiction

       The Tax Court is a court of limited jurisdiction and may exercise
jurisdiction only to the extent authorized by Congress. Judge v.
Commissioner, 88 T.C. 1175, 1180–81 (1987); Naftel v. Commissioner,
85 T.C. 527, 529 (1985). We are without authority to enlarge upon that
statutory grant.     See Phillips Petrol. Co. & Affiliated Subs. v.
Commissioner, 92 T.C. 885, 888 (1989). We nevertheless always have
jurisdiction to determine whether we have jurisdiction over a matter
brought before us. Hambrick v. Commissioner, 118 T.C. 348 (2002). And
we must assure ourselves of our jurisdiction even when not asked to by
the parties. Brannon’s of Shawnee, Inc. v. Commissioner, 69 T.C. 999,
1004 (1978).

      Under the default rules of Treasury Regulation § 301.7701-2(a)
and (c)(1), noncorporate entities with more than one member (such as
limited liability companies) are treated as partnerships for federal tax
purposes.     Because 23rd Chelsea’s TMP filed the Petition for
readjustment of partnership items within 90 days of the Commissioner’s
FPAA, we have jurisdiction under section 6226(f) to determine all of
23rd Chelsea’s “partnership items” for tax year 2009. Section 6231(a)(3)
defines “partnership item” as “any item required to be taken into

       7 The Commissioner initially disputed these amounts because 23rd Chelsea

had not provided satisfactory evidence that the amounts were in fact paid for
construction labor.
                                        9

account for the partnership’s taxable year . . . to the extent regulations
prescribed by the Secretary provide that . . . such item is more
appropriately determined at the partnership level than at the partner
level.” Treasury Regulation § 301.6231(a)(3)-1(a)(1)(i) provides that
partnership items include the partnership aggregate, and each partner’s
share, of items of income, gain, loss, deduction, or credit of the
partnership. Thus, 23rd Chelsea’s allowable LIHC for tax year 2009
(a credit) and the alleged recapture amount (an income item) are both
partnership items subject to redetermination in this proceeding.

II.   Computation of the LIHC

      Congress added the LIHC to the Code to incentivize construction
and rehabilitation of residential rental units for low-income tenants.
See H.R. Rep. No. 99-841 (Vol. II) (Conference Report), at II-85 (1986)
(Conf. Rep.), reprinted in 1986-3 C.B. (Vol. 4) 1, 85. The credit is
reserved for “qualified low-income building[s].” I.R.C. § 42(a)(2). These
are buildings that meet the following three requirements:

      1.     The building consists of “residential rental property” that
             satisfies at least one of two tests relating to rent
             restrictions and tenant income levels. See I.R.C. § 42(c)(2),
             (g). 8

      2.     The residential rental property satisfies one of the two
             tests (whichever is elected by the taxpayer) for at least 15
             years after it is placed in service. I.R.C. § 42(c)(2)(A), (i)(1).

      3.     The building is eligible for the modified accelerated cost
             recovery system (MACRS) of section 168 (as amended in

      8       Sec. 42(g)(1). In general.—The term “qualified low-income housing
      project” means any project for residential rental property if the project meets
      the requirements of subparagraph (A) or (B) whichever is elected by the
      taxpayer:
                      (A) 20-50 test.—The project meets the requirements of
              this subparagraph if 20 percent or more of the residential units
              in such project are both rent-restricted and occupied by
              individuals whose income is 50 percent or less of area median
              gross income.
                      (B) 40-60 test.—The project meets the requirements of
              this subparagraph if 40 percent or more of the residential units
              in such project are both rent-restricted and occupied by
              individuals whose income is 60 percent or less of area median
              gross income.
                                           10

               1986).   See I.R.C. § 42(c)(2)(B) (providing that “the
               amendments made by section 201(a) of the Tax Reform Act
               of 1986” must apply to the building); Tax Reform Act of
               1986, Pub. L. No. 99-514, § 201(a), 100 Stat. 2085, 2121–37
               (amending section 168).

