irc section 42 low income housing tax credits and irc section 47 historic tax credits
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3 1/2 hour CPE course regarding Sec 42 and Sec 47 Tax Credits, prepared for the Houston Chapter of Tax Executives Institute May 2013 Tax School.TRANSCRIPT
IRC Section 42:Low Income Housing Tax
Credits & Historic Credits
Presented by: Kutak Rock &Midwest Housing Equity Group
Presenters
Andrea FrymireExecutive Vice President
Midwest Housing Equity Group
Gregg YeutterPartner In Charge
Kutak Rock LLP
Jill GoldsteinPartner
Kutak Rock LLP
IRC Section 42
Andrea Frymire
Executive Vice President
Midwest Housing Equity Group
Tax Credit Syndicator – Midwest Housing
Non-profit organization established in 1993 at the request of Nebraska Governor Ben Nelson because rural areas underserved
Mission: Change lives for a better tomorrow by promoting the development and sustainability of quality affordable housing
Service area today includes Arkansas, Colorado, Iowa, Kansas Minnesota, Missouri Nebraska, Oklahoma, South Dakota and Texas
Background
The Tax Reform Act of 1986 signed by President Reagan Curbed tax shelters and introduced Section 42
Pre-1986 multifamily housing developments sold primarily to individual investors
Post-1986 Section 42 multifamily housing developments sold to corporate investors
The Omnibus Budget Reconciliation Act of 1993 signed by President Clinton – made the LIHTC permanent From 1987 through August 1993, the LIHTC program was
subject to various sunsets
Carryback 1 year
Carry forward 20 years
Purchaser Profile
Corporate Accredited Investor Accredited as per Regulation D of the Securities & Exchange Act $5,000,000+ in assets (varies by syndication firm, many much
higher) Can withstand losses due to depreciation or even loss of
investment
Usually a C Corporation Has to forecast a taxable need for credits Must utilize the credits themselves
SEC issues when buy credits to resell
Many Banks for CRA purposes Insurance Companies for both economic and social
responsibility No set standard for an exact profile other than paying
taxes
Why Do Investors Invest
Optimal Tax Planning Strategy 10 full years of federal tax credits 15 full years of depreciation and other passive
deductions Periodic Write-down of Paid in Capital CRA Investment Credit, if applicable Marketing and PR opportunities Stabilizing and Investing in your local communities Stable proven track record of a performing asset
class Accurately forecasted tax benefits Quarterly Reporting and Asset Management update
Tax Planning Strategy Keep your tax dollars out of Washington
You know where they are going and how being used You have a say in those dollars usage You generate a decent return versus a 0% (or cost) with sending to
Washington Spread the credits over 10 years
The Warren Buffet Rule What other program can you do something for society and
have society give you something in return
Why Do Investors Invest (cont.)
Tax Credit Calculation
$1,000,000 Total Project Cost$ 200,000 Project Cost Not Eligible for Credits$ 800,000 Eligible Basis for Credits* x 9% Tax Credit Percentage$ 72,000 Credits Received/year x 10 Years credits are received$ 720,000 Credits received x .85 Price paid for credits$ 612,000 Equity into project from MHEG
Allows for low debt on project enabling developers to keep rents Affordable
* States may allow 130% basis boost (not shown here).
Example Benefit Schedule
Points to Consider
MHEG does not want the capital you need for normal operations.
The dollars you are considering placing with MHEG are actually dollars you owe to the IRS as a result of your successful operations.
You receive no monetary return with your payment to the IRS.
You will receive an above market return and a CRA Investment Credit, if applicable, when you purchase tax credits with MHEG.
Your participation benefits the community and you receive a monetary return without jeopardizing your normal business capital.
