In re Tax Exempt Application of CLASS Homes I

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No. 101,658

IN THE COURT OF APPEALS OF THE STATE OF KANSAS

IN THE MATTER OF THE APPLICATION OF CLASS HOMES I, L.L.C.
FOR EXEMPTION FROM AD VALOREM TAXATION IN LABETTE COUNTY, KANSAS,

IN THE MATTER OF THE APPLICATION OF CLASS HOMES I, L.L.C.
FOR EXEMPTION FROM AD VALOREM TAXATION IN CRAWFORD COUNTY, KANSAS,

and

IN THE MATTER OF THE APPLICATION OF CLASS HOMES I, L.L.C.
FOR EXEMPTION FROM AD VALOREM TAXATION IN CHEROKEE COUNTY, KANSAS.


SYLLABUS BY THE COURT


K.S.A. 2009 Supp. 79-201b Sixth is analyzed and applied.

Appeal from the Court of Tax Appeals. Opinion filed June 25, 2010. Affirmed.

Douglas C. Fincher and R. Patrick Riordan, of Woner, Glenn, Reeder, Girard & Riordan, P.A.,
of Topeka, for appellant.

No appearance by appellees.

Before CAPLINGER, P.J., PIERRON, J., and BRAZIL, S.J.,

PIERRON, J.: CLASS Homes I, L.L.C. (CLASS), petitions for review from an
order of the Court of Tax Appeals (COTA) finding that CLASS does not qualify for a tax
exemption under K.S.A. 2009 Supp. 79-201b Sixth. CLASS sought the exemption for
group housing properties located in Labette, Crawford, and Cherokee counties, and
COTA found that because CLASS received low income housing tax credits, which were
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allocated to its majority owner, the exemption did not apply as the properties were not
used exclusively for the purpose of group housing of mentally ill or retarded and other
handicapped persons.

CLASS is a Kansas limited liability company with three members: (1) managing
member CLASS LTD, a not-for-profit Kansas corporation with a .01% interest in
CLASS; (2) investor member Kansas Equity Fund IV, L.P. (KEF), which has a 99.99%
interest in CLASS; and (3) special member Midwest Housing Assistance Corporation.
The CLASS operating agreement states that its purpose is to acquire, finance, construct,
own, maintain, improve, operate, and lease housing units consistent with Section 42 of
the Internal Revenue Code for the benefit of low income, developmentally disabled
individuals and in a manner that addresses their unique needs.

CLASS's housing units are four-plex apartments. To construct and operate the
apartments, KEF agreed to contribute $1,022,020.35 to CLASS. KEF bought the majority
interest in CLASS in return for allocation of the tax credit benefit because not-for-profit
entities' have no tax liability to offset so their projects under Section 42 cannot use the
corresponding tax credits. CLASS expects to receive $1,087,890 in tax credits in the
years 2007-2017 and intends to allocate this amount to KEF, which, under which
CLASS's operating agreement, is not entitled to any interest on its contribution as long as
the tax credits are properly allocated. If the full $1,087,890 is not allocated, or a recapture
of credits occurs, CLASS has to pay KEF the difference. CLASS expects to operate at a
net-income loss for the years 2007-2017.

Pursuant to the operating agreement, KEF has limited involvement in CLASS
because management and control of CLASS's business, assets, and affairs is vested with
CLASS LTD, which is not obligated to take action to maximize profits for CLASS or its
members. CLASS LTD cannot be removed except upon certain conditions constituting
default or malfeasance. KEF is prohibited from taking any part in the management,
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control, conduct, or operation of CLASS; is not authorized to act on CLASS's behalf; and
cannot bring an action for partition or dissolution of CLASS if it complies with Section
42. When the period of compliance with Section 42 expires, CLASS LTD has a 1-year
right of first refusal to purchase the apartments for the greater of (1) any offer price, (2)
$100, or (3) outstanding secured debt, plus tax liability owed, plus any amount owed to
KEF.

