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Special Issues for Projects Involving Nonprofits
IPED Housing Tax Credits “101”October 16-17, 2008
Molly R. Bryson
Thomas A. Giblin
2
Examples of Nonprofit Participation in Tax Credit Projects
• General partner, or co-general partner with a for-profit
• Developer or property management agent
• Lender
• Social service provider
• Lessor under ground lease (or managing general partner) to qualify for property tax exemption/abatement
• Holder of right of first refusal under § 42(i)(7)
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Obtaining and Maintaining 501(c)(3) Status: Background
• Difference between nonprofit under state law and federal law
• Tension between:• the tax credit program, which encourages nonprofit involvement and
joint ventures with for-profit organizations; and
• the IRS concern that nonprofits would be taken advantage of
• Serving charitable purpose vs. benefiting a for-profit• long history of what the IRS and courts will not allow
• obtaining 501(c)(3) status has been challenging and time-consuming
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Obtaining and Maintaining 501(c)(3) Status: IRS Memo Dated 4/25/06
• IRS memo outlines many factors, but failure of one is not fatal
• Limit the amount and length of the operating guarantee (6 months of expenses; 5 years from break-even)
• Use a fixed price construction contract
• Treat the payment on a tax credit guarantee as a capital contribution or loan (rather than outside the partnership)
• Limit the amount of tax credit guarantee (to extent of fees)
• Limit the repurchase price to 100% of capital contributions
• Remove only for cause after a reasonable cure period
• Hold a right of first refusal to purchase the project
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Federal Grants
• Often awarded to exempt organizations
• Reduce eligible basis
• Result in taxable income to the partnership receiving the grant
• Instead, structure grant award to exempt organization followed by a loan to the partnership
– partner non-recourse debt: potential issue if investor’s capital account goes negative
– 79/21 solution (use of a second unrelated exempt organization as minority stockholder of the general partner)
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Tax-Exempt Use Property
• 40-year depreciation of residential real estate (may be ok)
• Qualified allocation (0.01% interest in all tax items, including cash flow and sale/refinance proceeds)– be alert to incentive fees
• For-profit subsidiary of the nonprofit serves as general partner and makes a Section 168(h)(6) election, which results in taxable income to the subsidiary but 27½-year depreciation– election made on tax return
– also attached to exempt parent’s tax return
– must state it is a 168(h)(6) election
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Nonprofit Set-Aside
• Each state tax credit agency must set aside at least 10% of its annual credit ceiling each year for projects involving qualified nonprofit organizations
• Many states provide preferences for nonprofit sponsored projects by assigning “points” to projects with nonprofit involvement
• Whenever there is nonprofit involvement, need to determine whether the tax credit agency actually awarded credits from the nonprofit set-aside
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Nonprofit Set-Aside (cont’d)
• Nonprofit organization must be exempt from federal income tax under Section 501(c)(3) or 501(c)(4) of the IRC
• One of the organization’s exempt purposes must include the fostering of low-income housing
• Nonprofit cannot be “affiliated with or controlled by” a for-profit organization
• Nonprofit must own an interest in the project (directly or indirectly)
• Nonprofit must materially participate in the development and operation of the project throughout the compliance period
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Right of First Refusal Under IRC Section 42(i)(7)
• Added to IRC Section 42 in 1990 to facilitate nonprofit ownership of tax credit properties at the end of the 15-year compliance period
• Eligible holders and minimum purchase price are specifically set forth in IRC Section 42(i)(7)
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Eligible Holders of a Right of First RefusalUnder IRC Section 42(i)(7)
• Tenants of the project (in cooperative form or otherwise)
• Resident management corporation of such building
• Qualified nonprofit organization
• Government agency
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Determining Minimum Purchase Price Under IRC Section 42(i)(7)
• Minimum purchase price is equal to the sum of:
1) the principal amount of the outstanding indebtedness secured by the buildings (other than indebtedness incurred during previous 5 years), plus
2) all Federal, state and local taxes attributable to such sale
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Right of First Refusal: General Observations
• A right of first refusal is not an option. Needs to be triggered by a bona fide third party offer
• A right of first refusal can be granted at any time during a project’s lifecycle
• Parties may come together in year 15 to negotiate fair price
• Congress expected minimum purchase price to be favorable to nonprofits
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Business Considerations When Granting a Right of First Refusal
• The statutory purchase price is a minimum price. • Statutory purchase price does not include:
– accrued but unpaid fees to limited partners
– unpaid limited partner loans
– unpaid tax credit adjusters
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Business Considerations When Granting a Right of First Refusal (cont’d)
• Need to understand how sales proceeds are distributed under the partnership agreement
• Right of first refusal should terminate if an affiliate general partner withdraws or is removed
• Need to determine a specific term for the right of first refusal
• Loan documents should contemplate a sale in year 15
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