Special Issues for Projects Involving Nonprofits IPED Housing Tax Credits 101 March 5-6, 2009 Molly R. Bryson Thomas A. Giblin

2 Overview Roles nonprofits play in tax credit deals Federal tax-exempt status of nonprofits Federal grants to nonprofits Tax-exempt use property issues Nonprofit Set-Aside Right of First Refusal

3 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)

4 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

5 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

6 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 investors capital account goes negative –79/21 solution (use of a second unrelated exempt organization as minority stockholder of the general partner)

7 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) electio n, which results in taxable income to the subsidiary but 27½-year depreciation –election made on tax return –also attached to exempt parents tax return –must state it is a 168(h)(6) election

8 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

9 Nonprofit Set-Aside (contd) Nonprofit organization must be exempt from federal income tax under Section 501(c)(3) or 501(c)(4) of the IRC One of the organizations 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

10 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)

11 Eligible Holders of a Right of First Refusal Under 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

12 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

13 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 projects lifecycle Parties may come together in year 15 to negotiate fair price Congress expected minimum purchase price to be favorable to nonprofits

14 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

15 Business Considerations When Granting a Right of First Refusal (contd) 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