CLASS filed tax-exemption applications with COTA on March 22, May 15, and
May 23, 2007, respectively. In November 7, 2007, COTA held a hearing on the
applications, and on October 24, 2008, it issued an order denying the exemptions.
CLASS filed a motion for reconsideration on November 7, 2008, which COTA denied on
November 25, 2008.

COTA found that CLASS failed to qualify for the exemption under K.S.A. 2009
Supp. 79-201b Sixth, because KEF's involvement meant the properties were not used
exclusively for an exempt purpose. COTA found that KEF was an investor that kept the
property operating in the Section 42 program to maintain its flow of tax credits and that
an investor's use of property must be considered when determining whether it is used
exclusively for tax-exempt purposes. In the present case, COTA found that reaping tax
credits created a simultaneous use of the property as group housing and an investment
tool for KEF.

CLASS filed this timely petition for review.

COTA is considered the paramount taxing authority in Kansas, as it exists to
decide taxation issues. Therefore, its decisions made within its area of expertise are given
great weight and deference. The party challenging a COTA decision has the burden of
proving the decision was erroneous, but if COTA's legal interpretation is erroneous as a
matter of law, the appellate court must take corrective steps. In re Tax Appeal of Western
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Resources, Inc., 281 Kan. 572, 575, 132 P.3d 950 (2006); see also In re Tax Protest of
United Ag Services, 37 Kan. App. 2d 902, 906,159 P.3d 1050, rev. denied 285 Kan. 1174
(2007). Tax-exemption statutes are interpreted strictly in favor of imposing the tax and
against allowing an exemption for one who does not clearly qualify. In re Tax Appeal of
Western Resources, Inc., 281 Kan. 572, 575, 132 P.3d 950 (2006).

The present appeal focuses on whether CLASS's group housing properties were
used exclusively for group housing. COTA ruled that the properties were not used
exclusively for group housing because CLASS's transfer of low-income housing tax
credits to KEF constituted a separate or intervening use as an investment vehicle. CLASS
makes a number of arguments in alleging COTA erred as a matter of law.

In relevant part, K.S.A. 2009 Supp. 79-201b states:

"The following described property, to the extent herein specified, shall be and is
hereby exempt from all property or ad valorem taxes levied under the laws of the state of
Kansas:
. . . .
"Sixth. All real property and tangible personal property actually and regularly
used exclusively for the purpose of group housing of mentally ill or retarded and other
handicapped persons . . . ."

Although the Kansas appellate courts have not addressed the specific investment
arrangement present here, they have addressed the question of exclusivity in Board of
Wyandotte County Comm'rs v. Kansas Ave. Properties, 246 Kan. 161, 170, 786 P.2d
1141 (1990), and in In re Board of Johnson County Comm'rs, 225 Kan. 517, 518, 592
P.2d 875 (1979). In Johnson County Comm'rs, the court found that property owned by a
non-tax-exempt entity then leased for profit to a qualifying tax-exempt entity is not being
used exclusively for tax-exempt purposes and is subject to ad valorem and property taxes.
225 Kan. at 522-23. In Wyandotte County Comm'rs, the court examined the inverse
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situation and found that property owned by a qualifying tax-exempt entity then leased to
a non-tax-exempt entity is also not being used exclusively for tax-exempt purposes and is
subject to ad valorem and property taxes. 246 Kan. at 170, 176.

In both Wyandotte County Comm'rs and Johnson County Comm'rs the court
stressed the importance of interpreting tax-exemption statutes strictly in favor of
imposing the tax and defined "used exclusively" as that which is used only, solely, and
purely for the purposes stated, and without participation in any other use. Wyandotte
County Comm'rs, 246 Kan. at 166; Johnson County Comm'rs, 225 Kan. at 519. Of equal
importance is that both courts stated that taxation is the rule, that exemption is the
exception, and that all doubts are resolved against exemption and in favor of taxation.
Wyandotte County Comm'rs, 246 Kan. at 166; Johnson County Comm'rs, 225 Kan. at
519. In the present case, resolving all doubts in favor of taxation appears fatal to
CLASS's arguments.