       The LIHC for a given building is prorated over a period of ten
years (credit period), beginning in the tax year the building is placed in
service or, at the taxpayer’s election, the following tax year. I.R.C.
§ 42(a), (f)(1). During each year of the credit period, the taxpayer
receives a credit equal to an “applicable percentage,” specified annually
by the Internal Revenue Service (IRS), of the building’s qualified basis
(discussed below). I.R.C. § 42(a). The applicable percentage is
calculated so that the discounted present value of the ten annual credit
amounts (as measured from the end of the credit period’s first year)
equals 70% of qualified basis for certain new buildings. I.R.C. § 42(b).
However, if the building is funded at least in part with proceeds from
tax-exempt bonds, then unless the taxpayer excludes from eligible basis
the proceeds of those bonds, the applicable percentage is calculated so
that the discounted present value of the ten credits equals only 30% of
qualified basis. I.R.C. § 42(b)(2)(B)(ii), 9 (i)(2). (Because the Tate was
ultimately financed in part by tax-exempt bonds, 23rd Chelsea
computed its LIHC using the lower applicable percentage.)

       A building’s qualified basis is generally computed in the following
way:

       1.      Determine the building’s eligible basis, which equals its
               adjusted basis at the end of the first year of the credit
               period (but prior to any reduction for depreciation), less any
               amount of basis allocable to property that is not residential
               rental property (although the basis allocable to common
               areas is included). I.R.C. § 42(d)(1), (4).
       2.      Increase the eligible basis by 30% if the building is in an
               area with a high concentration of low-income residents, a
               high poverty rate, or high construction, land, and utility
               costs. I.R.C. § 42(d)(5)(C).

       3.      The qualified basis equals the eligible basis multiplied by
               the “applicable fraction,” which is the lower of (i) the
               fraction of residential rental units that are rent restricted

       9 The provision is currently codified at section 42(b)(1)(B)(ii).   See supra note 5.
                                          11

                and occupied by low-income tenants or (ii) the fraction of
                residential rental floor space allocated to such low-income
                units. I.R.C. § 42(c)(1), (i)(3). 10

        Section 42 also provides for the recapture, in certain
circumstances, of some of the credits allowed for prior years. The
recapture provisions apply if, at the end of any year during the 15-year
compliance period (beginning with the first year of the credit period), the
building’s qualified basis is lower than it was at the end of the previous
year. 11 I.R.C. § 42(j)(1).

III.    23rd Chelsea’s Eligible Basis

       The only part of 23rd Chelsea’s computation of its LIHC for tax
year 2009 that the Commissioner disputes (after conceding the union
dues and pension contributions) is the inclusion of $1,218,320 of the
financing costs in eligible basis. We must look to the terms of section 42
to resolve the dispute. Section 42(d)(1) provides that “[t]he eligible basis
of a new building is its adjusted basis as of the close of the 1st taxable
year of the credit period.” Section 42(d)(4)(A) clarifies that “the adjusted
basis of any building shall be determined without regard to the adjusted
basis of any property which is not residential rental property.” There is
no other statutory exclusion from eligible basis that the Commissioner
argues is relevant to this case.

       Section 42 does not expressly define “adjusted basis,” so we look
to section 1011(a), which provides the default rule that “[t]he adjusted
basis for determining the gain or loss from the sale or other disposition
of property, whenever acquired, shall be the basis (determined under

