Presentation on theme: "By: Dauby O’Connor & Zaleski, LLC Nancy M. Morton Jessica Cooper Corrie McConnell."— Presentation transcript:
By: Dauby O’Connor & Zaleski, LLC Nancy M. Morton Jessica Cooper Corrie McConnell
Agreements to consider Right of first refusal Conversion to market Issues related to deferred development fee Refinance options Discharge of indebtedness Exit strategies Exit taxes Conclusion
What to consider: Agreements affecting year 15 Right of first refusal Evaluate the state of the project Extended use provisions and qualified contract Conversion to market units Re-financing options
LIHTC should know the exact terms of the agreements and whether a right of first refusal agreements is in place. Are they any buy-sell agreements Provisions in the partnership agreements, lender agreements, or regulatory agreements that may contain restrictions and/or requirements on the disposition of the property.
IRC 42(i)(7)(A) provides that a project after the close of the compliance period will not lose its federal tax benefit with respect to any qualified low-income building merely by reason of a right of first refusal held by the tenants or residential management corporation of the building or by a qualified nonprofit organization or government agency that purchases the property for a defined minimum price.
IRC 42(i)(7)(B) defines a minimum price as the sum of the principal amount of the outstanding indebtedness secured by building, other than any indebtedness incurred within the five-year period ending on the date of the sale to the tenants, plus all federal, state, and local taxes attributable to the sale.
Financial health of project/Fair value of owners’ interest Physical condition of property Market conditions Current fair market value of property Realistic cash flow of property Review the regulatory agreements Future restrictions on operations and/or refinance Extended compliance period based upon state and local requirements
Section 42(h)(6) requires the owner of an LIHTC project, receiving an allocation after 1989, to maintain the percentage of low income tenants for at least 15 years after the close of the LIHTC compliance period. The LIHTC compliance period is defined in IRC 42(i)(1) as the period of 15 taxable years beginning with the first taxable year of the credit period.
Only compliance violations occurring in the compliance period will elicit the tax credit recapture provisions. There are several different potential penalties for owners failing to meet the additional affordability requirements including: A lawsuit by the tenants Legal action by the housing credit agencies for breach of contract Refusal by HFA to allocate tax credits or other local, state or federal resources to future development by the owner Refusal by potential project buyers to take on a property that is out of compliance.
The extended low-income housing contract is an agreement between the taxpayer and the housing credit agency. Typically, the agreement has the following provisions: Requires the taxpayer to maintain the percentage of low-income tenants for at least 15 years after the close of the compliance period. The portion of the building used for low-income tenants each year in the extended use period will not be less than the applicable fraction specified during the compliance period.
The agreement is binding on all successors of the taxpayer. The agreement must be recorded as a restrictive covenant with respect to the building under applicable state law. The agreement must prohibit evictions without good cause and rent increases not otherwise permitted in the agreement- LIHTC rents.
No LIHTCs are allowed with respect to any building for the taxable year unless an extended low-income housing commitment is in effect at the end of such year.
The IRC states that the extended use period for any building shall be terminated under the following provisions: On the date that the building is acquired by foreclosure. The IRS may reject this exception if it is determined that the foreclosure is an arrangement set forth by the taxpayer with the sole purpose of terminating the extended use period. If the housing agency is unable to present a buyer under a qualified contract arrangement.
Under IRS 42(h)(6)(F), an LIHTC project could become a market-rate project upon the owner’s written request and within one-year period beginning on the date after the 14 th year of the compliance period if the housing credit agency is unable to find a qualified contract for the acquisition of the low-income portion of the building. The qualified contract price for the low-income portion of the building may not be less than the applicable fraction of the sum of the outstanding indebtedness secured by the building, the adjusted investor equity in the building, and other capital contributions not already reflected, reduced by cash distributions from the project. It is important to verify with the partnership to determine if more stringent requirements are provided in any agreement or in the laws of the state where the project is located.
This is less likely with a post-1989 transaction due to the extended use provisions. The conversion will depend upon the following: Market factors Amount of affordable housing available The market rent levels Current and future proposed developments Physical condition of the project Properties that have deteriorated significantly in the first 15 years are not likely to be attractive for conversion. Even if the developer elects the 14-year opt-out with the tax credit agency, the project is still subject to a three-year transition period.
