Toledo Tax Credit Workshop - Structuring the Deal


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Mary Lovett of Ulmer Berne presents the legal overview of structuring historic tax credit deals. Presented March 25, 2011 at the Heritage Ohio Tax Credit Workshop.

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Toledo Tax Credit Workshop - Structuring the Deal

  1. 1. TAX CREDIT WORKSHOP March 25, 2011 Toledo, Ohio Mary Forbes Lovett, Esq. 216.583.7074 PPT 1888505© 2009 Ulmer & Berne
  2. 2. HOW TAX CREDITS WORKOVERVIEW © 2009 Ulmer & Berne 2
  3. 3. WHAT ARE THE DIFFERENT TYPE OFCREDITS AVAILABLE FOR REAL ESTATEPROJECTS  Federal historic tax credits  State historic tax credits  Federal New Market Tax Credits  State New Market Tax Credits  Low Income Housing Tax Credits  Facade and Lost Development Easements  Renewable Energy Credits © 2009 Ulmer & Berne 3
  4. 4. WHAT IS A TAX CREDIT? An indirect federal or state subsidy used to finance rehabilitation of historic and older buildings or projects in depressed areas, or renewable energy projects Eligible taxpayers receive the subsidy by claiming a dollar for dollar tax credit against tax liability and in some cases receive a refund It is not a tax deduction, unlike the easements © 2009 Ulmer & Berne 4
  5. 5. Federal Historic Tax Credit 20% or 10% credit against QRE’s (qualified rehabilitation expenditures) no allocation process as long as it meets the Secretary of Interior Standards must be an historic landmark or a contributing factor in an historic district © 2009 Ulmer & Berne 5
  6. 6. State Historic Tax Credit Pending renewal, this discussion pertains to existing awards. If renewed it is possible there might be some changes 25% credit/refunds Capped at $5,000,000 with $3,000,000 refund cap ($20,000,000 rehab) and the balance is a credit that can be carried forward or back Credit against taxes and then refund The refunds or loss of deduction makes it subject to federal income tax (assume a 35% tax rate) Subject to an application and award process Rounds 2-3 were a 2 year program of $60,000,000 for each year, $45,000,000 in each year was set aside for round 1 queue participants. Round 4 was the last round to get funded. What does not get used by current awardees will be available for new projects from Rounds 5 and 6. Round 6 closes on 3/31/2011 © 2009 Ulmer & Berne 6
  7. 7. Federal New Market Tax Credit A 39% credit taken over 7 years for qualified investments made in a qualified census tract (5% in years 1-3 and 6% in years 4-7) to a qualified business The allocatees/ CDE’s cannot control the QALICB so most of the investment comes in as subordinate debt that is forgiven at the end of the 7 year recapture period No more then 80% of revenue can come from the rental of housing Cannot be combined with LIHTC Qualified census tracts are where poverty rate exceeds 20% or median income is below 80% of state or metropolitan median income Subject to allocation at the federal level to CDE’s © 2009 Ulmer & Berne 7
  8. 8. State New Market Tax Credits similar to federal except no more then 15% of revenue can come from the rental of real estate/ targeted to end users, ie. Corporate headquarters or theatre renovations first 2 years no credit and the rest is accelerated over the remaining 5 years so the PV discount is greater then the FNMTC loss of deduction for state taxes paid results in a 35% federal income tax hit capped at approximately $2,500,000 in investment or $1,000,000 in credit per project $10,000,000 state max per year can be taken only by insurance companies and financial institutions Allocations have been awarded to CDE’s that have a federal allocation it is a 7 year program © 2009 Ulmer & Berne 8
  9. 9. Low Income Housing Tax Credits 4% and 9% credits for affordable housing Credit is earned at such rate for each year during a 10 year period. 9% projects have very little permanent debt but rent restricted Cannot be combined with NMTC, but could be combined with historic tax credits Subject to an application and award process © 2009 Ulmer & Berne 9
  10. 10. Facade and Lost Development Easements(Preservation Easements) Unlike credits these easements create a charitable contribution deduction equal to the value of the easement (35% of the value of the donation) Facade easements are based on a percentage of the value of the building (13%) Lost development are based upon the lost potential from the site. Ie. the difference between the cost to build condos on top and the price at which they could be sold Lots of audits and very limited market, but deals are getting done Need full working drawings and the legal and physical ability to build up © 2009 Ulmer & Berne 10
  11. 11. RENEWABLE ENERGYCREDITS 30% Investment Tax Credit If projects are commenced by the end of 2011 can be traded for a grant Eligible projects are:  Solar  Wind  Geothermal  Captive solar companies are an option for large real estate holdings© 2009 Ulmer & Berne 11