        10 23rd Chelsea computed its annual credit of $593,961 as follows: (1) The Tate

had a preliminary eligible basis of $71,665,478 (the sum of hard costs and soft costs
that 23rd Chelsea determined to be eligible); (2) pursuant to section 42(d)(5)(C), the
preliminary eligible basis was increased by 30%, to $93,165,121; (3) the eligible basis
was multiplied by an applicable fraction of 18.32% (39,863 square feet of low-income
housing units divided by total square footage of 217,613), yielding a qualified basis of
$17,067,850; and (4) the qualified basis was multiplied by an applicable percentage of
3.48% designated by the IRS for tax year 2002, see Rev. Rul. 2002-48, 2002-2 C.B. 239,
241, yielding an LIHC of $593,961. Although 23rd Chelsea elected to begin the credit
period in 2003, the applicable percentage generally corresponds to the year in which
the building is placed in service (here, 2002). See I.R.C. § 42(b)(2)(A).
        11 This may occur if, for instance, the applicable fraction decreases by reason

of fewer units being reserved for low-income tenants. Note that eligible basis cannot
change over time, since it is calculated as of the end of the credit period’s first year
(here 2003).
                                          12

section 1012 . . . ), adjusted as provided in section 1016.” 12 Section 1012,
in turn, provides that “[t]he basis of property shall [generally] be the
cost of such property.” Section 263A then clarifies this definition of basis
as it applies to taxpayer-produced real property (or other tangible
property) such as the Tate. That section provides that “the direct costs
of such property” and “such property’s proper share of those indirect
costs . . . part or all of which are allocable to such property” must be
“capitalized.” I.R.C. § 263A(a) and (b)(1). Treasury Regulation
§ 1.263A-1(c)(3) explains that “capitalize,” in the case of real property,
means “to charge to a capital account or basis,” while Treasury
Regulation § 1.263A-1(c)(1) provides, in relevant part, that “taxpayers
must capitalize their direct costs and a properly allocable share of their
indirect costs to property produced.” (Emphasis added.)

       It follows from these provisions, taken together, that the adjusted
basis of taxpayer-produced real property (before any reduction for
depreciation) typically equals the sum of the property’s direct costs and
its properly allocable share of indirect costs. 13 We reach this conclusion
as follows: (1) the direct costs and properly allocable share of indirect
costs must be capitalized to the property; (2) “capitalize” means to
charge to a capital account or basis; and (3) basis is adjusted for any
expenditures charged to the capital account. See I.R.C. § 1016(a)(1).
Therefore, the Tate’s eligible basis was the sum of 23rd Chelsea’s direct
construction costs and a properly allocable share of the indirect
construction costs, minus costs allocable to portions of the building that
were not “residential rental property” at the end of the first year of the
credit period. See I.R.C. § 42(d)(4)(A). 14

       For taxpayer-produced real or tangible property such as the Tate,
Treasury Regulation § 1.263A-1(e)(2)(i) defines “direct costs” as the sum
of “direct material costs” and “direct labor costs.” Treasury Regulation
§ 1.263A-1(e)(3)(i) provides that “[i]ndirect costs are defined as all costs

        12 Our recourse to section 1011 and its compatriots is supported not only by the

fact that those sections function (by their terms) as rules of general application for
Subtitle A (Income Taxes) of the Code but also by the reference to section 1016 in
section 42(d)(4)(D): “The adjusted basis of any building shall be determined without
regard to paragraphs (2) and (3) of section 1016(a) [dealing with depreciation,
amortization, and the like].”
        13 We ignore adjustments for depreciation pursuant to section 42(d)(4)(D).

         14 Although the Tate’s construction was financed in part by tax-exempt bonds,

23rd Chelsea did not elect under section 42(i)(2)(B) to exclude those bond proceeds from
eligible basis. Instead, 23rd Chelsea chose to have the discounted present value of its
credits equal 30% of qualified basis rather than 70%. See I.R.C. § 42(b)(2)(B).
                                         13