AtlantaChicagoDenver
Fayetteville Irvine
Kansas CityLittle Rock
Los AngelesMinneapolis
Oklahoma City Omaha
PhiladelphiaRichmondScottsdale
Washington, D.C. Wichita
Kutak Rock LLP – 16 Offices, 450 Attorneys
Tucson
Fyffe
Los AngelesWoodland Hills
Denver
Honolulu
Des Moines Chicago
Topeka
Louisville
Minneapolis
Kansas City
St. Louis
Omaha
Baltimore
Billings
Charlotte
New YorkCleveland
Oklahoma City
Portland
Pittsburgh
FairfaxMcLean
Location of Kutak Rock’s Tax Credit Clients
2013 LIHTC Allocation
Total Credits Allocated by States 700,000,000
Multiplied by Credit Period 10 Years
Total 2013 Allocation $7,000,000,000
4% Bond Transactions $1,500,000,000
Secondary Market $500,000,000
Estimated Total Credits in 2013 Market
$9,000,000,000
Estimated Credit Price $0.85
Estimated Equity Needs in 2013 $7,650,000,000
2013 LIHTC Market (Supply Slide)
Survey Total Stabilized Properties % Stabilized
Number of Properties 16,356 14,700 89.9%
Number of Units 1,191,198 1,049,723 88.1%
Housing Credit Net Equity
59,949,803,149 49,704,360,906 82.9%
Total Housing Credits
69,112,707,921 56,811,046,194 82.2%
Overall Portfolio Composition
2008 2009 2010
Median Physical Occupancy 96.4% 96.3% 96.6%
Median Hard Debt Coverage
Ratio1.15 1.19 1.24
Median Per Unit Cash Flow $246 $335 $412
Median Physical Occupancy 96.4% 96.3% 96.6%
Overall Portfolio Performance (2008-2010)
Median Debt Coverage Ratio (2008-2010)
Median Physical Occupancy
Median DebtCoverage Ratio
Median Per UnitCash Flow
Credit Type 2008 2009 2010 2008 200
9201
0 2008 2009 2010
4% Tax Credits
96.4%
96.3%
96.6% 1.15 1.19 1.23 $350 $43
2 $530
9% Tax Credits
96.5%
96.4%
96.6% 1.15 1.19 1.24 $215 $32
2 $387
Overall 96.4%
96.3%
96.6% 1.15 1.19 1.24 $246 $33
5 $412
Operating Performance by Credit Type
Median Physical Occupancy
Median DebtCoverage Ratio
Median Per UnitCash Flow
Development Type
2008 2009 2010 2008 2009 2010 2008 2009 2010
Historic Rehab
95.0% 94.7% 95.4% 1.05 1.14 1.16 $5 $129 $121
New Construction
96.7% 96.5% 96.8% 1.16 1.19 1.23 $273 $332 $414
Rehab 96.0% 96.3% 96.4% 1.15 1.21 1.21 $227 $368 $442
Mixed 96.0% 95.6% 96.1% 0.88 1.05 1.05$(11
4)$208 $290
Overall 93.4% 96.3% 96.6% 1.15 1.19 1.19 $246 $335 $412
Operating Performance by Development Type
Median Physical Occupancy
Median DebtCoverage Ratio
Median Per UnitCash Flow
TenancyType
2008 2009 2010 2008 2009 2010 2008 2009 2010
Family96.0%
95.9%96.0%
1.13 1.16 1.21 $217 $303 $385
Senior97.8%
97.5%97.5%
1.20 1.26 1.30 $317 $417 $466
Special Needs
97.0%
97.0%97.0%
1.29 1.34 1.42 $384 $505 $548
Other96.1%
96.5%96.8%
1.19 1.23 1.22 $102 $249 $298
Overall96.4%
96.3%96.6%
1.15 1.19 1.24 $246 $335 $412
Operating Performance by Tenancy Type
Federal Government Allocates credits to states, IRS oversees compliance
State Housing Agency Allocates credits to projects meeting its QAP priorities Does Financial Feasibility analysis
Developer/GP Puts all of the pieces of the project together Manages the owner/provides many guarantees
Lender(s) Provide construction and/or permanent financing Underwrite project economics
Key Participants in LIHTC Transactions
Tax Credit Investor/LP Provide equity Underwrite project economics Monitor ongoing performance
Property Management Company Leasing of project units in compliance with Code
Section 42 Accountants/Attorneys
Prepare financial projections Prepare annual audited project financial statements Issue tax opinions
Key Participants in LIHTC Transactions (Cont’d)
National Champion
$1.5T
Surplus!
