Tax Credit Finance Primer Tim Favaro Partner Cannon Heyman & Weiss, LLP tfavaro@chwattys.com
New Markets Tax Credit & Historic Tax Credit 101
New Markets Tax Credit Program: Background Codified in Section 45D of the IRC Enacted in 2000 Administered by CDFI, an arm of the U.S. Department of the Treasury Allocation authority awarded on annual basis
New Markets Tax Credit (NMTC)Program: Lexicon CDE Community Development Entity an entity that provides investments serving low-income communities and persons LIC Low Income Community a census tract with a poverty rate of more than 20% or median family income less than 80% of the applicable area median income QEI Qualified Equity Investment an equity investment in a CDE QLICI Qualified Low Income Community Investment an investment in or loan from a CDE to a qualified borrower QALICB Qualified Active Low Income Community Business a qualified borrower or investee
QALICB Requirements A QALICB is any corporation (including not-for-profit) or partnership engaged in the active conduct of a qualified business that meets five requirements: Must meet all five requirements 1. Gross income 2. Use of tangible property 3. Services 4. Collectibles 5. Non-qualified financial property
QALICB Requirements (continued) Active conduct (three years revenue test) Qualified business generally, any trade or business except: 1. Sin businesses 2. Rental of residential rental property as defined in Section 168(e)(2)(a) of the IRC 3. Rental of real property to tenants that are Sin businesses
NMTC Structure Equal to 39% of QEI - claimed over 7 year compliance period - 5% in years 1 through 3-6% in years 4 through 7 CDEs must use substantially all (at least 85%) of QEIs to make QLICIs which must remain invested for the full seven-year compliance period Amount of NMTC is solely a function of amount of QEI
Leverage Model Leveraging transaction sources that have already been spent Owner equity that has already been spent on pre-development costs can be used to fund the Investment Fund through the use of One Day Loan to Investment Fund Investment Fund combines these proceeds with other leveraged sources and equity to make required QEIs Proceeds from QLICIs are then used to reimburse the developer Developer, or an affiliate then uses those proceeds to purchase the One Day Loan so it is a long term lender to Investment Fund
Respecting the NMTC Structure Use of soft sources as a leveraged loan Grant proceeds and other soft sources often have strings attached Challenges associated with soft sources a) contractual privity issue b) timing of grant equity
Respecting the NMTC Structure continued: Mortgages Leverage lender cannot have a direct mortgage on the property securing its loan to Investment Fund In lieu of a mortgage, leverage loan secured by pledge of Investment Fund s membership interest in the CDE What happens if QLICI loans are in default? Investor request to forebear on enforcement of pledge
Is the Juice Worth the Squeeze? What are the benefits of using NMTC for your real estate project? Benefits are generally equal to Investor Equity minus incremental costs associated with NMTC such as: 1. fees to CDE or CDEs 2. fees to attorneys, accountants and/or consultants for the CDE, Investor and QALICB 3. expenses related to CDE audit and investor asset management Focus on the net benefit to the transaction, typically from $.40 to $.50 per NMTC The greater the QEI, the greater per credit net benefit received from the NMTC (economics of scale)
Is the Juice Worth the Squeeze? Our developer clients often say that the extra time, expense and complexity involved with the NMTC are justified by the rationale that the $.40 to $.50 per credit is found money NMTC transactions often require lengthy period of time to develop CDE and closing of transaction Timeframe includes finding a CDE with allocation, finding a NMTC investor, finding a leverage lender and time to get all project participants and funding sources on board with the proposed structure Typically 4 to 6 months but can be longer, depending on availability of allocation
Is the Juice Worth the Squeeze? Guarantees NMTC transactions require a guaranty in addition to those typical with borrowing Developers will be expected to guaranty yield generated by the NMTC to the Investor in the event of disallowance or recapture Typical recapture triggers Greatest risks of recapture Results of QLICI default
Is the Juice Worth the Squeeze? Reporting CDEs are required to report various community and economic impacts of their investments to the CDFI Fund QALICB will be required to provide detailed annual reports with respect to such community and economic impacts
So how do I start? First Step Have a story! Need to confirm proposed project is in a LIC Find a CDE, Investor and Leverage Lender Ask about the Project: 1. Will the project have a community and economic impact? 2. Will the project be developed in a highly distressed area? 3. Will there be a need for NMTC subsidy sources? 4. Will the project provide valuable community services or provision of essential goods to a low-income area?
So how do I start? Next Step Establish a Pro Forma Transaction must pass the underwriting scrutiny of investors and lenders Have development and operating budgets that meet investment and/or lender criteria Investors, CDEs, accountants, consultants and attorneys can assist with finding CDEs, investors and lenders, assembling budgets and structuring proposals
So how do I start? Final Steps Signing of a term sheet that memorializes the proposed investment and/or loan terms Getting to closing Gear up for the next NMTC transaction!