other than direct material costs and direct labor costs” and that they are
properly allocable to taxpayer-produced property “when the costs
directly benefit or are incurred by reason of the performance of
production . . . activities.” The U.S. Court of Appeals for the Second
Circuit 15 has held that for indirect costs to be “incurred by reason of” the
performance of production activities, “the costs . . . must be a but-for
cause of the taxpayer’s production activities.” Robinson Knife Mfg. Co.,
Inc. & Sub. v. Commissioner, 600 F.3d 121, 131–32 (2d Cir. 2010), rev’g
and remanding T.C. Memo. 2009-9; see also City Line Candy & Tobacco
Corp. v. Commissioner, 624 F. App’x 784, 787 (2d Cir. 2015) (“[Robinson
Knife] requires capitalization only of costs that are a ‘but-for cause’ of
the taxpayer’s production or sales activity.” (quoting Robinson Knife
Mfg. Co. v. Commissioner, 600 F.3d at 131–32)), aff’g 141 T.C. 414
(2013).

       Here, we hold that at least $1,218,320 of the financing costs
(which included bond fees) were a but-for cause of the Tate’s
construction, given 23rd Chelsea’s decision to finance construction by
borrowing from the HFA. Specifically, all amounts of the financing costs
that 23rd Chelsea included in its computation of eligible basis were
necessary to induce the HFA to initiate and/or maintain the $110 million
loan used for construction of the Tate. Moreover, the amount of each
cost component that 23rd Chelsea allocated (by proration or otherwise)
to the construction and production period was incurred during that
period, i.e., before the Tate was ever placed in service. Therefore, 23rd
Chelsea incurred at least $1,218,320 of the financing costs “by reason
of” the Tate’s construction within the meaning of Treasury Regulation
§ 1.263A-1(e)(3)(i), as interpreted by the Second Circuit.

       Treasury Regulation § 1.263A-1(e)(3)(i) acknowledges that
certain indirect costs may be allocable to both production activities and
activities not subject to section 263A, in which case taxpayers must
make a “reasonable allocation of indirect costs” between the former and
the latter. However, nothing in this regulation indicates that the costs
of obtaining financing for production activities are necessarily allocable
to a separate “financing” activity not subject to section 263A. In fact, we
note that section 263A(f)(1) confirms that interest on loans used to
finance the production of property generally must be capitalized under

        15 This case is appealable to the Second Circuit absent a contrary stipulation

by the parties. See I.R.C. § 7482(b)(1)(E). Therefore, we follow all Second Circuit
precedent that is squarely on point. See Golsen v. Commissioner, 54 T.C. 742, 757
(1970), aff’d, 445 F.2d 985 (10th Cir. 1971).
                                         14

the rule of section 263A(a), although Congress has provided that the
latter rule applies only to interest “paid or incurred during the
production period” and allocable to property with “a long useful life,”
such as residential property like the Tate. Section 263A(f) thus
indicates that financing costs allocable to the production period are not
per se allocable to a “financing” activity separate and apart from
production.

       Therefore, we hold that for purposes of Treasury Regulation
§ 1.263A-1(e)(3)(i), the costs of obtaining financing for production
activities are not allocable to a separate “financing” activity (ostensibly
not subject to section 263A) insofar as those costs are allocable to the
production period. Rather, 23rd Chelsea’s financing of the Tate’s
construction through loans funded by bond issuances was an “indivisible
part” of the construction to the extent that that financing was allocable
to the production period. City Line Candy & Tobacco Corp., 141 T.C.
at 431 n.20 (finding that the taxpayer’s purchase of cigarette tax stamps,
a legal prerequisite of reselling the cigarettes, was an “indivisible part”
of the taxpayer’s resale activity); cf. Anschutz Co. v. Commissioner, T.C.
Memo. 2006-40, 91 T.C.M. (CCH) 860, 867–68 (holding that the
taxpayer, which had installed fiberoptic cable or conduit for its own
future use simultaneously with installing cable or conduit for third
parties, must make a reasonable allocation of indirect costs between its
production activities and its long-term contract activities, the latter of
which are excluded from section 263A by section 263A(c)(4)),
supplemented by T.C. Memo. 2006-124.

