Impact Fees

Impact fees are one-time charges imposed by a state or local government for new real estate development or the expansion of an existing development, to pay for specific off-site, capital improvements for general public use that result from such development (e.g., schools, police stations and firehouses). Fees take into consideration the number and size of buildings in a development and are commonly paid on the issuance of a building permit. They are generally refundable (in full or in part) if the development is not constructed as planned.

The impact fees issue was part of the IRS's Industry Issue Resolution Pilot Program, in which the Service intended to resolve issues common to large business taxpayers, rather than relying on case-by-case audits and various treatments of similar problems. Rev. Rul. 2002-9 resolved the impact fee issue for real estate developers.

In TAM 200043016, the IRS concluded that impact fees are intangible property that should not be added to the depreciable basis of constructed real estate, because they have no determinable useful lives. The Service initially viewed the fees as having an overall benefit to a taxpayer's business and no relationship to the depreciable life of any tangible asset. Thus, the fees had to be capitalized as an intangible asset, with no determinable useful life (and no corresponding tax deduction). The TAM apparently ignored the connection between impact fees and the building being constructed.

IRS Revisits Impact Fees

The IRS issued guidance on the capitalization of impact fees. Rev. Rul. 2002-9 provides a sensible resolution to the capitalization issue: impact fees incurred in connection with the construction of a new residential rental building are capitalized costs allocable to the building and, thus, depreciable. No portion of the costs are allocable to the land.

In so ruling, the IRS looked at the number of cases and decided that the taxpayer at issue had to allocate the impact fees to property produced, based on all the facts and circumstances. Thus, the fees are assessed on the taxpayer's building construction plans and have to be calculated based on the building's characteristics; because the fees would be generally refundable if the taxpayer decides not to construct the building as planned, they are allocable to the building. Accordingly, the fees have to be capitalized under Sec. 263A, as indirect costs allocable to the taxpayer's new residential rental building.

Procedures

Any change in the treatment of impact fees resulting from new construction or expansion of a building to conform to Rev. Rul. 2002-9, is treated as an accounting-method change. Taxpayers can obtain automatic approval of such change by filing Form 3115, Application for Change in Method of Accounting. They should write "Automatic Change Filed Under Revenue Ruling 2002-9" across the top of the form. The IRS has also stated that if a taxpayer changes its accounting method for impact fees to conform to the ruling, the treatment of impact fees will not be raised as an issue in any tax year before the change year. If the issue has already been raised, a treatment inconsistent with the ruling will not be pursued.

Conclusion

Observation: Taxpayers must depreciate impact fees under Sec. 168 as residential rental or nonresidential real property, beginning when they place the newly constructed building or expansion in service. Rev. Rul. 2002-9 also holds that impact fees are includible in the eligible basis of a qualified low-income building. This will presumably increase the tax credits available for investors and may increase the attractiveness of certain projects.

The ruling is a sensible resolution for treating impact fees, which can be substantial real estate project expenditures. The Service's assurance is welcome relief to real estate developers and tax advisers. Taxpayers who have treated impact fees conservatively should file for an automatic accounting-method change under Rev. Proc. 2002-9.

From Leo Parmegiani, CPA, PKF, New York, NY