Tuesday, March 02, 2010

Does A Submetering Tax Break Give Landlords Incentive to Set Low Utility Allowances and Displace Tenants in Federally Subsidized Housing?

In a recent case involving conversion of a HUD subsidized Section 236 housing project from master metering of electricity to submetering, the landlord initially proposed to establish certain utility allowances. These defray increased payment burdens to be imposed upon tenants after implementing submetering of their apartments. At some point in the process, the owner shifted course and implemented a significantly lower schedule of utility allowances than it had initially proposed. The PSC Order in the case states, based on information provided by the owner, there is a mismatch between actual electricity costs and the utility allowances: "the average monthly electric bill . . . was 16.4% higher than the utility allowance."

As a result, tenants must pay the difference and their total payments for rent and utilities may be significantly above 30% of their income. The tenants argued that the 16.4% gap between what they must now pay for electricity and the amount of the utility allowance is understated due to flaws in the method of estimation. The notion that this is motivated by "green" values is belied by the fact that the brutalist high rise building, poorly insulated with one inch of insulation in the exterior walls, is heated at great cost with electric baseboard units lacking any thermostatic controls.

Despite inadequate notice to tenants, potential displacement effects, and failure of the owner to apprise the PSC and the tenants beforehand that it was submetering electric heat, the PSC Order allowed adopted the owner's last-minute proposal and allowed submetering to continue if the owner installs thermostats in the next two years.

Under HUD guidelines for setting rents in federally subsidized housing projects
, owners submit and certify a budget for the future expenses and revenues of the building, and rents are increased by HUD when it is found justified to meet rising costs and balance the project budget.

The actual electric utility bill paid by the landlord (typically to Con Edison in the New York City area) for the master metered service to the entire building, is considered an expense under HUD guidelines for calculating the project budget and determining rents. The bill for the whole building based on the master meter includes service used for the building common areas, lobby, hallways, exterior lighting, HVAC systems outside the apartments, laundry rooms, etc. plus the cost of the portion of electric service that is resold to submetered tenants. Tenants are billed monthly by the landlord (or an outsourced agent) based on the electric usage in their apartments measured by submeters.

But it appears that the actual revenue received by the owner from the submetered tenants to pay their share of the total building electric bill may not be disclosed to and considered by HUD in its rent setting process, and understating the revenue may fatten federal low-income housing tax credits. While it is unclear, it appears that in estimating revenue from all the tenants, the owner can omit actual revenue from the resale of electricity and simply add the utility allowance to the rent, and use that as the projected revenue from tenants. Thus, in situations where the utility allowances are significantly lower than the actual electric service charges paid to the owner by tenants, the difference between the amount actually collected and the utility allowance may not be reported as project revenue for purposes of future rent calculations.

This may give the landlord a very strong incentive to propose a low utility allowance that is much less than the actual amount of charges demanded and collected from tenants for submetered electricity. The actual bill from Con Edison for all the electric service to the whole building is an expense, in the budget, but if revenue from tenants is understated, the result would be that rents will be set higher than if actual revenue from submetered electric service is used in the revenue calculation.

Hypothetically, in a building with a million dollar electric bill for the tenant portion of total usage -- which is not uncommon in former Mitchell - Lama projects now under HUD Section 236 regulation -- a 16.4% gap between the portion of the bill covered by the utility allowance and the amount paid by the tenants is $164,000 per year. Future rents will be set by HUD assuming that electric bill expenses are $1 million (plus the owner's share for common areas) while revenue from submetered tenants for the portion of electric service they use is deemed to be only $836,000 -- even though the owner actually collects $1 million from tenants. Thus future rents may be inflated by $164,000, in the rent setting process.

One might wonder why an owner would place the added economic pressure on low-income tenants.

In a building where the owner has committed to a set percentage of occupancy by low-income tenants, and where the building currently has a percentage of low income tenants greater than the minimum requirement, the added economic pressure from high electric bills not covered by the utility allowances might result in displacement of the poorest tenants, enabling vacant units to be rented to new tenants at much higher market rate rents.

If the owner makes a profit to the extent a higher amount than the utility allowance is collected from the tenants, one might think that would increase the owner's bottom line and taxable income, for federal income tax purposes. However, an IRS rule for the low-income housing tax credit may allow owners not to recognize the income actually received from submetered tenants in subsidized housing. The IRS deems the owner merely to be a conduit for the payments received, which "are treated as paid directly by the tenant [to the utility company], and not by or through the owner of the building." Thus, the revenue received by owners for electric service that is not taken into account when rents are set is also not reportable as income to the owner for federal income tax credit purposes.

Also, it may be that owners can exclude revenue from state tax refunds in the calculation of costs and revenues of housing projects. As we recently pointed out, submetering landlords may be able to receive 8.5% or more in refunds for state and city sales taxes paid by the owner on the master metered bill. The PSC has approved submetering applications which propose to pass these refundable charges on to the tenants in the calculation of the per kilowatt hour rates for the monthly electric bills. As a result, the owner recovers all the cost of the tax paid on the owners Con Edison bill from the tenants, but sales tax refunds or credits may be reaped later, in the owner's quarterly tax reports or separate refund applications, for the benefit of the owner, not the tenants. If such tax refunds are sporadically obtained, it is unclear whether this would affect owner's expense and revenue projections when rents are set by HUD or DHCR. This, combined with a 16.4% gap between electric bills and utility allowances such as recently permitted by the PSC, may create a profit margin for landlords of up to 25% on submetered electric service.

The situation is admittedly less than clear. More information is needed to shed light on these issues and to assess whether the HUD and DHCR utility allowance and rent-setting process, and federal and state tax breaks, are working to enrich submeterers at the expense of low-income tenants. When owners of HUD-regulated projects seek necessary HUD permissions for conversion of master metered projects to submetering, and for rent increases, they are required under HUD regulations to post notices to tenants in high-rise buildings, and HUD requires an opportunity for the tenants to participate in review of the owners' applications.

The treatment of owners' actual revenue from submetering and owners' receipt of tax refunds or credits on utility bills deserves careful scrutiny in such proceedings. See
Town House West Tenants Seek PSC Ruling to Clarify Tax Issues in Setting Rates for Submetered Electric Service, PULP Network, February 19, 2010.

See Power Companies Overcharging Some Co-ops & Condos: How to Stop Them
Habitat Magazine - 02-01-2010, discussing availability of tax refunds to owners of residential buildings who purchase utility service in non-residential service classifications.

No comments: