1. LIHTC Accounting Overview
Affordable Housing:
LIHTC Accounting Overview
July 30, 2014

2. Tax Credits 101 TOPIC Welcome and Overview Project Proforma
Roles, Motivations and Responsibilities of Developer and Investor
10% Test
50% Test
Cost Certification
Life Cycle of Credit Deal: Compliance, Asset Management, Disposition

3. Low Income Housing Tax Credits
10/1/2012
Overview of
Low Income Housing Tax Credits

4. What is a Low-Income Housing Tax Credit?
10/1/2012
What is a Low-Income Housing Tax Credit?
Authorized under Section 42 of the Internal Revenue Code
Designed to help fund low-income housing
Investors purchase tax credits from developers of low-income housing. The money paid by investors is contributed to the project as equity.

5. Types of LIHTCs 9% Credit
New construction or substantial rehabilitation – awarded through competition
4% Credit
New construction or substantial rehabilitation awarded in conjunction with tax-exempt bonds

6. How Do You Get Tax Credits?
Developer applies to housing credit agency (HCA) for reservation of credits 9% credits are awarded through competition 4% credits are awarded “as of right” in conjunction with tax exempt bonds

7. Role of Housing Credit Agency “HCA”
HCAs are responsible for selecting developments to allocate the Credit, “underwriting” the Credit (sizing it according to financial needs of the project), reporting Credit activity to the IRS, and monitoring for compliance with federal regulations.

8. Qualified Allocation Plan “QAP”
HCA guidelines must be published in annual Qualified Allocation Plans (“QAPs”), which detail selection criteria and compliance monitoring rules. Most HCAs select projects through competitive cycles (at least one per year), with various threshold and scoring criteria.
Selection criteria includes project characteristics, owner characteristics, location, market feasibility, energy efficiency, income targeting, and affordability periods.

9. Tax Exempt Bonds Tax-Exempt Bond Financed Developments
Developments with at least 50% of aggregate basis financed with tax- exempt bonds are eligible.
Credits are awarded “as of right.”
Projects do not compete. Must meet QAP and underwriting criteria.
Applicable Tax Credit Percentage is published monthly by U.S.Treasury, and is a “floating” rate at or below 4%.
August 2014 applicable tax credit percentage is 3.25%
Frequently used to finance acquisition and rehabilitation of existing properties (e.g., “Preservation” deals).
Project size usually 100 units or more

10. Low Income Use Restriction
Minimum Requirement: rent and income restrictions must remain in place for a 15-year Compliance Period, plus an additional 15-year Extended Use Period. Property owners may elect to “opt-out” of the Extended Use Period with HCA approval under certain circumstances; Qualified Contract. Many QAP’s have longer use restrictions and prohibit opting out early.

11. Eligible Basis
Eligible basis = adjusted basis of building at end of 1st year of credit period Includes common areas 30% boost in QCTs or DDAs Projects located in HUD-designated Qualified Census Tracts or difficult to develop areas receive a 30% increase on eligible basis

12. Eligible Basis (cont.) Costs that ARE included:
Engineering & architecture
Tenant relocation
Survey
Accounting & legal
Appraisal
Environmental
Construction costs
Depreciable land improvement
Market study
Developer fee
Impact fees/permits
Construction period interest, loan fees, insurance, real estate taxes
Inspections

13. Eligible Basis (cont.) Costs that ARE NOT included: Land
Permanent loan fees
Marketing and lease-up costs
Tax credit fees
Reserves
Syndication fees
Commercial or income-producing space

14. Community Service Facilities
Generally, costs included in basis are limited to space used exclusively for low-income tenants.
In qualified census tracts, basis may include costs of providing a community service facility for use primarily by low-income residents of the area. They do not have to be tenants. There are limitations on the percentage of basis that may be eligible for tax credits for community service facilities. Consult your tax credit advisor.

15. Rent Rules
Rent + utility allowance (gross rent) cannot be >30% of household income
Qualifying income based on family size and # of bedrooms
Gross rent does not include Section 8 or other subsidies
Rent limits change annually when HUD publishes new Area Median Incomes (AMIs)

16. Income Limits
Minimum set aside: certain % of units restricted for % of AMI
20/50: 20% of units at 50% of AMI
40/60: 40% of units at 60% of AMI
NYC only: 25/60: 25% of units at 60% of AMI

17. Recapture for Non-Compliance
Decrease in qualified basis
Not meeting minimum set-aside
Low-income occupancy decreases
Sale or foreclosure
Eminent domain
Damaged building out of service (e.g. Sandy casualty losses)

18. Role of the Investor
Purchases tax credits and tax benefits Current price is approximately $.90 for $1.00 of tax credits Investors may pay more for credits in areas eligible for CRA credit Investors may pay less for credits in areas deemed higher risk Becomes 99.99% limited partner in project ownership entity

19. Typical Ownership Structure

20. Financial Model

21. Project Summary & Assumptions
Construction start & placed in service dates Occupancy (lease-up) Debt & equity Operating income & expenses Development budget (sources & uses) Tax credit assumptions (4%-9%, 30% basis boost, tax credit pricing)

22. Project Income Unit mix Bedrooms Number of units
Target median income %
LIHTC rent limits
Proposed rents
Cannot exceed LIHTC rent limits
Market study
Vacancy allowance
Tenant paid utilities

23. Project Expenses Administrative
Management fees (% of effective gross income)
Monitoring fees
Annual audit/tax
Utilities
Operating expenses
Realistic per unit cost
Replacement reserves
Typically $250 - $300 per unit per year

24. Operating Pro Forma Income Trend 2% Expense Trend 3% Vacancy Allowance7%
Management Fee 5%
Income
Year 1
Year 2
Year 3
Year 4
Year 5
Gross Project Income
874,800
892,296
910,142
928,345
946,912
(61,236)
(62,461)
(63,710)
(64,984)
(66,284)
Effective Gross Income
813,564
829,835
846,432
863,361
880,628
Expenses
Total Expenses
540,974
556,796
573,085
589,854
607,118
Net Operating Income
272,591
273,039
273,347
273,506
273,510
Debt Service Financing
Private Loan
238,647
Cash Flow
33,944
34,393
34,701
34,860
34,863
Debt Coverage Ratio
1.14
1.15
Cash Flow Financing
HOME
16,972
17,196
17,350
17,430
17,432
Remaining Cash Flow
Def Dev Fee Balance
691,244
674,272
657,076
639,726
622,296
Def Dev Fee Payment
(16,972)
(17,196)
(17,350)
(17,430)
(17,432)
604,864

25. Development Budget - Uses
Acquisition costs
Land
Existing building (rehab)
Construction costs (hard costs)
General requirements
Builder’s profit & overhead
Hard cost contingency
Soft costs
Development related
Financing (construction/perm)

26. Development Budget – Uses (cont.)
Soft costs
Syndication
Tax credit related
Developer fee
Max developer fee limits (state)
Reserves
Operating
Rent-up
Escrows

27. Development Budget - Sources
Construction financing
Construction
Permanent
Debt
Permanent debt
Cash flow financing
Grants
Equity
LIHTC equity
State tax credit equity
Deferred developer fee

28. Tax Credit Equity Eligible Costs QCT/DDA Boost (130%) Eligible Basis
14,405,812
QCT/DDA Boost (130%)
x %
Eligible Basis
Applicable Fraction
Qualified Basis
Applicable Percentage
x %
Annual LIHTC Eligible
1,296,523
10 years x
Total LIHTCs Over Period
12,965,231
Investor Ownership %
x %
Total Investor LIHTCs
12,963,934
Tax Credit Price x
Tax Credit Equity
12,315,738

29. Investor Metrics Investor IRR Schedule of benefits Losses Depreciation
Tax credits
Distributions (cash flow)
Capital contributions
Quarterly compounding
Capital account
Minimum gain

30. The 10% Test

31. Why Conduct a 10% Test?
If a project is not placed in service in the year of credit allocation, the project must apply for a Carryover of the Allocation. This process is specific only to competitive LIHTCs. LIHTCs in conjunction with tax exempt bonds are exempt. The 10% Test is part of the Carryover Allocation Application to demonstrate progress toward project completion. Typically, the HCA requires an Independent Accountant’s Report. The form of report is dictated by the HCA and may vary from state to state.

32. What is a 10% Test?
A 10% Test supports Accumulated Basis* in a project. Accumulated Basis must be at least 10% of the Reasonably Expected Basis* of the project on a specific date. *Accumulated Basis: Total costs incurred to date which represent project’s depreciable basis plus land. *Reasonably Expected Basis: Project’s depreciable basis plus land costs. This amount is generally stipulated by the Owner as part of the Carryover Allocation. * Note: terminology varies by HCA

33. 10% < The 10% Calculationdl
10% <
Accumulated Basis (land + depreciable basis)
Reasonably Expected Basis
(total expected land + depreciable basis)

34. What is involved in a 10% Test?
The Independent Accountant will test, on a sample basis, costs presented by the Owner as Accumulated Basis. Testing could include:
Sampling of invoices or other documentation.
Confirmation of costs incurred with third party vendors.
Recalculation of fees to determine inclusion in accordance with terms.
Relevant project documents will be obtained, reviewed and retained as part of the engagement documentation.
Additional specific procedures required by the HCA, if applicable.

35. 50% Test: Projects Financed with Tax Exempt Bonds

36. Background on Bond Financing
HCAs allocate competitive LIHTCs to projects based on their annual LIHTC volume cap allocation received from the U.S. Treasury. An exception to this rule relates to projects financed with Tax-Exempt Bonds. LIHTCs awarded as of right to projects financed with Tax-Exempt Bonds do not count against the HCAs’ LIHTC volume cap allocation. As of right 4% LIHTCs are non-competitive. Projects must only meet requirements under the State’s QAP and tax exempt bond rules.

37. What is the 50% Test?
The 50% test is calculated by dividing the Bond Proceeds by the Aggregate Basis of the Project. For these purposes:
Bond Proceeds: Include only the amount of bonds used to finance the acquisition, hard construction and soft costs of the project. Generally this will equal the mortgage amount. Bond Proceeds do include interest earned on the bonds or bond reserve funds.
Aggregate Basis: Includes the Project’s depreciable basis and land costs.

38. ____________________
The 50% Test
50% <
Bond Proceeds
____________________
Aggregate Basis
(of building and land)

39. Other Bond Nuances
For a bond financed project to obtain LIHTCs the bonds must be volume cap bonds, a separate application and allocation process from an issuing agency. Tax exempt bond volume cap is allocated annually by the U.S. Treasury to issuing agencies.
The Project must meet the 95/5 Test. This test is often called the “good cost / bad cost” test and is typically performed by an Independent Accountant. For these purposes some examples are:
Good Costs: Building and land, common space, resident recreation and parking facilities related to the rental residential units.
Bad Costs: Commercial space, financing fees, bond issuance costs, some costs incurred prior to bond inducement.

40. Meeting the 50% Test
If the Project meets the 50% Test, the Project may claim 100% of the 4% credits on the total amount of eligible basis.

41. What Happens if a 50% Test Fails?
If the Project does not meet the 50% Test the Project is limited to 4% credits on the amount of eligible basis times the final ratio. This has a severe impact on the available credits!

42. To prevent failing 50% Test
Alternative methods for calculating capitalization of project costs; i.e., construction interest capitalization, 266ii election, etc.. This is typically the first alternative evaluated. Reduction of Aggregate Basis costs via funding at General Partner level through GP guarantees of maximum project costs for construction. Obtain an additional allocation of volume cap bonds to increase the numerator in the calculation. These bonds would be used to pay qualified costs and typically repaid with permanent sources such as equity or other debt. Reduction of developer fee until the 50% ratio is met -- typically the last resort!

43. Reporting for 50% Tests
50% Tests are reported in different ways depending on the HCA. Reports are generally required to be prepared by an Independent Accountant. Two options are typical:
Report as part of the final 8609 cost certification: In this option there is a separate provision in the HCA’s reporting format which includes a calculation and report on the 50% status.
Report in a separate letter: In this option there is a separate report stipulated by the HCA which specifically addresses the 50% test.

44. The Independent Accountant’s Report
Report typically in form of an Agreed Upon Procedures (AUP) report performed by an Independent Accountant Specific procedures required by the HCA are reported upon by the Independent Accountant

45. 8609 Cost Certification

46. What is a Cost Certification?
CPA’s audit of project costs. Required by HCA’s to certify eligibility for LIHTCs.
Each HCA has specific information required to be included. Typically required: schedules of total and eligible costs by project and building, calculation of credits, sources and uses of funds, gap analysis and project proformas.
Upon final issuance of the cost certification, as a part of the final application package, which usually includes additional materials, forms 8609 will be issued to the owner.

47. New Construction vs. Acquisition Rehab
New Construction: Involves construction of a project “from the ground up.” In these circumstances, there was either vacant land with no existing building, or all existing structures were demolished and a new structure constructed.
Acquisition / Rehabilitation: Involves acquiring an existing project and rehabilitating the structure. This can involve rehabilitation around tenants, tenants do not vacate units, or vacate units on a daily basis; or units can be taken out of service, tenants are relocated during rehabilitation.
The nature of the construction/rehabilitation has direct effects on the ability to capitalize costs as eligible as well as the method for determining credit rates.

48. Acquisition Rehab – Additional Considerations
Minimum Rehab Test: Rehabilitation of the Project must meet minimum requirements: $6,200 per unit or 20% of adjusted acquisition basis, or whatever is stipulated in the relevant QAP
Purchase from an unrelated party: Acquisition of the Project must be from an unrelated party for tax purposes.
10 Year Rule: The project must not have been placed in service within 10 years previous to acquisition (certain exceptions apply).

49. Eligible Costs (Refresher)
Costs that ARE included (wholly eligible):
Engineering & architecture
Depreciable land improvement
Survey
Tenant relocation
Appraisal
Inspections
Market study
Impact fees/permits

50. Acquisition Analysis
New Construction: Generally limited to ineligible land costs
Acquisition/Rehab: Must create or obtain a purchase price analysis to establish basis in acquired assets:
In most cases an independent appraisal is used to support allocation of acquisition cost to land and building (potentially furniture & fixtures and existing leases, etc.)
In complex transactions involving commercial space, long term tenants, or related parties, a 3rd party specialist may need to perform a purchase price allocation
Basis related to acquired building is eligible for 4% acquisition credits.

51. Construction Costs
Construction costs related to residential rental units, common space, tenant amenities (non-commercial) and depreciable land improvements are eligible.
Construction costs related to demolition (non-rehab), commercial space, permanent land improvements are not eligible.
Contractor fees for overhead, general requirements and profit are limited – subject to specific limits prescribed by the HCAs. See QAP for year of allocation.
Related party contractors require additional documentation for testing purposes to support costs (job costs, etc.).

52. Developer Fees
Developer Fees are eligible to the extent of underlying developer activity, which can be determined via review of the developer agreement and direct inquiry. Developer Fee may be allocated to:
Acquisition / Rehab and Commercial / Residential
Development and construction related services: eligible
Financing related activity (acquisition of debt/equity): partially eligible (equity related = ineligible)
Developer fees are also subject to specific limits prescribed by the HCA.