       Accordingly, under section 263A(a)(2)(B) and Treasury
Regulation § 1.263A-1(e)(3)(i), 23rd Chelsea was required to capitalize
into the Tate’s basis the incurred financing costs that were a but-for
cause of production. Accordingly, the Tate’s eligible basis includes all
the financing costs that were (1) allocable to the residential rental
property, (2) a but-for cause of the Tate’s construction, given 23rd
Chelsea’s decision to finance construction with the HFA loan, and
(3) incurred by the end of 23rd Chelsea’s 2003 tax year (i.e., the first
year of the credit period). The record clearly indicates that the amount
of financing costs includible in the Tate’s eligible basis was at least the
amount that 23rd Chelsea actually included (viz, $1,218,320). 16

       16 We note that Treasury Regulation § 1.263A-2(a)(3)(i) generally provides that

taxpayers must capitalize into taxpayer-produced property all indirect costs properly
                                         15

IV.    The Commissioner’s Arguments

       The Commissioner offers two arguments against 23rd Chelsea’s
position.

       A.      Depreciation Provisions

       First, the Commissioner notes that the LIHC statute requires a
building to be subject to MACRS in order to be a “qualified low-income
building.” See I.R.C. § 42(c)(2)(B). The Commissioner then argues that
the costs of obtaining bond proceeds should be capitalized into the
underlying loan and thus are subject to depreciation under section 167
but not to MACRS under section 168—rendering those bond costs
ineligible to be part of the “qualified low-income building” for purposes
of section 42. Section 167(a) allows depreciation deductions generally
for “exhaustion, wear and tear . . . of property used in the trade or
business,” while the accelerated deductions of section 168 are reserved
for “tangible property.” I.R.C. § 168(a). (Accordingly, all section 168
deductions are section 167 deductions, but not all section 167 deductions
are section 168 deductions.)

      However, the Commissioner overlooks the changes that Congress
made in adopting “uniform capitalization rules” (including section 263A)
in 1986. See Tax Reform Act of 1986, § 803(a), 100 Stat. at 2350–55.
Those new rules displace prior law where inconsistent. The Senate
Finance Committee provided helpful background on the changes:

              The committee believes that the present-law rules
       regarding the capitalization of costs incurred in producing
       property are deficient in two respects. First, the existing
       rules may allow costs that are in reality costs of producing,
       acquiring, or carrying property to be deducted currently,
       rather than capitalized into the basis of the property and
       recovered when the property is sold or as it is used by the
       taxpayer. This produces a mismatching of expenses and
       the related income and an unwarranted deferral of taxes.
       Second, different capitalization rules may apply under

allocable to the property “without regard to whether those costs are incurred before,
during, or after the production period.” Here, the parties have not asserted that
indirect costs incurred outside the production period might qualify for capitalization
and inclusion in eligible basis. Consequently, we have not addressed the issue of
preproduction or postproduction costs under section 263A and decline to do so on our
own.
                                          16

       present law depending on the nature of the property and
       its intended use. These differences may create distortions
       in the allocation of economic resources and the manner in
       which certain economic activity is organized.

             The committee believes that, in order to more
       accurately reflect income and make the income tax system
       more neutral, a single, comprehensive set of rules should
       govern the capitalization of costs of producing, acquiring,
       and holding property, including interest expense, subject
       to appropriate exceptions where application of the rules
       might be unduly burdensome.

S. Rep. No. 99-313, at 140 (1986), as reprinted in 1986-3 C.B. (Vol. 3) 1,
140.

       The Tate is tangible business property subject to wear and tear
and thus eligible for MACRS under section 168. Section 42(d)(1)
accordingly directs us to find the Tate’s adjusted basis at the end of the
first year of the credit period, which—under section 263A and the
accompanying regulations, as discussed above—includes the financing
costs incurred for production. The fact that 23rd Chelsea’s bond-
financed loan from the HFA was not tangible property is irrelevant,
because the related costs were indirect costs “incurred by reason of” the
Tate’s construction. See Treas. Reg. § 1.263A-1(e)(3)(i).