Case Study Triangle Plaza HUB Developer: Triangle Equities CDEs: Goldman Sachs, Low-income Investment Fund, and National Community Fund Location: Bronx, NY Investor: Goldman Sachs Leverage Lenders: Goldman Sachs and LIIF
Project Description New Construction of 88,000 square foot mixed-use commercial and community facility and 8,000 square foot public plaza located at the intersection of Bergen and 149 th Street. Provides a variety of community amenities, including a campus for Metropolitan College of New York and a Fine Fare supermarket being built as part of the City s Food Retail Expansion to Support Health (FRESH) Program.
Rendering
Rendering
Rendering
Structure - Leverage Structure - Leverage Loan and grant through LIIF from New York Healthy Food Healthy Communities program - Leverage Loan from Sponsor - Leverage Loan from Goldman Sachs - Leveraged a QEI of $34,885,000 (generating roughly $10.5 million in NMTC equity) - Total QLICIs made to QALICB of $34,199,000 - Total Project costs roughly $35 million
Community Impacts - - Highly distressed area of South Bronx Poverty Rate: Greater than 48% Median income: 40% of benchmark Unemployment 1.8 times national average. - Expected Job creation 191 permanent jobs, 50% target to those earning less than 80% of AMI - Needed Services Fresh foods grocery store (Fine Fare) NY S defined food desert Metropolitan College of New York Other retail and nonprofit office space - Serve as a catalyst for redevelopment of the neighboring community
Historic Tax Credits
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit Internal Revenue Code Section 47 / NY Tax Law 606(oo) Eligibility for NYS Credit generally made by reference to eligibility for Federal Credit (with a few exceptions). 20% tax credit for rehabilitations of historic buildings Dollar-for-dollar reduction of federal income tax liability Passive activity loss rules can limit use of credit if taxpayer is not widely held C-Corp. Calculated as a percentage of the eligible qualified rehabilitation expenses (QRE s) Applies to buildings: Listed in the National Register of Historic Places Eligible for listing on the National Register or Located in a National Register historic district
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Unused credit can be carried back one year and forward for 20 years. State Credit is refundable for projects PIS after 2015 IRS has authority to determine tax policy and monitor compliance. National Park Service (NPS), a division of the U.S. Department of the Interior certifies the rehabilitation. Each state s Historic Preservation office (part of NY Parks Department) reviews /recommends to NPS. May apply for the historic rehabilitation tax credit before or during a rehabilitation project.
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Historic Preservation Certificate Application - three parts: Part 1 - Evaluation of Significance A building is eligible if: Building contributes to an historic district or Building itself is historically significant A preliminary determination of significance can be obtained to allow rehabilitation to commence pending nomination process
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Historic Preservation Certificate Application - three parts: Part 2 - Description of Rehabilitation approval of construction plans NPS evaluates for compliance with The Secretary of the Interior s Standards for Rehabilitation the analysis of current architectural and historical features of the building description of the proposed work to be undertaken we recommend that Part 2 be filed before any work is started
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Historic Preservation Certificate Application - three parts: Part 3 Certification of Completed Work After the rehabilitation is completed, the owner submits the Request for Certification of Completed Work. NPS evaluates the completed work against the work described in the Part 2 Takes approximately 45 days from submission Can immediately claim 100% of the historic credits When building is placed in service (See Treasury Regulation 1.46-3(d)) so long as Substantial Rehab test is met. 20% of the qualified rehab. expenditures Per accountant cost certification
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Historic Preservation Certificate Application - three parts: (cont.) Application Process: Owner submits the application to the SHPO SHPO reviews the application and forwards it to the NPS NPS reviews the rehabilitation project for conformance and issues a decision.
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Two other tests to qualify for historic rehabilitation tax credits: Income Producing Must be income-producing property - office, retail, industrial, hotel and/or rental residential housing (i.e., a depreciable building). Owner-occupied residences are not depreciable, and do not qualify for federal rehabilitation tax credits. Residential rental use is considered to be incomeproducing.
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Two other tests to qualify for historic rehabilitation tax credits: (cont.) Substantial Rehabilitation rehabilitation must be substantial to qualify for any tax credits. a building is substantially rehabilitated if QRE s during a 24-month period (or 60-month, if phased project is specified prior to the start of rehabilitation) selected by the taxpayer exceed the greater of $5,000 or the adjusted basis of the building and its structural components, determined as of the beginning of the first day of the 24-month period (or 60-month) or the holding period of the building, whichever is later.
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Two other tests to qualify for historic rehabilitation tax credits: (cont.) Substantial Rehabilitation (cont.) The adjusted basis is defined as the purchase price, minus the cost of the land minus any depreciation already claimed plus previously incurred rehabilitation costs. No tax credits can be taken until the substantial rehabilitation test is satisfied.