53. Legal Fees
Similar to Developer Fees, legal fees are eligible to be capitalized based on the underlying characteristics for which they were rendered.
Fees are treated similarly to those underlying costs. For example, if related to organizational/partnership or syndication costs, legal fees are 100% ineligible. Financing fees are amortized over the life of the related financing instrument.

54. Monthly Capitalization (for periodic costs)
The amount of a specific cost to be capitalized for a specific month; i.e., eligible, can be determined by the proration of the project which is out of service.
New Construction: This scenario is straight forward, at inception, 100% of units are out of service, decreasing to 0% as the Project is completed.
Rehabilitation: Capitalization is determined by units out of service at the beginning of each month. Factors such as whether the project has in place tenants at acquisition, rehabs around tenants, etc. all factor in to capitalization determination
Note: “out of service” indicates that the unit is NOT ready and available for its intended use

55. Monthly Capitalization – New Construction Example
Example: Uniform units.

56. Monthly Capitalization – Rehabilitation Example
Example: Uniform units with existing tenants in place, units taken offline.

57. Monthly Capitalization – Rehabilitation (cont.)
Project is vacant at acquisition: monthly capitalization will work like New Construction.
Rehab around tenants: monthly periodic costs will not be eligible.

58. Periodic Costs
Costs which attach to specific periods of time such as insurance, real estate taxes, etc. These costs are allocated across the relevant period and are eligible in the percentage that the related month is out of service – see monthly capitalization.
Construction loan costs and costs of issuance including title & recording on loans are periodic costs. This is an often confused concept.

59. Interest Capitalization
Interest is also a periodic cost, but varies from the previous costs in that capitalization is typically done on a quarterly basis on the first day of each quarter.
Monthly capitalization is an option for acquisition rehab projects with a irregular pattern for quarterly capitalization.
Interest capitalization can be a complex calculation.

60. Interest Cap Example – Traditional Financing

61. Interest Cap Example – Tax-Exempt Bond Financing
* Note = 266ii election can be made to capitalize investment interest expense rather than deducting the amounts. This results in no offset to any income earned on bond reserves, which will be recognized as revenue.

62. Avoided Interest
Avoided interest relates to the cost of interest which has been avoided through the use of equity for financing the Project.
Avoided interest is calculated on non-traced debt as the weighted average interest rate for the period.

63. Determining the Applicable Percentage – New Construction

64. Determining the Applicable Percentage - Acquisition

65. Determining the Applicable Percentage - Rehabilitation

66. Definitions
“30% Boost”: Properties located in a federally-designated Qualified Census Tract, or Difficult Development Area, are eligible for 30% increase in eligible basis in calculating the credit for new construction and rehabilitation costs (acquisition portion not eligible). Aggregate Basis: Land + depreciable basis; relevant for calculating tax exempt bond 50% test. Annual Credit Amount: Product of Qualified Basis and Applicable Credit Percentage Fraction.

67. Definitions (cont.)
Applicable Fraction: The lesser of the unit fraction or floor space fraction. Must meet for each BIN in project. Applicable Tax Credit Percentage: Rate published monthly by Treasury to determine credit amount based on Qualified Basis. Fixed at 9% for most new construction and rehabilitation expenses for projects receiving allocations until December 31, Floating rate at or below 4% for acquisition and construction/rehab costs financed with tax-exempt bonds.

68. Definitions (cont.)
Eligible Basis: Development costs related to acquisition, rehabilitation, or construction of a new building that are depreciable to that building.
Floor Space Fraction: S. F. low income units
S.F. total units
Qualified Basis: Product of Eligible Basis and Applicable Fraction.
Unit fraction: low income units
total units

69. QUESTIONS?

70. Presenter
Marshall Phillips Principal CohnReznick, LLP 525 North Tryon Street, Suite 1000 Charlotte, NC

71. Presenters
Nic Mathias, CPA Garrick Gibson, CPA Senior Manager Senior Manager 525 N. Tryon Street, Suite Congress Avenue, Suite 200 Charlotte, NC Austin, TX