IPEDAFTER THE CLOSING: Maximizing Value and Avoiding Pitfalls
at Tax Credit Properties
Pre-Conference Workshop:Tax Credit Basics
San Diego, CaliforniaApril 25-27, 2007
James F. Duffy – Nixon Peabody LLPThomas A. Giblin – Nixon Peabody LLP
Brad Elphick – Novogradac & Company LLP
Background
• Tax Reform of 1986
• Section 42 of IRC of 1986– Housing Program in the Tax Code– Statute Amended Several Times, Including in 2000
• Objective to Provide Investor Equity
• Credit is a Dollar-for-Dollar Tax Reduction
Structure
Investor LP$$$
Syndicator GP
InvestmentPartnership LP
Local GP
Developer
OperatingPartnership
Key Business Terms
• Projects Generally Owned by Limited Partnership or Limited Liability Company
• Limited Partner Generally Owns 99.99% of Tax Credits, Losses & Profits
• Limited Partner Pays in Capital Contributions in Multiple Installments (generally 3 or 4), Based on Negotiated Benchmarks
• General Partner Guarantees Completion, Amount of Credits and Funding of Deficits
Calculating Credits/Defining Terms
• “Applicable Percentage” times “Qualified Basis” = Annual Credit Amount
• Annual Credit Amount available for 10 years.
Applicable Percentage
• Two Credits:– 70 Percent Present Value Credit (the “9% Credit”)– 30 Percent Present Value Credit (the “4% Credit”)
• Credit Rates– 8.10% (9% Credit) & 3.47% (4% Credit) – April
2007– Lowest rates in July 2003 – 7.78% and 3.33%
Applicable Percentage (cont’d)
• Owner’s election to set the Applicable Percentage either (i) when receiving a binding commitment from the state to allocate credits (or when tax-exempt bonds issued) (a “lock-in election”) OR (ii) when building placed in service
4% New Construction/Substantial Rehabilitation Credit
• “Federally Subsidized” new construction or rehabilitation expenditures– Building Receives Tax-Exempt Bonds or Below Market
Federal Loan• “Below Market Federal Loan”– Interest Rate below the “applicable federal rate”
(the “AFR “) which is approximately 4.81% in April 2007 (for long-term loans compounded annually)
– Funded from federally appropriated dollars
Exceptions From Federally Subsidized Definition
• HOME Loan if 40% at 50% Targeting (in each building)
• Community Development Block Grant (“CDBG”) Loans
• Affordable Housing Program (“AHP”) Loans
• Loan is Subtracted from “Eligible Basis”
• Section 8
• Native American Housing Assistance and Self-Determination Act of 1996 (“NAHASDA”) of 1996 if 40% at 50% Targeting (in each building)
4% Acquisition Credit
• Existing Buildings/Acquisition Costs
• Purchase from “Unrelated Party”
• Ten-Year Rule
• Waiver of Ten-Year Rule from Treasury Department
4% Acquisition Credit (cont’d)
• Certain Placements in Service Ignored– Carryover Basis– Acquired from Decedent– Placement in Service by Governmental Unit or Non-
Profit Entity– Foreclosure
Substantial Rehabilitation Requirement
• Greater of:– $3,000 per Low-Income Unit, or– 10% of Adjusted Basis
• “Separate New Building”
• Can Receive 4% plus 9% Credits
9% New Construction/Substantial Rehabilitation Credit
• If Not Federally Subsidized
Basis Calculations
• Start with “Eligible Basis”, then “Qualified Basis”
“Eligible Basis”
• New Construction = Adjusted Basis (generally, development cost less land)
• Acquisition = Acquisition Cost
• Substantial Rehabilitation = Capitalized Rehabilitation Expenditures (24-month rule)
• Must Subtract Federal Grants
• 130% Increase in Qualified Census Tracts Census (“QCTs”) and Difficult Development Areas (“DDAs”)
“Qualified Basis”
• “Applicable Fraction” times “Eligible Basis” equals “Qualified Basis”
• “Applicable Fraction” is the Lower of:– Number of Occupied “Low-Income Units” divided by
the Total Number of Units, or– “Floor Space Fraction”
“Low Income Units”
• Threshold of Election of:– 20% of Units at 50% of Area Median Income (“AMI”),
or – 40% of Units at 60% of AMI
• Election Upon Placement in Service
• Must Meet Minimum by End of 1st Credit Year
• HUD Publishes Area Income Figures Annually
“Low Income Units” (cont’d)
• Adjustments for Family Size like Section 8– Family of 4 Qualifies at 60% (50%) AMI– Family of 3 Qualifies at 54% (45%) AMI– Family of 2 Qualifies at 48% (40%) AMI– Single Household Qualifies at 42% (35%) AMI
“Rent Restricted”
• Rent (including utilities) cannot exceed 30% of qualifying income for assumed family size; based on bedrooms per unit
• Occupancy Assumptions:– One Person for Studio– 1.5 Persons per Bedroom
Rent Calculation Example
• Median Income = $60,000
• Two Bedroom Unit
• 3 Person (2BR x 1.5) Income Limit = $32,400
• 30% of Income Limit = $9,720
• Monthly Rent (1/12) = $810
Additional Rent Rules
• Rent Limits Change Annually with Publication of New Area Median Incomes
• Rent Will Not Decrease Below Original Floor• Gross Rent Does Not Include Section 8 (or Similar
Rental Subsidies)• Gross Rent Must Include Utility Allowance for
Tenant-Paid Utilities (i.e., Deduct from Rent to Owner)
Example of Tax Credit Calculation
• 100 Unit Project/70 Low-Income Units
• Total Development Costs (Including Land) = $5.5M
• Land Value = $500K
• Eligible Basis = $5.0M
