The American Taxpayer Relief Act of 2012 extends the New Markets Tax Credit program for two years and $7 billion, with the first $3.5 billion scheduled to be awarded in April.
On January 2, President Obama signed into law the American Taxpayer Relief Act of 2012 (ATRA). Section 305 of ATRA extends the New Markets Tax Credit (NMTC) under Section 45D of the Internal Revenue Code by providing for $3.5 billion of NMTC allocation authority to be available for the Treasury to award for calendar years 2012 and 2013. In addition, Section 305 of ATRA extends the deadline by which the Treasury must re-allocate any unused awards by two years to the end of 2018.
The NMTC industry was optimistic there would be an extension of the program, though the hope was for Congress to authorize $5 billion of the NMTC allocation authority for each year of the extension (consistent with the amounts authorized in 2008 and 2009). Similar to the most recent 2-year extension of the program in 2010, the Community Development Financial Institutions Fund (CDFI Fund), the division of the Treasury delegated the authority to administer the NMTC program, conducted an application round assuming there would be an extension of the program. In fact, the 2012 applications were due in September, and there were 282 applications submitted, seeking an aggregate total in excess of $21.9 billion in NMTC allocation authority (i.e., greater than 625% of the amount made available under ATRA).
On January 3, the CDFI Fund posted on its website that it is currently reviewing these 2012 applications, and it plans to announce the awards in April.
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January 3, 2013
Tax Credit & Syndication Alert
Author(s): Susan P. Reaman
Congress averted the expiration of many key tax credit and deduction provisions affecting the housing, new markets, and energy credit industries by passing the American Taxpayer Relief Act of 2012 on January 1, 2013, and President Obama has since signed the legislation into law. This alert summarizes select provisions relevant to these industries.
Low-Income Housing Tax Credit
The Act includes a 9% housing credit floor provision that allows any project receiving an allocation of Low-Income Housing Tax Credits before January 1, 2014, to qualify for the 9% credit floor. Effectively, because of the regular two-year placed-in-service deadline for carryover allocations, this amounts to a two-year extension for projects receiving 2013 allocations and a one-year extension for projects receiving 2012 allocations. Please note that this rule applies only to 2013 or earlier housing allocation authority. Thus, the 9% credit does not apply to binding commitments to allocate housing credit authority from a housing agency’s allocation authority in years after 2013, even if such a commitment is entered into in 2013. The 4% credit was not changed by this legislation, and continues to float.
Military housing allowance
The Act retroactively extends the provision that the basic housing allowance of a member of the military is not considered income for purposes of calculating whether that person qualifies as a low-income tenant from December 31, 2011, through December 31, 2013.
New Markets Tax Credit
The Act retroactively extends the new markets tax credit for 2012 and also for 2013, providing for annual allocations of qualified equity investments of $3.5 billion, and it extends the period for re-allocating unused allocations to 2018.
Current law allows a 100% bonus depreciation for investments placed in service after September 8, 2010, and before January 1, 2012, and a 50% bonus depreciation for investments placed in service during 2012 (with the possibility of 100% for certain longer-lived and transportation assets). The Act extends the current 50% expensing provision for qualifying property purchased and placed in service before January 1, 2014 (before January 1, 2015, for certain longer-lived and transportation assets), and also allows taxpayers to elect to accelerate some alternative minimum tax (AMT) credits in lieu of bonus depreciation, thereby helping to avoid the AMT.
Energy PTCs and ITCs
The Act makes a significant change to the production tax credit (PTC) and the investment tax credit (ITC) that applies to otherwise PTC-eligible facilities (e.g., those that generate electricity using wind, geothermal, biomass, landfill gas, municipal solid waste, hydroelectric production, and marine and hydrokinetic energy). All of these are now eligible for the PTC or the 30% ITC, provided the facility begins construction not later than December 31, 2013. Formerly, the test had been whether the facility was placed in service by that date (or even earlier, in the case of wind). As yet, there is no guidance on what it means to “begin construction.” Treasury may adopt rules similar to those used by Treasury in administering the 1603 grant in lieu of tax credits program under the American Recovery and Reinvestment Act of 2009—i.e., either (A) continuous physical work of a significant nature commencing before 2014, or (B) incurring 5% of the cost of the facility before 2014—but remember that Treasury’s rules for grants are not binding on the IRS in administering this new energy credit extension. The rules for solar, fuel cells, and geothermal that generates heat continue to have the same placed-in-service tests as before the extension (e.g., solar facilities must be placed in service by the end of 2016 to qualify for the 30% ITC).