  12. 12. Mixing CreditsVery complicated, but you can do multiple credittransactions. The bigger the project the morethey make sense. The easiest credits tocombine are the federal and state historic.Historic credits are often combined with newmarket tax credits depending on their location © 2009 Ulmer & Berne 12
  14. 14. Types of qualifying structures FHTC- only national register or contributing factor in a historic district SHTC- in addition to the above can also be a local landmark designated by a certified local government © 2009 Ulmer & Berne 14
  15. 15. Credit vs Refund FHTC is 100% credit/ therefore a 3rd party investor is necessary SHTC is part refund and part credit/ could be used directly by the developer and in smaller projects But still need a bridge loan because the investment or refund comes in after the project is complete © 2009 Ulmer & Berne 15
  16. 16. Taxation of Benefit FHTC does not create tax liability therefore get more per dollar of credit SHTC must be either taken in as income at the federal level or reduces the deduction for state taxes paid at the federal level, therefore there is a 35% cost to the program before you even get to the investor profit © 2009 Ulmer & Berne 16
  17. 17. End User FHTC difficult (but not impossible) to use for non profit end users but can be allocated to a master tenant SHTC does not restrict the non profit end use but the award can only be made to the fee simple owner and they must be a tax payer and cannot be used by the state or any political subdivision © 2009 Ulmer & Berne 17
  18. 18. Timing FHTC is earned, and therefore the equity is contributed, when placed in service i.e. placed in condition of readiness for a specific purpose. One benchmark is the issuance of a certificate of occupancy FHTC can be taken over a 2 to 5 year period once you exceed basis SHTC comes in when the tax return is filed for the year in which the project is placed in service and no sooner then the year the state designated in its award SHTC has a one time shot to cost certify, but FHTC can be taken over a 2-5 year period (this is one item that might change in the new legislation) SHTC because of the major factor test cannot commence construction until the award has been made, however with FHTC once there is Part II approval the project can commence © 2009 Ulmer & Berne 18
  19. 19. Flexibility FHTC allows for a master lease structure so that tax credits can be allocated away from the fee simple owner to a lessee. This permits different investors for different credits and does not require the developer to give up the depreciation deduction. SHTC now permits special allocation i.e., disproportionate allocation but it still must be taken by the fee simple owner © 2009 Ulmer & Berne 19
  20. 20. Recapture FHTC have recapture on a pro rata basis during the 5 years after it is placed in service if there is a transfer of the real estate or if the final Part 3 approval is never obtained SHTC there is no recapture, however case law from other states advises that the SHTC investor needs to stay in the project for 2-3 years to be treated as a true partner. (This is an area that might change in the new legislation) © 2009 Ulmer & Berne 20
  21. 21. Scope of Rehabilitation FHTC must be substantial - the greater of $5000 or adjusted basis of the building and entire building must be substantially rehabilitated SHTC - no minimum amount of rehab is specified FHTC can only be used for commercial structures SHTC can be used for personal residences © 2009 Ulmer & Berne 21
  22. 22. Cap FHTC has no cap on the amount of QRE or the number of projects SHTC is subject to an annual allocation and award based on economic development benefit and geographic diversity Currently limited to $5,000,000 in credit per project © 2009 Ulmer & Berne 22
  23. 23. WHAT IS THE DIFFERENCE BETWEEN A10% AND 20% FEDERAL HISTORIC TAX CREDIT 10% credit can be taken on the rehab of any building that was built before 1936 10% credit cannot be used on residential project 10% credits do not require that the project be built in accordance with the department of interior standards Cannot be on the national register or in a historic district 20% credit must be an historic building either by being on the national register or being in an historic district and being a contributing factor Department of interior standards must be followed No prohibition on residential development © 2009 Ulmer & Berne 23
  24. 24. HOW AND WHEN DO YOU TURN ATAX CREDIT INTO CASH FOR YOUR PROJECT For FHTC you need to identify an investor who has tax liability to shield. They will pay between 85-95 cents on the dollar of credit in return for being allocated the credits. Generally speaking these investors are large c corporations and banks because of passive activity loss rules, community reinvestment act requirements and the size of the tax liability to be shielded. The investors become passive members in the for profit fee simple owner or master tenant in the case of a pass through, which is usually a SPE LLC set up for this project only At the end of 5 years in the case of FHTC the investor is bought out for a predetermined price through a call/put agreement © 2009 Ulmer & Berne 24