The Basics of Federal Historic Rehab Tax Credits Historic Tax Credit Substantial Rehabilitation Test Project Cost Assumptions Acquisition Cost QREs $2,500,000 non-qre $500,000 Total $3,500,000 $500,000 ($100,000 allocated for land) Adjusted Basis of Building Calculation Purchase Price - Land Cost Depreciation +Incurred Rehab Costs = Adjusted Basis in Building $500,000 (Acq. Cost)- $100,000 (Land Cost) - $0 (Depreciation ) + $0 (I.R.C.)= $400,000 (Adj. Basis) Substantial Rehabilitation Test QREs = $2,500,000 Adj. Basis = $400,000 QREs Greater Than Adj. Basis = Pass
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Qualified Rehabilitation Expenditures (QRE s) The rehabilitation tax credit is 20% of the qualified rehabilitation expenditures incurred before and during, and after, the taxable year in which the property is placed in service. Rehabilitation expenditures must be capital in nature and depreciable as real property to qualify for a rehabilitation tax credit. This includes almost all hard and soft construction costs.
The Basics of Federal Historic Rehab Tax Credits 20% Historic Rehabilitation Tax Credit (cont.) Qualified Rehabilitation Expenditures (QRE s) (cont.) Architect s fees, engineering fees, legal fees, consulting fees, reasonable developer fees, construction management costs and construction period interest and taxes and any other fees paid that would normally be charged to a capital account are allowable as part of the qualified rehabilitation expenditures. Building and land acquisition costs are not considered qualified rehabilitation expenses. The cost of new construction beyond the shell of the existing building, such as expenditures attributable to landscaping, parking lots, site work and building enlargements, are not considered qualified rehabilitation expenses. The costs of personal property and furnishings are typically not considered qualified rehabilitation expenses.
The Basics of Federal Historic Rehab Tax Credits Recapture Historic rehabilitation tax credits claimed may be subject to prorated recapture by the IRS if within five years of completion of the rehabilitation: if a rehab property is disposed of or foreclosed, if a rehab property is destroyed by casualty if ownership is transferred if the facade is changed or if the property loses its status as income-producing
The Basics of Federal Historic Rehab Tax Credits 10% Rehabilitation Tax Credit Internal Revenue Code Section 47 also offers a 10% tax credit for rehabilitations of non-historic, non-residential income producing pre-1936 buildings Building must NOT be listed in the National Register Building must NOT be located in a Registered Historic District (or if so, has been determined to be a non-contributing structure ) Building was placed in service before 1936 and has not been moved since Properties must be income-producing (i.e., a depreciable building) Building is used for non residential rental purposes
The Basics of Federal Historic Rehab Tax Credits 10% Rehabilitation Tax Credit (cont.) calculated as a percentage of qualified rehabilitation expenses. requires only a single IRS tax form submission without any other federal or state involvement. Must satisfy the substantial rehabilitation test. Must satisfy the following internal and external wall retention tests: 50% or more of the existing external walls are retained in place as external walls, 75% or more of the existing external walls are retained in place as internal or external walls, and 75% or more of the existing internal structural framework is retained in place.
NYS Commercial Historic Tax Credit Allows state credit equal to 100% of federal credit value (equivalent to 20% of qualified rehabilitation costs) up to a maximum of $5,000,000 in credit with respect to a qualified historic structure. For Projects PIS in 2014 or earlier, unused credit may be carried forward indefinitely. For Projects PIS in 2015 and after, unused credit will be refunded.
NYS Commercial Historic Tax Credit Rehabilitation must be located in a census tract with a median family income of at or below 100% of the statewide median income. Does NOT make the credit transferable within business partnerships. Sunsets December 31, 2019.
Syndication and Developer Issues Historic Boardwalk Hall, LLC v. Commissioner, 3d. Cir., August 2012 Safe Harbor Revenue Procedure 2014-12 Issues with Small Projects: no economies of scale; investor interest; lower equity raise passive activity loss rules; Development Team: Architect; Consultant; Accountant; Lawyer.
Syndication and Developer Issues Guarantees to investor will be required Not-for-profit issues (seek counsel) Hidden reducers of equity raise such as preferred return and exit costs. Establish a short form set of projected development budget and operating budget.
Syndication Simple Syndication Structure
Syndication Equity Raise
Syndication Master Lease HTC Syndication Structure
Timmon M. Favaro Partner tfavaro@chwattys.com Tel.: 716.856.1700 ext. 314 Tim Favaro is a partner at the law firm of Cannon Heyman & Weiss, LLP and received his law degree from the State University of New York at Buffalo. He concentrates his practice in the areas of community development and affordable senior and multi-family housing development law, utilizing various tax driven development incentives including among others the Low-Income Housing Tax Credit, the New Market Tax Credit, the Federal and New York Historic Tax Credit. Mr. Favaro represents developers (for-profit and non-profit), lenders, and investors in the development, financing, planning, structuring and closing tax credit transactions. Mr. Favaro has represented qualified active low-income community businesses in obtaining, structuring and deploying over $300,000,000 million in NMTC qualified low-income community investments, developers and investors in over 100 LIHTC transactions with LIHTC equity generated in such transactions aggregating many hundreds of millions of dollars and stand-alone HTC transactions with equity raised from the syndication of such past HTC transactions amounting to over $100,000,000.