5 Year Cost(JCT Estimates)
Home Mortgage Interest Ded.
$573B
LIHTC $30B
Renewable Energy Credits $10B
HTC $3.6B
NMTC $3.5B 19x more
government
subsidy to
ownership than
LIHTC
Source: Congressional Budget Office
Federal Deficits by Year
Three Ways to Invest
Fund Investment Offer Diversity Multiple investors Multiple projects Fund General Partner has
financial risk Fund level of reserves Less concerns over FIN 46,
consolidation issues Less need for tax credit
expertise by the investor
Direct Investment No diversity-all eggs in one
basket Do get specific project in
investors area More of a say in investment
terms
Direct (cont.) Less reserves and no financial
backing from Fund
General Partner Sole investor-FIN 46 comes into play
May need staff expertise
Proprietary Fund Investment Some diversity, usually fewer
projects
Usually specifies where projects must be located
Usually dictates deal terms
Less chance of Fund General Partner taking financial risk
Most likely FIN 46 comes into play
Usually has tax credit staff expertise
Fund Investment Structure
Midwest HousingTax Credit Syndicator
MHEG FUND 40, L.P.Owned 99.99% by Investors
Owned 00.01% by Midwest Housing
Investors
State HFATax Credits
Project ALower Tier Partnership
LP/LLC
Owned .01% by Developer/GPOwned 99.99% by Fund
What is the Real Risk?
Ownership risks of multifamily low-income rental housing pools Mitigated by MHEG’s investment policies, ongoing
management and financial oversight, as well as MHEG’s financial strength
Compliance risk Mitigated by MHEG’s continuing compliance practices
and oversight
Changes in current law Highly improbable any law change would affect any
current investments
Reputation Risk We take “the high road”, we know that we represent our
fund participants who are financial pillars of their communities
What to Expect in the Future
At the end of the 15-year tax credit compliance period, our goal is to exit the partnership in a manner that allows the property to continue to comply with the states extended compliance period.
The general partner or managing member in most cases has a right of first refusal to purchase our interest for an amount stipulated in the IRS code.
Since the project still has restricted rents, it will not be able to refinance much additional debt. Our exit usually does not generate significant cash or create a tax event. Therefore, we do not include any residual value in our analysis of return to investors.
(note: this narrative is greatly oversimplified, but does represent the results of a typical exit)
Historical Tax Credits: Overview & Recent Topics
Jill Goldstein, Esq.
Partner
Kutak Rock LLP
General Partner
Investor
Property
Developer
99.99%
0.01% — Interest, Management Fee, etc.
Development Fee
Fee Ownership
LeaseLease
Owner, L.P.
