Toledo Tax Credit Workshop - Structuring the Deal

TAX CREDIT WORKSHOP
March 25, 2011
Toledo, Ohio

Mary Forbes Lovett, Esq.
mlovett@ulmer.com
216.583.7074

PPT 1888505

© 2009 Ulmer & Berne www.ulmer.com

HOW TAX CREDITS WORK

OVERVIEW

© 2009 Ulmer & Berne 2 www.ulmer.com

WHAT ARE THE DIFFERENT TYPE OF
CREDITS AVAILABLE FOR REAL ESTATE
PROJECTS
 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


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

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


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


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


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


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


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


RENEWABLE ENERGY
CREDITS
 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


Mixing Credits

Very complicated, but you can do multiple credit
transactions. The bigger the project the more
they make sense. The easiest credits to
combine are the federal and state historic.
Historic credits are often combined with new
market tax credits depending on their location


WHAT IS THE DIFFERENCE BETWEEN
A FEDERAL AND STATE HISTORIC TAX
CREDIT


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


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


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


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


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


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


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)


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


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


WHAT IS THE DIFFERENCE BETWEEN A
10% 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


HOW AND WHEN DO YOU TURN A
TAX 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


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


QREs
 Qualified
 demolition
 Hard costs of construciton
 Soft costs for architect, accountant, title
fees and lawyers
 Construction period interest
 Developer fee


QREs
 Non qualified expenses
 Land and interest carry on land
 Building acquisition and interest
 Site improvements and landscaping
 Enlargements
 Personal property


 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.


 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.


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.


CAN A NON PROFIT BE INVOLVED IN A HISTORIC
REHABILITATION?

 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


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)


TYPICAL DIRECT INVESTMENT STRUCTURE

Tax Credit
Developer Member
0.1% 99.9%

Tax Credit
Entity

Historic
Building

Lease to
Third Parties


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%


WHAT ARE THE ADVANTAGES AND DISADVANTAGES
OF DOING A TAX CREDIT TRANSACTION

Advantages
 brings additional equity
 preserves historic buildings

Disadvantages
 soft costs
 compliance with the department of interior standards
 outside investor and record keeping
 takes more time
 investor guarantees
 need a bridge loan


Toledo Tax Credit Workshop - Structuring the Deal

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