Bona Fide Debt: Any debt obligation, including an obligation to pay a deferred developer, must be respected as bona fide debt in order to be included in the basis of the project for credit and depreciation purposes. At a minimum, this means that the obligation must have a definite maturity date and the partnership must be able to establish that it is likely to be paid on or before such date. Under Section 267, depreciation can not be taken on the deferred developer fee until paid under the matching principal. However, Section 267(a)(2) applies only to the matching of income and deductions; therefore it does not preclude the claiming of credits on fees incurred by a partnership but not included in the income of a related cash basis payee.
Care needs to be taken to determine when and how the deferred developer fee is to be paid. The partnership agreement and/or the developer fee agreement may have specific language as to when and how this fee is to be paid including having the general partner make a capital contribution to pay the fee as of a certain date. The payment of the deferred developer fee may also be part of the waterfall provisions in the partnership agreement.
There may be opportunities to refinance with the state or local housing finance agencies as well as the federal agencies. HUD-approved lenders can help facilitate the purchase or refinance of existing multi-family rental housing projects using HUD-insured loans. Apply for additional soft loans and/or grants. Restructuring of the debt.
Exit Strategies, Opportunities, and Obstacles
Discharge of indebtedness is included in gross income under Section 61(a)(12) COD results in ordinary income
1. The discharge occurs in a title 11 case 2. The discharge occurs when the taxpayer is insolvent 3. The indebtedness discharged is qualified farm indebtedness
4. For a taxpayer other than a C corporation, the indebtedness discharged is qualified real property indebtedness 5. The indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013
Tax Attributes are reduced in this order: 1. NOL 2. General Business Credit 3. Minimum Tax Credit 4. Capital Loss Carryovers 5. Basis Reduction – see Section Passive activity loss and credit carryovers 7. Foreign tax credit carryovers
Attributes are deemed reduced on first day of the year after discharge Allows attributes to be used in the year the debt is discharged
Taxpayer may elect to reduce basis first Partnerships – the basis reduction is an adjustment to the basis of the partnership property with respect to that partner only Basis adjustments are recovered in the manner described in Reg. Sec
Three most helpful exclusions for real estate developers… 1. Bankruptcy 2. Insolvency 3. Qualified Real Property Indebtedness In the case of partnerships, Section 108 provisions are applied at the partner level
Section 108(i) – Deferral and ratable inclusion of income arising from business indebtedness discharged by the reacquisition of a debt instrument Created by The American Recovery and Reinvestment Act of 2001 Rev. Proc provides guidance
Permits business taxpayer that reacquires its own debt at a discount during 2009 or 2010 to make an irrevocable election to: Defer the resulting COD Income For 5 years if it occurred in 2009 For 4 years if it occurred in 2010 Spread that income over five years after the deferral period is over Partnerships make the election at the partnership level
Rev. Proc allows a partnership to make a partial election Make election for amounts that are allocable to some partners while not making the election for the COD income allocable to other partners Some partners might want the 108(i) election, while others might benefit from a Sec. 108 exclusion provision
When you make a deferral election for a particular amount of COD income, the income is generally ineligible for the COD income exclusions. Electing to defer will expose the taxpayer to whatever federal income tax regime exists in those years ( )
COD income deferred under Sec. 108(i) is accelerated if the partnership liquidates, sells its assets, ceases operations or goes bankrupt Amounts deferred at the partner level due to partnership elections are accelerated if the partnership interest is sold, exchanged, redeemed or abandoned, or if the partner dies or liquidates.
Significant modification of debt terms can be considered an exchange of the old debt for the new New debt generates debt forgiveness income if the issue price of the new debt is less than the balance of the old debt
Reg explains what a significant modification is Some examples… 1. Any change in a debt instrument that results in a substitution of a new obligor, the deletion or addition of a co-obligor. 2. A change in the yield of a debt instrument if the change exceeds the greater of 25 basis points or 5% of the original yield of the instrument.
