1 CRITICAL TAX ISSUES IN TODAYS HOUSING TAX CREDIT TRANSACTIONS: DEFERRED DEVELOPMENT FEES San Francisco, California July 24-25, 2008 Molly R. Bryson

2 DEVELOPMENT FEES A fee to the Developer for developing and constructing/rehabilitating the property Fee earned for services rendered in connection with construction/rehabilitation – Earned in full by construction/rehabilitation completion – May be paid after completion Development services described in a Development Agreement between the property owner and the Developer Typically included in the propertys eligible basis (ie. Development Fee will generate tax credits) Development Fee often paid to an affiliate of the general partner/sponsor

3 DETERMINING THE APPROPRIATE DEVELOPMENT FEE FOR A PROPERTY Total Development Fee must be reasonable for services being performed Amount of fee often restricted by state qualified allocation plans Development Fee is included in eligible basis to the extent the fee is earned in connection with tax credit eligible activities – Eligible activities include construction/rehabilitation activities (reviewing plans, applying for building permits, monitoring construction) – Ineligible activities include lease-up/marketing activities, obtaining permanent financing, acquiring land and obtaining tax credits Investor/IRS scrutiny

4 HOW IS A DEVELOPMENT FEE PAID? From development sources (ie. equity and loan proceeds) – Timing of payment (benchmarks) – Lenders/investors will closely monitor any portion paid prior to completion/stabilization From operations (cash flow available after payment of expenses) – When development cost uses exceed development sources, some or all of the Development Fee is deferred for later payment – Final amount of any Deferred Development Fee is subject to scrutiny Generally, the Developer is a cash basis taxpayer, so it takes the Development Fee into income as it is paid

5 WILL A DEFERRED DEVELOPMENT FEE REDUCE ELIGIBLE BASIS? The entire Development Fee is generally included in eligible basis even if its payment is deferred The Deferred Development Fee can bear interest There must be an unconditional obligation to pay the Deferred Development Fee at some reasonable point The financial projections should demonstrate that the Deferred Development Fee will be paid 50% Bond Test caution

6 TREATMENT OF UNPAID DEVELOPMENT FEE ON ITS REQUIRED PAYMENT DATE Investors will require that any Deferred Development Fee be unconditionally due and payable at some specified date Maturity date varies with facts/circumstances (usually years) Typical payment method: the general partner (typically an affiliate of the Developer) contributes capital to the Partnership and the Partnership applies the funds to pay the unpaid balance of the Deferred Development Fee A paper transaction, but it generates taxable income to the Developer and is treated as a capital contribution by the general partner

7 DEFERRED DEVELOPMENT FEE MAY CAUSE A REALLOCATION OF LOSSES/CREDITS Once the capital account of the limited partner hits zero, losses and credits are allocated based on the lowest priority debt, which is usually the Deferred Development Fee If the Development Fee obligation is recourse or the Developer is related to a general partner (80% test) losses and credits attributable to it will have to be allocated to the general partner

8 STRUCTURING DEFERRED DEVELOPMENT FEES TO AVOID REALLOCATION OF LOSSES/CREDITS Refinance the Development Fee obligation with third party non- recourse debt If the Developer and the general partner are affiliates, the general partner can transfer 21% of its interest to a third party. In doing so, the Developer is no longer related to the general partner for purposes of this test If the Development Fee obligation is non-recourse, the Developer can assign the right to receive any unpaid Development Fee to an unrelated person

9 RESTRUCTURING DEFERRED DEVELOPMENT FEES PRIOR TO PAYMENT If the Development Fee was reasonably likely to be paid at the end of the first year of the credit period, a renegotiation of the fee in a later year should not impact eligible basis Restructuring the terms of a Deferred Development Fee may cause cancellation of indebtedness income if it impacts the interest rate, maturity date, collateral, or guarantee