Myrtle Manor Apartments v. City of Phoenix

• Decision Date: 18 January 1994
• Docket Number: CA-TX,No. 1,1
• Citation: 868 P.2d 1048,177 Ariz. 465
• Parties: MYRTLE MANOR APARTMENTS, an Arizona limited partnership, and Morningside Villa Apartments, an Arizona limited partnership, Plaintiffs, Counterdefendants-Appellants, Cross Appellees, v. CITY OF PHOENIX, a municipal corporation, Defendant, Counterclaimant-Appellee, Cross Appellant. 91-0040.
• Court: Arizona Court of Appeals

Page 1048

868 P.2d 1048

177 Ariz. 465

MYRTLE MANOR APARTMENTS, an Arizona limited partnership, and Morningside Villa Apartments, an Arizona limited partnership, Plaintiffs, Counterdefendants-Appellants, Cross Appellees, v. CITY OF PHOENIX, a municipal corporation, Defendant, Counterclaimant-Appellee, Cross Appellant.

No. 1 CA-TX 91-0040.

Court of Appeals of Arizona Division 1, Department T.

Jan. 18, 1994.

As Amended Feb. 18, 1994.

[177 Ariz. 466] Newman, Ahern, Chambliss & Banen by Kevin T. Ahern and Copple, Chamberlin & Boehm, P.C. by Scott E. Boehm, Phoenix, for plaintiffs, counterdefendants-appellants, cross appellees.

Roderick G. McDougall, Phoenix City Atty. by James H. Hays, Asst. City Atty., Phoenix, for defendant, counterclaimant-appellee, cross appellant.

OPINION

GARBARINO, Judge.

Taxpayers Myrtle Manor Apartments and Morningside Villa Apartments appeal from a judgment in favor of the City of Phoenix on refund claims for Phoenix privilege taxes assessed on sums the taxpayers received under housing assistance payment (HAP) contracts funded by the United States Department of Housing and Urban Development (HUD). The City cross-appeals from the tax court's holding that the value of the taxpayers' on-site managers' use of apartment units was not includable in the taxpayers' gross income. We consider:

(1) Whether the tax court erred in holding that HUD housing assistance payments to the taxpayers were taxable under Phoenix tax code sections 14-2 or 14-445(a) as "gross income from the business activity ... of leasing ... or renting real property located within the city;"

(2) Whether the tax court erred in concluding that federal law did not preempt application of the city's real property rental income privilege tax to HUD housing assistance payments; and

(3) Whether the tax court erred in holding that the value of services performed by the taxpayers' on-site managers in partial exchange for personal use of apartment units was not taxable as gross income from the business of renting real property.

We have jurisdiction pursuant to A.R.S. section 12-2101(B).

FACTS AND PROCEDURAL HISTORY

The taxpayers borrowed funds from First Interstate Bank to construct multi-family housing complexes, and HUD agreed to insure the loans. To obtain the HUD guarantee, each taxpayer signed a "regulatory agreement for insured multi-family housing projects." The agreements required each taxpayer to enter into a HAP contract under which the taxpayer would rent apartment units to low-income persons in return for HUD subsidy payments on each unit.

The HUD program authorizing these agreements, known as the "General Program of Assisted Housing," is governed by 42 U.S.C. sections 1437 through 1437w. Section 1437 sets forth the federal government's policy of promoting the general welfare of the nation by assisting the states and their political subdivisions in providing safe and sanitary dwellings for low-income families, while vesting local public housing agencies with the maximum amount of responsibility for administering these programs. Section 1437a fixes eligibility criteria for low-income housing and caps the percentage of monthly income a family may be charged as rent.

Section 1437f determines the amount of housing assistance payments due owners of low-income housing. A HAP contract establishes the maximum monthly rent, including utilities and all maintenance and management charges, that the owner is entitled to receive on each dwelling unit for which assistance payments are to be made. 42 U.S.C. 1437f(c)(1). Maximum monthly rents may not exceed by more than ten percent the rental value set by HUD for the relevant market area. Id.

Section 1437f(c)(2) provides in part:

(A) The assistance contract shall provide for adjustment annually or more frequently in the maximum monthly rents for units covered by the contract to reflect changes in fair market rentals established in the housing area for similar types and sizes of dwelling units or, if the [HUD] Secretary determines, on the basis of a reasonable formula.