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Year-15 Low-Income Housing Tax Credit (LIHTC) exit strategy
Property owners who want to exit the LIHTC program before the end of the property’s lengthy extended low-income housing commitment may consider using the qualified contract process. This process allows an owner, at any time after the 14th year of the 15-year compliance period, to request the state housing agency to find a buyer who will operate the building as an LIHTC property. If the housing agency is unable to find a qualified buyer within a year, the land use restrictions terminate. The owner is free to operate the building at market rate subject to a three year period that caps rents for exiting tenants at the LIHTC rents and prohibits eviction except for good cause.
The IRS received many comments on how to implement the qualified contract process and, in particular, how to apply the qualified contract price formula. After considering these comments, the IRS final rules explain how the qualified process works and the requirements owners and state housing agencies must follow.
What is a qualified contract?
A qualified contract is a contract to acquire the LIHTC building for a price computed under a formula described in the section 42 statute and regulations. The formula breaks out the components of the building into a low-income portion and a non low-income portion.
Under the formula, the non low-income portion of the building is valued at fair market value. The value of the low-income portion is an amount not less than the sum of the outstanding debt, adjusted investor equity, and other capital contributions. This amount is then reduced by cash distributions from the project. Adjusted investor equity is the amount of cash invested in the project increased by an annual cost-of-living adjustment. The IRS final rules provide a mathematical formula to compute the adjuster investor equity.
The IRS rules explain in more detail other components of the purchase price formula that we will discuss below.
Qualified contract price formula components
Low-income portion price
Some commentators thought that the price of the low-income portion of a building should be capped at fair market value. The adjusted investor equity amount, which could possibly increase based upon the consumer-price-index-based cost-of-living adjustment, could inflate the formula price above the fair market value of a project. As was the case under the proposed rules, the IRS did not adopt this suggestion in the final rules. The language of the section 42 statute itself requires that the low-income portion purchase price cannot be less than the formula price. Also, the IRS made it clear in the preamble to the final rules that state housing agencies have no authority under the qualified contract rules to adopt a fair-market value cap for the low-income portion of the building.
Non low-income portion price
The proposed rules allowed state housing agencies to reduce the price of the non low-income portion of the building below the fair market value if, after a reasonable period of time within the one-year offer-of-sale period, no buyer has made an offer or market values decline. Commentators thought it unfair to grant the agencies a unilateral right to reduce the contract price. They were also concerned that such a rule might encourage potential buyers to wait out the qualified contract process until the agency lowers the price.
The IRS agreed that these were valid concerns. Consequently, the final rules allow a state housing agency to adjust the fair market value of the non low-income portion of the building only with consent of the owner. If no agreement can be reached between the parties, the fair market value determined at the time of the agency’s offer of sale of the building to the general public remains unchanged.
Despite some commentators’ view that the land is not explicitly mentioned in the purchase price formula, the final rules include the value of the underlying land in the qualified contract formula. Thus, the fair market value of the land underlying the entire building, taking into account the existing and continuing LIHTC restrictions, is included in the value of the non low-income portion of the building. The IRS reasoned that land is inherently part of the LIHTC project. Also, this approach is consistent with industry standards for valuing land.
Any adjustments to the qualified contract price between the date the sale price is first determined and the closing date due to adjustments to outstanding debt, is the responsibility of the buyer and owner, and not the housing agency as was originally provided for under the proposed rules.
Cash distributions and outstanding debt
With respect to project reserves, the final rules clarify that cash distributions only include reserve funds not legally required by mortgage restrictions, regulatory agreements, or any third-party contractual agreements that remain with the building following the sale of the building.
Also, debt from refinancings or additional mortgages in excess of qualifying building costs does not qualify as outstanding debt. The IRS rules define qualifying building costs generally as costs that go into the eligible basis of the building plus these types of costs that may be incurred after the end of the first year of the credit period. Some commentators argued that these debt limiting rules go beyond the scope of the statutory formula. They note the right of first refusal purchase price formula provision in which Congress explicitly excluded certain debt incurred in the five year period prior to the sale to the tenants. No such limiting language exists under the qualified contract purchase price formula.
Commentators also questioned the rationale for the requirement in the proposed rules that would discount outstanding debt having an interest rate below the AFR. The final rules remove the provision altogether. Instead, outstanding debt includes only those amounts secured by the building that do not exceed qualifying building costs, are true debt under federal income tax law, and upon the sale of the building, are actually paid to the lender or are assumed by the buyer as part of the sale.