3. Change in timing of payment – safe harbor is the lesser of 5 years or 50% of the original term 4. Generally, a change from a debt that is substantially all recourse to one that is substantially nonrecourse 5. Change in security or credit enhancement that results in a change in payment expectations
Exit Strategies, Opportunities, and Obstacles
Exit strategies available for investors and general partners and their tax consequences How a LIHTC partnership can better prepare for year 15
Buy – Sell Agreement Among the Partners Partnership Agreement
Sell the Property Potential Buyers General Partner Related Party Residents Unrelated Third Party
Cash Distribution Waterfall Gain/Loss on sale of property Unrecaptured Sec 1250 Gain (25%) Sec 1245 Depreciation recapture – ordinary income
Sale of Partnership Interest Impact to Selling Partner – Gain/Loss recognition Unrecaptured Sec 1250 Gain Potential Sec 1245 depreciation recapture
Impact to Partnership Potential Sec 708(B) technical termination Restart of depreciation lives Sale to general partner Original partnership remains intact No real estate transaction costs GP owns both the GP and LP partnership interests and continues to service the debt
Charitable Contribution/Bargain Sale of Property or Partnership Interest Partnership donates or sells the property at a reduced price to a charitable organization Investor donates or sells her partnership interest at a reduced price to a charitable organization
IRC Reg Sec 1.170A-(4)(C)(2)(ii) Two step process – part sale/exchange of property; part charitable contribution Charitable contribution is the fair market value of the property donated less the sales price or amount of debt assumed by the not-for-profit organization
Partnership recognizes gain on sale of property Adjusted basis of property sold shall bear the same ratio as the amount realized bears to the fair market value of the property The amount realized (sales price or debt assumed) less adjusted basis equals the amount of gain recognized
Items to consider when re-syndicating: There must be at least $6,000 per unit of rehabilitation costs within a 24-month period as defined in IRS 42(e)(3)(A)(ii). Typically, the project must also meet the 10-year rule, as described in IRC 42(d)(6) to be able to claim acquisition credits. Per IRC 42(d)(2)(B)(ii), a federal assisted building is any building that is substantially assisted, financed or operated under section 8 of the U.S. Housing Act of Under the amended IRC 42(d)(6) by the Housing and Recovery Act of 2008, federal or state assisted buildings are exempt from the 10 year rule.
Re-Syndication May need to be structured to generate acquisition credits or there might not be enough tax credit equity Depends on availability of tax credits Must conform to the Qualified Allocation Plan for the respective state where the project resides
Taxes can be a significant liability for the exiting investor partner Investor partner recognizes taxable income to the extent it has a negative capital account at time of sale Negative capital account is a result of loss allocations and distributions during the life of the partnership in excess of the original investment Tax liabilities include federal, state and even local in some states, and can include franchise or excise tax as well
Non resident withholding tax liabilities are imposed by some states on the income allocated to the exiting partner This can be an unexpected cash outlay for the partnership Minimization strategies Forgiveness of sponsor debt – creates income which increases capital account Reducing the Investor interest in the partnership in years prior to the potential exit year Capitalize rather than expense repairs
Improve overall property performance to reduce losses and therefore increase capital account balances Project can remain affordable with restructuring/withdrawal by the investor Refinancing/debt restructuring lowers debt service and may provide funds to pay the withdrawing investor and fund capital improvements Developer maintains control of the project and continues to receive property management fees
Like-kind exchanges under Section 1031 are not a common exit strategy. Some successful like-kind exchange practices have occurred between affordable housing properties and investment grade credit-tenant lease commercial properties. This type of strategy works better for older projects that have completed the required compliance period and have large negative capital accounts and very low basis.
The end result of this strategy is the investors in the partnership end up owning a credit- tenant property at a more favorable tax position with gain deferral; and the affordable- housing project is recapitalized with new debt, renovated by the new owners, who in turn receive both low-income housing tax credits and depreciation benefits (assuming all requirements are met).
There are multiple obstacles and opportunities to consider when disposing of or retaining a project: Be familiar with all executed agreements including loan documents. Compare estimated disposition plan with the original underwriting projections. Compare all available exit strategies and estimate potential exit taxes including all state and local taxes. It’s never to early to begin planning for year 15 of a LIHTC partnership