• Qualified Basis = $3.5M ($5.0M x 70%)
Example Tax Credit Calculation (cont’d)
• Applicable Percentage = 8.10% (Not Federally Subsidized)
• Annual Credit = $283,500 ($3.5M x 8.10%)
• 10 Year Credits = $2,835,000
Equity Calculation
• Pricing Primarily Based on Total Amount of 10 Year Credits Available to Investor and Market Conditions
• Expressed as “Cents Per Tax Credit Dollar”• In Above Example, if Investor Will Pay 90 Cents Per
Tax Credit Dollar, Equity Equals $2,551,245 ($2,835,000 x 99.99% x 0.90)
• Equity generally paid in several installments (often 3 or 4 installments) based upon negotiated benchmarks
Equity Calculation (cont’d)
• If Tax-Exempt Bond Financing “4% Credit”, Equity Equals $1,092,941
• ($5,500,000 - $500,000) x 70% x 3.47% x 10 x 0.90 x 99.99% = $1,092,941
Continued Compliance
• 15-Year “Compliance Period”
• Continued Tenant Qualification:– 40% Increase Above Then-Current Eligibility Level is
OK– Vacant Units/Over-Income Units OK if “Next Available
Unit Rule” Followed
Recapture
• Recapture on Non-Compliance:– “Accelerated Portion” of Credit Recaptured (1/3 of
Credit 1st 10 years, Decreasing Through Year 15)– If Minimum Set-Aside Fails, All Accelerated Credits
Recaptured– Otherwise, Unit-by-Unit (Extent of Decrease in
Qualified Basis)
Recapture (cont’d)
• Recapture on Change of More Than 1/3 in Ownership or Sale of Project
• Bond Posting Procedure
• New Owner Steps into Seller’s Shoes Upon Sale of Project
Extended Use
• Recorded “Extended Low-Income Housing Commitment”
• “Extended Use Period”:– At Least 30 Years, May be Longer to Gain Points
• Termination (with three-year vacancy de-control)– Upon Foreclosure– “Qualified Contract”
“Qualified Contract”
• State to Find Buyer If Requested by Owner After 14th Year Pursuant to “Qualified Contract”– Contract Price = Fair Market Value of Any Market Rate
Portion Plus, for the Low-Income Portion, the Applicable Fraction Times:
• Outstanding Debt Plus• “Adjusted Investor Equity” Plus• Other Capital Contributions, Less• Cash Available for Distribution
Qualified Contract (cont’d)
• “Adjusted Investor Equity” = Initial Investor Equity to Project, to the extent reflected in the adjusted basis of the Project, Inflated by COLA (up to 5% per year)
• If No Buyer Found Within One Year, the Extended Use Period ends, Subject to 3-Year Vacancy Decontrol
Compliance Monitoring
• State Credit Agencies Monitor Projects• Owners’ Recordkeeping Requirements:– Number of Low-Income & Total Units– Income Certifications/Annual Re-Certifications & Backup
Verifications– Qualified Basis & Eligible Basis Amounts– Rent Amounts
• Owner Annual Compliance Certifications
$0.00
$0.20
$0.40
$0.60
$0.80
$1.00
$1.20
$1.40
$1.60
$1.80
$2.00
'00 '01 '02 '03 '04 '05 '06 '07
•Congress Raised Cap in 2000 From $1.25 to $1.50 in 2001, $1.75 in 2002, Then Adjusted for Inflation
•$1.95 Per Person for 2007
•$2,275,000 State Minimum in 2007
STATE ALLOCATION VOLUME LIMIT
Volume Limit Rules
• Example:– State With Three Million Population has $5,850,000 in
Credits in 2007• Amount is for One Year of Credit • 10% Non-Profit Set-Aside• 50% Test: Private Activity Tax-Exempt Bonds
Subject to Bond Volume Cap; Tax Credits Do Not Count Against the State’s Limitation of Aggregate Tax Credits
“Qualified Allocation Plans”
• State Must Adopt QAP to Allocate Credits
• QAP Must Set Forth Allocation Priorities
• QAP Must Give Preference to:– Lowest Incomes– Longest Period of Low-Income Use– QCT Projects Contributing to a Concerted
Revitalization Plan
Additional QAP Rules
• QAP Must Provide Procedure for Notifying IRS of Non-Compliance
• Bond Financed Projects Must “Satisfy” QAP
Project Evaluation
• Credit May Not Exceed Amount State Agency Determines Is Necessary For Feasibility and Viability
• Agency Must Consider:– Sources and Uses– Amounts Expected to Be Generated by Tax Benefits– Reasonableness of Development and Operating Costs
Project Evaluation (cont’d)
• Evaluation Occurs at Application, Allocation and Completion
• Owner Must Certify as to Amount of Subsidies
• For Tax-Exempt Bond Financed Projects, Issuer Must Do Similar Evaluation
• Agency Must Require Market Study Paid by Developer
State Allocation Process
• “Carryover Allocation”– 10% of “Reasonably Expected Basis” Must be
Incurred by 12/31 of Allocation Year or 6 Months After Allocation, if Allocation After 6/30
– Building Must be Placed in Service by 12/31 of 2nd Year After Carryover
– Carryover Basis Includes Costs of Land and Depreciable Property
Carryover Allocation Document
• Must be Issued by State Agency by 12/31 of Allocation Year
• 10 Elements Required in Document
• Agency Must Later Issue Forms 8609 After Buildings Complete
• State May Carry Forward Unused Credits for One Year; Then Goes to National Pool
Who Can Use Credits?
• Individuals Limited Under Passive Loss Rules to Approximately $9,900/Year at the 39.6% rate
• C Corporations Can Use Losses and Credits Against Ordinary Income and Taxes
• Cannot Use Credits Against AMT
• Limitations on “Closely-Held” Corporations
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