       The regulations under section 263A specifically enumerate
several categories of capitalizable indirect costs that, but for section
263A, might otherwise be deducted or capitalized into an intangible
asset (and then either amortized or depreciated under section 167 but
not under MACRS). See, e.g., Treas. Reg. § 1.263A-1(e)(3)(ii)(M)
(requiring capitalization into taxpayer-produced property of “the cost of
insurance on plant or facility, machinery, equipment, materials,
property produced, or property acquired for resale,” which if prepaid
might otherwise be capitalized into an intangible asset); 17 id.
subdiv. (ii)(P) (requiring capitalization into taxpayer-produced property
of “[e]ngineering and design costs,” some of which might otherwise be
capitalized into intellectual property); id. subdiv. (ii)(T) (requiring
capitalization into taxpayer-produced property of “[b]idding costs,” i.e.,

        17 For instance, in Johnson v. Commissioner, 108 T.C. 448, 488 (1997), aff’d in

part, rev’d in part, and remanded on another issue, 184 F.3d 786 (8th Cir. 1999), we
required the taxpayer to capitalize and amortize the portion of a premium for excess
loss insurance coverage that was allocable to tax years after the year of payment.
                                          17

“costs incurred in the solicitation of contracts [to produce property],”
which might otherwise be capitalized into the contracts solicited); id.
subdiv. (ii)(U) (requiring capitalization into taxpayer-produced property
of “[l]icensing and franchise costs,” including “fees incurred in securing
the contractual right to use a trademark, corporate plan, manufacturing
procedure, special recipe, or other similar right,” which might otherwise
be capitalized into the license or franchise right). Therefore, when we
look to the uniform capitalization rules, we discover that the plain
statutory text, the legislative history, and the regulations all belie the
Commissioner’s argument that 23rd Chelsea should have capitalized
the financing costs into an intangible asset rather than the Tate.

        B.      Legislative History

       The Commissioner next argues that even if some portion of the
financing costs is includible in the Tate’s adjusted basis for purposes of
depreciation deductions under sections 167 and 168, the legislative
history of section 42 shows that the portion of the costs allocable to the
tax-exempt bonds is not includible in the Tate’s eligible basis for
purposes of the LIHC. 18 The Commissioner’s argument proceeds as
follows:

        1.      Section 42(d)(4)(A) provides that generally “the adjusted
                basis of any building shall be determined without regard to
                the adjusted basis of any property which is not residential
                rental property.”
        2.      The Conference Report at II-89, 1986-3 C.B. (Vol. 4) at 89,
                states that “[r]esidential rental property for purposes of the
                low-income housing credit has the same meaning as
                residential rental property within Code section 103.”

        3.      Section 103 (which provides an exclusion for interest on
                certain state and local bonds) is statutorily linked to
                section 142, which defines the term “exempt facility bond”
                as “any bond issued as part of an issue 95 percent or more
                of the net proceeds of which are used to provide . . . [among
                other things] qualified residential rental projects.” I.R.C.

        18 In his posttrial brief, the Commissioner contends that 23rd Chelsea

effectively conceded that all the financing costs were allocable to the tax-exempt bonds,
by virtue of 23rd Chelsea’s not timely raising the possibility of including in eligible
basis only a proper portion of the financing costs allocable to the taxable bonds.
However, our holding under section 263A does not distinguish between financing costs
for tax-exempt versus taxable bonds.
                                    18

             § 142(a). Section 142(d)(1) provides that “[t]he term
             ‘qualified residential rental project’ means any project for
             residential rental property.” (Emphasis added.)