  25. 25. Process Get certified by National Park Service and State Preservation Office Form for profit single purpose entity (SPE) controlled by developer Transfer the property to the SPE Architectural design Construction Make sure the investor is brought in prior to being placed in service/ certificate of occupancy© 2009 Ulmer & Berne 25
  26. 26. QREs Qualified  demolition  Hard costs of construciton  Soft costs for architect, accountant, title fees and lawyers  Construction period interest  Developer fee© 2009 Ulmer & Berne 26
  27. 27. QREs Non qualified expenses  Land and interest carry on land  Building acquisition and interest  Site improvements and landscaping  Enlargements  Personal property© 2009 Ulmer & Berne 27
  28. 28.  SHTC investment is different because most if not all the tax benefit come to the owner as a refund, so unless you have an investor with large NOL’s who will pay more on an after tax basis for the credit or is willing to make the investment at the beginning of the project or you have credits in excess of $3M, it might be better for the developer herself to get the refund. This is why the special allocation provisions are so important. Then the only issue is getting a bridge loan based on that future refund. © 2009 Ulmer & Berne 28
  29. 29.  Timing is always an issue with tax credit deals, the developer needs the cash up front at the beginning of construction and the investor does not want to put it in until the risk of completion is over. FHTC investors will put most of the equity in when the project is placed in service, ie. certificate of occupancy is obtained. In these times it is difficult to find a lender who will do a bridge loan based on the promise of contribution upon completion. Investors will ask for a large discount to put the money in up front. SHTC investors will want to wait until the project is completed, the Part 3 approval has been obtained and perhaps the tax return for that year has been filed. Still have the bridge loan issue. © 2009 Ulmer & Berne 29
  30. 30. WHO CAN CLAIM THE CREDIT,I.E. WHO IS THE INVESTOR FHTC- because it is a credit generally speaking you need a tax payer with a large enough tax liability to soak up the credit. This is also compounded by passive activity rules so that a C corporation is the most likely investor. A wealthy individual might qualify but he/she would need to be actively involved in a real estate business. To be a real estate professional you need to spend 750 hours per year over a 5-year period as a real estate professional. You can also look to small closely-held banks but bank regulations have to also be considered. There are limits on how much can be loaned to an affiliate. The at risk rules also come into play with individual investors or closely held companies. SHTC are a little bit different because a substantial portion is a refund. © 2009 Ulmer & Berne 30
  31. 31. CAN A NON PROFIT BE INVOLVED IN A HISTORICREHABILITATION? disqualified lease- if end user is tax exempt then cannot get a credit unless one of 2 exceptions apply first if less then 50% is used by a non profit second if all of the 4 part test is met (i) no tax exempt bond financing (ii) lease does not contain a fixed purchase price at other then fmv (iii) lease is less then 20 years (iv) no sale lease back and prior use by such entity tax exempt partner – if you have a non profit partner they must do a 168(h) election which will create taxable income for the non profit sponsor © 2009 Ulmer & Berne 31
  32. 32. © 2009 Ulmer & Berne 32
  33. 33. Small Deal Example $300,000 project Assuming the developer is actively involved in real estate or if passive has sufficient passive income to take the credits against 20% federal historic credits (.20x$300,000=$60,000) taken against developer’s tax liability and carried back one year forward for 20 years untill used up 25% state historic credit, reduces state liabililty and balance is a refund (.25X$300,000=$75,000)© 2009 Ulmer & Berne 33
  34. 34. TYPICAL DIRECT INVESTMENT STRUCTURE Tax Credit Developer Member 0.1% 99.9% Tax Credit Entity Historic Building Lease to Third Parties © 2009 Ulmer & Berne 34
  35. 35. TYPICAL LEASEHOLD INVESTMENT STRUCTURE Developer 100% Fee Owner Entity Master Lease to Tax Credit Entity Lease to Tax Credit Developer Third Parties or Member .01% Developer Affiliate 99.9% © 2009 Ulmer & Berne 35
  36. 36. WHAT ARE THE ADVANTAGES AND DISADVANTAGESOF DOING A TAX CREDIT TRANSACTIONAdvantages brings additional equity preserves historic buildingsDisadvantages soft costs compliance with the department of interior standards outside investor and record keeping takes more time investor guarantees need a bridge loan © 2009 Ulmer & Berne 36
  37. 37. Mary Forbes Lovett, Esq. 216.583.7074© 2009 Ulmer & Berne