As with the proposed rules, the final rules do not adopt any specific methodology or standards for appraising the LIHTC property. However, they do prohibit appraisers currently on any list for active suspension or revocation for performing appraisals in any state or listed on the Excluded Parties Lists System (EPLS) maintained by the General Services Administration for the United States Government. Agencies have discretion to select the appraisers involved in the qualified contract process and to require all appraisers to be state-certified general appraisers.
Actual offer of sale
The IRS seemed reluctant to place too many restrictions on the state housing agencies’ ability to enter into contracts or to provide any conflict resolution process, where the parties may disagree over the terms and conditions under the contract. Citing to the variations of contract law that exists from state to state concerning the terms of a bona fide contract and methods for resolving disputes, the IRS concluded that final rules should not explicitly address these issues. Instead, the final rules allow the state housing agencies to specify other conditions applicable to the qualified contract consistent with section 42 and the final rules.
Administrative discretion and responsibilities of the state housing agencies
The final rules allow the state housing agency to establish reasonable requirements for written qualified contract requests. Failure to follow these requirements could ultimately suspend the one-year qualified contract period to find a qualified buyer.
Examples of agency administrative discretion include—
- Concluding that the owner’s request lacks essential information and denying the request until such information is provided.
- Refusing to consider an owner’s representations without substantiating documentation verified with the agency’s records.
- Determining how many, if any, subsequent requests to find a buyer may be submitted if the owner has previously submitted a request for a qualified contract and then rejected or failed to act upon a qualified contract presented by the agency.
- Assessing and charging the owner certain administrative fees (for example, real estate appraiser costs).
Now that the qualified contract rules have been finalized, they will hopefully provide some consistency in the implementation of the qualified contract process throughout the country as between owners and the state housing agencies.
Susan Reaman is of counsel in the Tax Credit Finance & Syndication Group, focusing on tax credit financing for transactions involving the low-income housing, new markets, historic, and energy tax credits. For more information, contact Susan Reaman at 202-585-8327, firstname.lastname@example.org, or your Nixon Peabody LLP attorney.
In addition to the usual rules defining “low income communities” where projects are eligible for the new markets tax credit, the Code provides that certain individuals or groups of individuals who are low income or lack access to loans or equity investments, may qualify as a “targeted population” that is also eligible. The IRS first provided guidance, describing how an entity serving certain targeted populations could meet the requirements to be a qualified active low-income community business (or QALICB), in Notice 2006-60, and then, proposed regulations were published in September, 2008. Under those rules, a QALICB could rely on the Notice until the regulations became “final.”
Now, more than three years later, final regulations for targeted populations have been published. The IRS received many comments with respect to the proposed regulations to expand and clarify the rules. However, with few exceptions, the final regulations adopt the guidance from the Notice and the proposed regulations. The final regulations are effective December 5, 2011. Taxpayers may apply these new rules to taxable years ending before December 5, 2011 for targeted populations designated as eligible low-income communities by Treasury after October 22, 2004. Thereafter, Notice 2006-60 is obsolete and QALICBs must use the new final regulations.
As you may recall, an entity qualifies as a QALICB serving targeted populations if at least 50% of its gross income is “derived from” sales, rentals, services, or other transactions with low-income persons, at least 50% of its ownership is by low-income persons, or at least 40% of its employees are low-income persons. Such a QALICB could not be located in a census tract that exceeds 120% of the area median family income. A targeted population also includes individuals displaced by Hurricane Katrina.
The final regulations do not expand the definition of targeted populations. However, the IRS and Treasury have asked for comments to identify other individuals or groups that may be appropriate as additional targeted populations.
Here is a summary of the important additions and clarifications to the targeted populations rules.
Documenting Low-income Persons
In general, a person is considered low-income in a metropolitan area if his or her income is not more than 80% of the area median family income; and in a non-metropolitan areas, if his or her income is not more than the greater of (i) 80% of the area median family income; or (ii) 80% of the statewide non-metropolitan area median family income. The final regulations allow a QALICB to measure family income of a person using a range of methods, including (i) the method employed by the U.S. Census Bureau, (ii) the method used by HUD, or (iii) the individual’s total family income as reported on Form(s) 1040. Under the Form 1040 method, an individual’s family income includes the income of any member of the individual’s family (as defined in section 267(c)(4); i.e., spouse, siblings, ancestors and lineal descendants) if the family member lives with the individual regardless of whether the family member files a separate return.