End User End User
HTC Only: Traditional Single Entity Structure
First Mortgage Debt
Special Limited Partner 0.05%
AHAPLoan
Debt$2,412,000
$1,818,182
Equity$6,262,968
Owner
TBD LossPartner99.99%
Federal LIHTC& HTC
Partner99.98%
General Partner0.05%
State LIHTCPartner0.01%
0.01%
DebtRepayment
Equity$3,150,000
Equity$4,962,968 Grant
$1,300,000
Equity$100
(Missouri)
Single Tier LIHTC/HTC Combo Entity Structure
Acquisition $155,000
Exterior demolition 47,400
Rehab of existing building 8,450,000
Enlargement 200,000
Furniture, fixtures, etc. 47,600
Other costs 100,000
TOTAL COSTS $9,000,000
$8.45 M
$47.6 K
$47.4 K
Qualified Rehabilitation Expenditures (QREs)
Qualified Rehabilitation Expenditures $ 8,450,000
Tax Credit % x 20%
Tax Credits $ 1,690,000
Investor % x 99.99%
Price Per Credit x 0.90
Equity $ 1,520,848
2012Tax Return
$1.69 M
$9M
$1.52MTotal Costs
Equity
17%
Qualified Rehabilitation Expenditures (QREs)
The Investor is the L.P. in the Project PartnershipHistoric Tax Credit $100,000
Syndication Proceeds ($.90/Credit) $90,000
Residential Value $0
GAAP Treatment
Historic Tax Credit Tax Benefit $100,000
Deferred Tax Liability (35%) - Resulting from the basis adjustment under IRC Section 50(c) (Old IRC Section 48(q))
$(35,000)
Net GAAP Benefit from the HTC $65,000
Book Loss on Investment (Residual Value $0) ($90,000)
Less: Tax Benefit on Book Loss (35%) $31,500 ($58,500)
TOTAL GAAP Benefit $6,500
RETURN ON INVESTMENT 7.22%
Traditional Example
The Investor is the L.P. in the Master TenantHistoric Tax Credit $100,000
Syndication Proceeds ($.90/Credit) $90,000
Residential Value $0
GAAP Treatment
Historic Tax Credit Tax Benefit $100,000
Deferred Tax Liability (35%) - Resulting from the basis adjustment under Treasury Regulation 1.48-4 in lieu of a basis adjustment)
$(35,000)
Deferred Tax Benefit (35%) - Resulting from the increase in basis in the L.P.’s partnership interest due to recognizing income under the basis adjustment rule above (Treas. Reg. 1.48-4)
$35,000
Net GAAP Benefit from the HTC $100,000
Book Loss on Investment (Residual Value $0) ($90,000)
Less: Tax Benefit on Book Loss (35%) $31,500 ($58,500)
TOTAL GAAP Benefit $41,500
RETURN ON INVESTMENT 46.11%
Alternate Example
Exhibit III-BRun 3.6Page 5
9.57%
(single-tier)
Calculation of Rates of Return on InvestmentIn Low-Income, Federal Historic & AHAP Contribution
General Partner
0.01% Ownership0.01%
Losses/LIHTC
Lessor L.P.(LIHTC)
99.98% LIHTC
HRTC Equity
SubleasesSec. 42Income
Restrictions
General Partner
0.01% Ownership0.01%
Profits/HRTC
Tenant L.P.(HRTC)10.00%
Ownership0.01%
Losses/LIHTC
Rent
LeaseSec.48(d) HRTC Pass-ThroughSec. 42 Income Restrictions
LIHTC Limited Partner
89.99% Ownership99.98% Losses/LIHTC
Low IncomeTenants
HRTC Limited Partner
99.99% Ownership99.99% Profits/HRTC
LIHTC Equity Rental
Income
HRTC Equity
99.99%
HRTC
HRTC/LIHTC CombinationMaster Lease/Credit Pass-Through
General Partner
0.01% Ownership0.01%
Losses/LIHTC
Lessor L.P.(LIHTC)
99.98% LIHTC
HRTC Equity
SubleasesSec. 42 Income
Restrictions
General Partner
0.01% Ownership0.01%
Profits/HRTC
Tenant L.P.(HRTC)10.00%
Ownership0.01%
Losses/LIHTC
Rent
LeaseSec.48(d) HRTC Pass-ThroughSec. 42 Income Restrictions
LIHTCLimited Partner89.98%
Ownership99.98%
Losses/LIHTC
Low IncomeTenants
HRTC Limited Partner
99.99% Ownership99.99% Profits/HRTC
LIHTC Equity
RentalIncome
HRTC Equity
99.99%
HRTC
State LIHTC L.L.C.0.01%
Ownership0.01%
Losses/LIHTC100% State
LIHTC
100% StateLIHTC
State LIHTCEquity
NOTE: State LIHTC Investor likely will have a true 1% interest in light of recent IRS challenges.
