Presentation on theme: "DEFERRED DEVELOPMENT FEES"— Presentation transcript:
1 DEFERRED DEVELOPMENT FEES LEARN THE BASICS: HOUSING TAX CREDITS 101Critical Tax Issues in Today’s Tax Credit TransactionsThe Institute for Professional and Executive Development, Inc.David KavanaughNixon Peabody LLP100 Summer StreetBoston, MATel.: (617)
2 DEVELOPMENT FEES A fee to the developer for developing the property Not a contractor’s fee
3 DEVELOPMENT FEESAmount of fee often restricted by state qualified allocation plansDevelopment Services spelled out in a Development Agreement between the property owner and the developerEligible Basis concernsTiming of payment (benchmarks)
4 DEFERRED DEVELOPMENT FEES When Uses exceed Sources on the Source and Use of Funds, some or all of the Development Fee is deferred for later paymentGenerally, the Developer is a cash basis taxpayer, so it takes the Development Fee into income as it is paid
5 DEFERRED DEVELOPMENT FEES The Development Fee is generally included in Eligible Basis even if its payment is deferredThere must be an obligation to pay the Deferred Development Fee at some reasonable point
6 DEFERRED DEVELOPMENT FEES The financial projection demonstrates that the Deferred Development Fee will be paidThe Deferred Development Fee can bear interest
7 DEFERRED DEVELOPMENT FEES Tax ramifications of having to fund the pay off of a Deferred Development Fee at its outside payment dateGenerally, the General Partner (an affiliate of the Developer) would contribute capital to the Partnership, the proceeds of which would be applied by the Partnership to pay to the Developer the unpaid balance of the Deferred Development FeeA paper transaction, but taxable income is generated
8 POST CLOSING DEFERRED DEVELOPMENT FEE ISSUES Reallocation of Losses and CreditsA. When capital accounts hit zero Deferred Development Fees can cause a reallocation of losses and creditsRenegotiation of Deferred Development FeesA. Actual Cancellation of Debt IncomeB. Deemed Cancellation of Debt Income
9 DEFERRED DEVELOPMENT FEES AND REALLOCATION OF LOSSES AND CREDITS Once the Capital Account of Limited Partner hits zero, losses and credits are allocated based on the lowest priority debt, which is usually the Deferred Development FeeIf 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
10 DEFERRED DEVELOPMENT FEES AND REALLOCATION OF LOSSES AND CREDITS SolutionsRefinancing the Development Fee obligation with third party non-recourse debt will fix problemIf Developer owns the General Partner, it can transfer 21% of interest to a third party. In doing this, the Developer is no longer related to the General Partner for the purposes of this testIf Development Fee obligation is non-recourse, the Developer can transfer the Development Fee Note to unrelated person
11 RENEGOTIATION OF DEFERRED DEVELOPMENT FEES AND CANCELLATION OF DEBT INCOME If payment of fee is forgiven, there will be a cancellation of debt income (CODI).If terms of the Development Fee are changed, it can cause CODI.
12 FORGIVENESS OF DEFERRED DEVELOPMENT FEES AND CANCELLATION OF DEBT INCOME If the debt is forgiven there will be cancellation of debt income equal to the unpaid balance of fee plus any accrued interest.Investors do not want income. They want losses and credits.
13 RESTRUCTURING OF DEVELOPMENT FEES CAN CAUSE CANCELLATION OF DEBT INCOME Restructuring the terms of a Development Fee can cause CODI if it impacts the Interest Rate, Maturity Date, Collateral, or GuaranteeThis can get complicated, but in general if the amount of the Deferred Development Fee on a present value basis is reduced in a restructuring, tax advice should be sought
14 RENEGOTIATING A DEVELOPMENT FEE AND ELIGIBLE BASIS 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.If the situation that resulted in the restructuring of the fee existed in the first year of the credit period, then it is possible that the restructuring would call into question whether the fee was reasonably likely to be paid from the onset.