Items Included in Gross Income
The final regulations clarify that when establishing that the QALICB’s income is “derived from” dealing with low-income persons, the computation includes money and the fair market value of contributions of property or services provided to a QALICB primarily for the benefit of low-income persons. This position is consistent with a recent private letter ruling. Since letter rulings are not precedential, incorporating this definition of “derived from” in the final regulations will greatly assist QALICBs in assuring compliance with the targeted populations rules.
The Preamble to the final regulations notes that persons providing the money and contributions to a QALICB on behalf of low-income persons cannot receive a direct benefit from the entity. A contribution that benefits the general public is not a direct benefit. Thus, gross income derived from federal, state, or local grants, charitable donations, or in-kind contributions, as well as collected fees, insurance reimbursements, and other sources of income are acceptable as long as these payments and contributions are provided for the benefit of low-income persons on either an individual basis or as a class of individuals.
The QALICB must be able to document that such payments are legally required to be paid on behalf of individuals that meet the definition of low-income persons.
Under the Notice, an owner had to be a low-income person at the time the qualified low-income community investment (QLICI) was made and was then “locked in,” i.e., considered a low-income person throughout the NMTC 7-year credit period. One commentator suggested that the rule locking in an owner’s status as a low-income person as of the time of the QLICI should be similarly applied to low-income persons who acquire an ownership interest after the QLICI is made. The final regulations adopt this suggestion by locking in the status of an owner as a low-income person at the time the QLICI is made or at the time the ownership interest is acquired.
Rental to Others of Real Property
The final regulations provide a special rule for QALICBs whose sole business is the rental to others of real property by treating the QALICB as satisfying the 50-percent gross-income requirement if the entity is treated as being located in a low-income community. A QALICB is treated as being located in a low-income community if at least 50% of the entity’s total gross income is derived from (i) rentals to individuals who are low-income persons or (ii) rentals to a QALICB serving low-income targeted populations.
Gross Income—Fair Market Value of Sales, Rentals, Services, or Other Transactions
The final regulations provide a limited rule that allows a QALICB with gross income that is derived from sales, rentals, services, or other transactions with both non-low-income persons and low-income persons, to treat the value of the sales, rentals, services, or other transactions with low-income persons at fair market value even if the low-income persons do not pay fair market value.
This column, authored by Boston tax credit finance & syndication partner Forrest Milder, discusses the U.S. Treasury’s recently published document, "Evaluating Cost Basis for Solar Photovoltaic Properties,” which provides some explanations of how it thinks about valuations and grants.
For the complete article, please access the following: http://www.novoco.com/journal/2011/08/news_retc_201108.php
July 1, 2010
New tax credit or cash grant for qualifying therapeutic discovery projects
Do I choose grant or credit? The Qualifying Therapeutic Discovery Project Credit (QTDPC) provides a new business tax credit, or grant in lieu of the credit, for small companies that show significant potential to produce new cost-saving therapies, create U.S. jobs, and increase U.S. competitiveness.
Click here to read the full article on nixonpeabody.com.
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This newsletter is intended as an information source for clients and friends of Nixon Peabody LLP. The content should not be construed as legal advice, and readers should not act upon information in this publication without professional counsel. This material may be considered advertising under certain rules of professional conduct. Copyright © 2010 Nixon Peabody LLP. All rights reserved.
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By Forrest Milder
Perhaps the most important energy financing legislation of last year is Section 1603 of the American Recovery and Reinvestment Act of 2009. It provides for a payment from the U.S. Treasury that is generally equal to 30 percent (sometimes 10 percent) of the applicant’s basis in a wide range of renewable energy properties. A payment is available only if the property is placed in service before the end of 2010, or construction commences in 2009 or 2010 and the property is placed in service before certain termination dates, depending on the kind of property. For solar and fuel cells, that date is December 31, 2016; for wind, it’s December 31, 2012; and for most other renewables, including biomass, municipal solid waste, and most geothermal, it’s December 31, 2013.
Since last July, Treasury has been soliciting questions from the public, and in January 2010 it released a set of 35 questions and answers (Q&As) intended to clarify the Section 1603 rules. Click here to read about the highlights.
By Susan P. Reaman
Among the many welcome changes to the low-income housing credit program under the Housing and Economic Recovery Act of 2008 (“HERA”) was the establishment of the Capital Magnet Fund (CMF). With direct funding of $80 million under the president’s 2010 budget, the CMF will provide grants to finance affordable housing and related community development projects. Eligible grantees include community development financial institutions (CDFIs) and nonprofit organizations having the development or management of affordable housing as one of their principal purposes.