HRTC/LIHTC CombinationMaster Lease/Credit Pass-Through (w/ State LIHTC)
Exhibit VIII-MTRun 4.4
Page 49
25.55%
Calculation of Rates of Return to Limited Partner onInvestment in Federal Low-Income, Federal Historic Tax Credits
Qualified Rehabilitation Expenditures
$ 8,450,000
Tax Credit % x 20%
Tax Credits $ 1,690,000
Investor % x 99.99%
Price Per Credit x 0.90
Equity $ 1,520,848
2012Tax
Return$1.69 M
2012
Placed in Service
100%
5 Year Recapture Period
2013 2014 2015 2016 2017
80% 60% 40% 20% 0%
HTC Recapture
Recapture of the credit occurs if, within five years of placing in service: ownership of the property changes the property ceases to be investment credit property, sale of a partnership interest, or reduction of a partner’s interest to less 2/3 of original
ownership interest
The recapture amount is equal to 100 percent of the credit claimed and used to reduce tax if the recapture event occurs before the first anniversary of the placed in service date, and is reduced by 20 percent for each subsequent year.
HTC Recapture
StateEstimated Tax Credit
Available in 2013Bifurcated from Federal LIHTC?
Credit Period Type of Credits
Arkansas Not Available Not Available Not Available Not Available
California TBD TBD TBD TBD
Connecticut $10,000,000 Yes 1 Year Other
Georgia $15,791,000 Yes 10 Years 9 Percent
Hawaii Not Available Not Available Not Available Not Available
Illinois Not Available Not Available Not Available Not Available
Massachusetts
$10,000,000 Yes 5 Years Other
Missouri $13,489,545 Yes 10 Years 9 Percent
New Mexico Not Available Not Available Not Available Not Available
New York Not Available Not Available Not Available Not Available
North Carolina
Contact NCHFA for information
N/A N/A Other
Puerto Rico $20,000,000 Yes 1-10 Years Other
Utah Not Available Not Available Not Available Not Available
Vermont Not Available Not Available Not Available Not Available
“TBD” - indicates this figure or date is still to be determined by the according state agency.“Not Available” - indicates that the state agency was unable to respond to our inquiries by the time this book went to print.
State LIHTCs
Arkansas Colorado Connecticut Delaware Georgia Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota
Mississippi Missouri Montana New Mexico New York North Carolina North Dakota Ohio Oklahoma South Carolina Utah Vermont Virginia West Virginia Wisconsin
States with Historic Tax Credits
Los Angeles
Irvine
Scottsdale
Denver
Omaha
Wichita
Oklahoma City
Kansas City
Minneapolis
Chicago
Atlanta
Richmond
Washington, D.C.
Philadelphia
FayettevilleLittle Rock
States with Historic Tax Credits
In fiscal year 2010, states with their own historic tax credit programs occupied eight of the top 10 ranking for number of completed historic tax credit rehabilitation projects.
Rank State # of Completed Projects
1 Missouri 118
1 Virginia 118
3 Massachusetts 63
5 North Carolina 44
6 Louisiana 43
7 Ohio 32
8 Kentucky 27
9 New York 24
10 Mississippi 23
State Historic Tax Credits Success
State Historic Tax Credits Virginia Historic Tax Credit Fund 2001 LP v. IRS, 4th Circuit
Court held that a transaction was a disguised sale of property interests.
Recent Legal Challenges to Historic Tax Credits
Federal Historic Tax Credits Historic Boardwalk Hall, LLC v. IRS, 3rd Circuit
Court held investor was not a bona fide partner in the partnership and was not entitled to HTCs.
Consolidated Edison Company of NY v. U.S. “Reasonable likelihood” of put exercise = sham transaction
IRS Chief Counsel Memo Applied Boardwalk analysis to “traditional” HTC transaction
to disallow credits to an HTC investor.
Recent Legal Challenges to Historic Tax Credits
Significant structuring uncertainty Major HTC investors are sitting on sidelines Other investors slowing/reducing involvement Historic Tax Credit Coalition (KR is a member)
Met with IRS Sent letter to U.S. Treasury, members of Congress Prepared Amicus Brief to 4th Circuit re: Virginia Historic
Tax Funds
Industry Reaction
Questions?