      4.     The Conference Report at II-697, 1986-3 C.B. (Vol. 4)
             at 697, explains the procedure for determining whether at
             least 95% of the net proceeds of a candidate exempt facility
             bond were used for an exempt purpose, such as a qualified
             residential rental project (95% test): “Net proceeds are
             defined as proceeds less amounts invested in a reasonably
             required reserve or replacement fund. (No reduction is
             made for amounts paid for costs of [bond] issuance since
             those amounts are not treated as spent for the exempt
             purpose of the borrowing.)”

      5.     Because issuance fees for tax-exempt bonds are not
             deducted from net bond proceeds in determining the
             proportion of such proceeds used for constructing
             residential rental property for purposes of the 95% test in
             section 142, they should not be treated as costs for
             residential rental property (and thus should not be
             includible in basis) in the context of section 42. To do
             otherwise would impermissibly result in “disparate
             treatment of the term residential rental property” between
             the two sections, contrary to the Conference Report’s
             implication that the term has the “same meaning” in both
             sections.

       First of all, we note that the Commissioner has not alleged any
ambiguity in the relevant text of section 42, viz: “[T]he adjusted basis of
any building shall be determined without regard to the adjusted basis of
any property which is not residential rental property.” See I.R.C.
§ 42(d)(4)(A). When statutory terms have a clear and unambiguous
meaning on their face, we do not look past that meaning to the
legislative history. As the Supreme Court has said:

      In statutory interpretation disputes, a court’s proper
      starting point lies in a careful examination of the ordinary
      meaning and structure of the law itself. Schindler Elevator
      Corp. v. United States ex rel. Kirk, 563 U.S. 401, 407 (2011).
      Where . . . that examination yields a clear answer, judges
      must stop. Hughes Aircraft Co. v. Jacobson, 525 U.S. 432,
      438 (1999).
                                     19

Food Mktg. Inst. v. Argus Leader Media, 139 S. Ct. 2356, 2364 (2019);
see also Sullivan v. Stroop, 496 U.S. 478, 482 (1990).

        Even assuming that the legislative history the Commissioner
cites is legitimate evidence for our construction of section 42, it does not
speak against our holding as to the Tate’s eligible basis. For our holding
does not import a different meaning to the phrase “residential rental
property” in section 42 compared to section 142. The difference we find
is not in the definition but rather the requirements Congress imposed
on the use of tax-exempt funds in financing low-income housing projects.
In section 142 Congress provided (implicitly in the statute, explicitly in
the Conference Report) that 95% of bond proceeds (unreduced by bond
issuance costs) must be used in acquiring qualified residential property,
meaning that 5% may be used otherwise. By contrast, we hold that for
purposes of determining eligible basis in section 42, bond issuance costs
are allocable to residential rental property, provided that they were
incurred by reason of construction or production.              There is no
inconsistency in definition; at most, there is a difference in the allocation
of costs. But that difference violates no rule of statutory construction or
expression of congressional intent. Congress already specifically
reduced the LIHC for buildings financed with tax-exempt bonds by
mandating an applicable percentage calculated so that the discounted
present value of the ten annual credits equals 30%, rather than 70%, of
qualified basis. I.R.C. § 42(b)(2)(B)(ii). If Congress had intended to
further rein in the LIHC for such buildings by excluding tax-exempt
bond issuance costs from eligible basis, it could have said so in the
statute. We will not judicially impose such an exclusion. See Greer v.
Commissioner, 230 F.2d 490, 493–94 (5th Cir. 1956) (“We think that the
tax statutes and regulations must be applied as written and without any
equitable consideration of the desirability of offsetting prior tax
benefits.”), rev’g Brazoria Inv. Corp. v. Commissioner, 20 T.C. 690
(1953).

      We therefore do not uphold the Commissioner’s proposed
adjustments in the FPAA, and we do not reach the question of whether
the credit recapture provisions of section 42(j) would apply to 23rd
Chelsea. We have considered all arguments made by the parties and, to
the extent they are not addressed herein, we conclude that they are
moot, irrelevant, or without merit.

      To reflect the foregoing,

      Decision will be entered for Petitioner.