CLASS attempts to distinguish Wyandotte County Comm'rs and Johnson County
Comm'rs, suggesting that in both cases, the crucial fact was that the property owner
leased the property in an attempt to make rental income, creating an economic benefit
separate from the exempted use of the property. CLASS suggests the present case is
different because it does not concern a lease but instead a tax credit. COTA recognized
this distinction but found it inconsequential and stated the premise is the same because
KEF reaps a financial investment benefit from the properties and is therefore not entitled
to the exemption.

CLASS argues there is a distinction between a lease and the financial investment
benefit in the present case because KEF is not the property owner and because COTA's
interpretation means that income received from an exempt use would create a lack of
exclusivity when used to pay employee salaries or mortgage interest. In this sense,
CLASS argues that its relationship is most analogous to that of a lender-borrower.
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CLASS admits that the present case creates a financial arrangement "outside the norm"
for a tax-exempt enterprise but asserts that KEF is in the same position as a lender.

There are a number of problems with CLASS's analogy. First, as explained by
COTA, CLASS has to pay KEF $1,087,890 in full either through allocation of the tax
credits or otherwise, and KEF possesses ultimate control over the properties because it
has a 99.99% interest in CLASS. Unlike a lender-borrower scenario, and contrary to
CLASS's assertions, KEF's contractual interest means it is essentially an owner. CLASS
attempts to undercut this distinction by pointing out that KEF must abide by certain
contractual restrictions and that it is not the operator of the property. In fact, COTA did
find that KEF was not the operator, but CLASS did not argue, nor did COTA find, that
KEF was not the owner. Although in practice under the CLASS operating agreement,
KEF's rights are limited, its majority interest in CLASS is distinguishable from a lender's,
in that a lender is merely owed an obligation.

KEF is also distinguishable from employees of a not-for-profit enterprise, as
employees are paid in return for personal services rendered to the enterprise, whereas
KEF is a majority owner with a direct financial stake. There is no evidence or argument
that the tax exemption provisions of K.S.A. 2009 Supp. 79-201b Sixth were intended to
function as an investment vehicle for entities with an ownership interest.

This point is reinforced by In re Tax Appeal of Univ. of Kan. School of Medicine,
266 Kan. 737, 766-67, 973 P.2d 176 (1999), in which the court analyzed K.S.A. 2009
Supp. 79-201 Ninth, a provision similar to K.S.A. 2009 Supp. 79-201b Sixth concerning
tax exemptions for community service organizations providing humanitarian services. In
finding that a lease of property between two tax-exempt organizations did not necessarily
preclude exemption as in Wyandotte County Comm'rs, the court stated that pursuant to
the language of K.S.A. 2009 Supp. 79-201 Ninth, no part of the income generated by the
lease could inure to the benefit of any private shareholder or individual. 266 Kan. at 766-
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67. In the present case, KEF is not a tax-exempt organization and it is a private
shareholder-owner that would derive income generated by the tax-exemption credits
CLASS expects to accrue through its operations. Therefore, even if we analogize KEF's
position to that of a lessor, its ownership interest and contractual financial benefit create a
position that is anathema to exemption under K.S.A. 2009 Supp. 79-201b Sixth.

CLASS fails to satisfy its burden to show it clearly qualifies for an exemption.
Although this particular contractual relationship between an otherwise tax-exempt
operator (CLASS) and a for-profit shareholder-owner (KEF) is not discussed in K.S.A.
2009 Supp. 79-201b Sixth or Kansas case law, the resolution of doubt against exemption,
coupled with the standards set forth in Wyandotte County Comm'rs, Univ. of Kan. School
of Medicine, and Johnson County Comm'rs, suggest that CLASS does not qualify for the
exemption under K.S.A. 2009 Supp. 79-201b Sixth, given its current arrangement with
KEF, and that COTA did not err as a matter of law.

Affirmed.