(B) The contract shall further provide for the Secretary to make additional adjustments in the maximum monthly rent for units under contract to the extent he determines such adjustments are necessary to reflect increases in the actual and necessary expenses of owning and maintaining the units which have resulted from substantial general increases in real property taxes, utility rates, or similar costs which are not adequately compensated for by the adjustment in the maximum monthly rent authorized by subparagraph (A). The Secretary shall make additional adjustments in the maximum monthly rent for units under contract ... to the extent the Secretary determines such adjustments are necessary to reflect increases in the actual and necessary expenses of owning and maintaining the units that have resulted from the expiration of a real property tax exemption.

(Emphasis added.) Section 1437f(c)(3)(A) provides in part: "The amount of the monthly assistance payment with respect to any dwelling unit shall be the difference between the maximum monthly rent which the contract provides that the owner is to receive for the unit and the rent the family is required to pay under section 1437a(a) of this title."

HUD has adopted numerous regulations affecting HAP contracts. 24 C.F.R. §§ 880.101 through 880.613. 24 C.F.R. section 880.501(d)(1) provides that the amount of the housing assistance payment made to the owner of the unit is the difference between the contract rent for the unit and the tenant rent payable by the eligible family. For a vacant unit, the regulation provides that the owner will receive eighty percent of the contract rent for the the first sixty days of the vacancy. § 880.501(d)(2). Any excess over the contract rent collected by the owner from any source must be repaid as HUD directs. Id. For any vacancy exceeding sixty days, the housing assistance payment for the vacant unit is that amount "equal to the principal and interest payments required to amortize that portion of the debt attributable to the vacant unit for up to 12 additional months." § 880.501(d)(3).

Under 24 C.F.R. section 880.609(a), "contract rents" will be adjusted on the anniversary date of the contract upon the owner's request of the contract administrator. In addition, if not adequately compensated for by the annual adjustments, special adjustments may be granted to the extent HUD determines necessary to reflect increases in actual and necessary expenses of owning and maintaining the units as a result of substantial general increases in real property taxes, assessments, utility rates, and utilities not covered by regulated rates. § 880.609(b). Contract rent adjustments may not result in material differences between rents charged for assisted units and those for comparable unassisted units beyond differences that existed when the contract was executed. § 880.609(c).

24 C.F.R. section 880.205 sets the limitations on the distribution of project funds to the owner. The maximum distribution for a project for elderly families is six percent of the owner's equity in the project. § 880.205(b)(1). The maximum for all other projects is ten percent. § 880.205(b)(2).

In 1983, each taxpayer entered into a HAP contract with HUD and its contract administrator, the City of Phoenix, for its respective project. The provisions of each contract were consistent with 42 U.S.C. section 1437f and the HUD regulations. Both projects were managed by Biltmore Properties, Inc. The Biltmore Properties' comptroller testified that between 1984 and 1990, approximately eighty-three percent of Myrtle Manor's income and eighty-seven percent of Morningside Villa's income came from HUD.

Nancy Bills, an employee of Biltmore Properties, testified that some of the residents may qualify to contribute nothing toward the rent, and may thus have a "negative rent" from allowances to which they are entitled. In those cases, HUD pays the entire contract rent on the unit and gives the tenant a check for an additional sum.

Bills further testified that if Biltmore had paid Phoenix privilege taxes on the taxpayers' housing assistance payments as they became due, those taxes would have been "taken into consideration." She stated that the four-year assessment of privilege taxes Biltmore Properties paid on the taxpayers' behalf came out of the operating account, which is usually applied to mortgages, insurance, taxes, operating expenses, and maintenance expenses. She testified that Biltmore Properties has no way to recoup this amount other than through the rent increase process.

Bills also testified that owners receive an annual percentage increase in contract rates based on the particular area in which the projects are situated; here, the Phoenix Standard Metropolitan Statistical Area. This annual adjustment factor is not directly connected to a project's actual expenses, damages or utility increases.

An administrative aide with the City's Neighborhood Improvement and Housing Department testified that neither taxpayer had inquired how they might recoup the sales taxes they paid under protest in this litigation.

Nancy Bills testified that Biltmore Properties employed resident managers for each of the taxpayers' projects. Resident managers, usually a couple, maintain the property, collect the rent, do the necessary paperwork, and keep the peace. They are on call twenty-four hours a day. The owners' policy requires managers to live on site in an employee apartment. When the resident managers' employment is terminated, they must vacate the apartment. The employment agreement for the resident managers of Morningside Villa, who were hired on July 10, 1984, provided in part:

2. Your gross cash wages are $500.00 per month, payable semi-monthly. In addition, you are permitted to occupy employee apartment No. 18, the rental value of which is $629.00 per month (the "Rental Allowance").

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