The CMF was established as a permanent trust fund and will be administered by the Treasury Department’s Community Development and Financial Institutions (CDFI) Fund. The CDFI Fund administers other grant programs, including the CDFI Grant Program which provides financial and technical assistance to CDFIs serving low-income people and communities and the New Markets Tax Credit Program, which provides investors a tax credit for investing in businesses located in under-served areas.
As its name suggests, CMF grant dollars are to be used to attract private capital for and increase investment in the development, preservation, rehabilitation, or purchase of affordable housing primarily for extremely low-, very low-, and low-income families, and related economic development activities or community service facilities such as day care centers, workforce development, and health care clinics.
Awards of CMF grants are intended to stabilize and revitalize low-income or under-served rural areas. Grantees may use grant monies to establish loan loss reserves, to capitalize a revolving loan fund, an affordable housing fund, or a fund to support economic development activities or community service facilities, and to provide risk-sharing loans.
In March 2009, the CDFI Fund published a Request for Public Comment on how the CDFI Fund should design, implement, and administer the CMF. In July 2009, the CDFI Fund released, on its website (www.cdfifund.gov), 37 comment letters it received in response to its request for public comment. Many commentators urged the CDFI Fund to use definitions and criteria from existing programs, such as the CDFI Grant Program, to fashion similar rules for the CMF. As for what constitutes “affordable housing,” many commentators suggested that housing units meet the income, rent, or purchase price term requirements of either the Low-Income Housing Tax Credit (LIHTC) for rental properties or the HUD HOME Investments Partnerships Program for rental and home ownership. At least one commentator suggested that a percentage of the affordable housing funding be used for workforce housing or specific populations, including but not limited to artists, teachers, firefighters, and police officers. The CDFI Fund specifically asked for comments on whether it should support economic development activities, and/or community service facilities in conjunction with affordable housing activities financed by sources other than CMF grants such as the LIHTC, HOPE VI, or private sources.
The CDFI Fund will administer competitive application rounds to distribute CMF grants. Officials from the CDFI Fund estimate that an Interim Final Rule should be released this year as early as late February. A final application should be published shortly thereafter. Administration of the CMF program will most likely be similar in many respects to the CDFI Grant Program.
On its website, the CDFI Fund describes some of the information that the application will require, including: a detailed description of the types of affordable housing, economic, and community revitalization projects the grantee would fund with a grant through the CMF; the specific use of grant funds; the types, sources, and amounts of other funding for such projects; and the timeframe for use (deployment) of grant funds.
In addition, selection criteria, prioritization, and compliance requirements must ensure that the CMF grants support activities in geographically diverse areas, including (to the extent practical) metropolitan and under-served areas in every state.
As required under the HERA, no more than 15 percent of the aggregate amount of funds available in a given round may be awarded to any one grantee (or its affiliates and subsidiaries); grantees must leverage their CMF awards by at least 10 times the award amounts; and the grant funds must be committed for use within two years of allocation. We expect clarification of these statutory criteria will be forthcoming under the Interim Final Rule and application.
The funding of the CMF comes at a critical time for developers in the affordable housing industry who are eager to jumpstart the industry in 2010. Grants available through the CMF Program provide yet another government economic tool toward realizing that goal.
Please feel free to contact your regular Nixon Peabody attorneys, or Susan P. Reaman at 202-585-8327 or email@example.com, with your thoughts and questions. We look forward to hearing from you.
By Richard Michael Price and Susan P. Reaman
We often refer to affordable housing as a public-private partnership, in that it often takes public and private resources working together to create lasting affordable housing. Generally, affordable housing includes some form of government involvement, ranging from direct subsidies (e.g., the Section 8 rent subsidy program) to financing programs (e.g., low-income housing tax credits( LIHTCs)), which bring with them substantial compliance obligations.
As a refresher, it is important to be mindful of how the actual or perceived lack of compliance is manifested. The Inspector General Act of 1978 authorized inspectors general to audit program operations and examine waste, fraud, and abuse. Often, seemingly innocuous activities can be questioned as inefficient, ineffective, or occasionally incorrect. Any such finding can bring with it significant issues, ranging from civil to criminal penalties.
The HUD Office of Inspector General (HUD OIG) has been in existence since before the 1978 act. The HUD OIG has a three-step audit process. If you are contacted by the HUD OIG, this is what you should expect. The first step is the entry conference, where OIG representatives explain what they plan to review. The second step is a review of the books, records, and condition of any property in question. The last step is the exit conference, where the OIG reveals findings.
It is very important to prepare for the OIG in advance, because preparation will help avoid misunderstandings. Ideally, you should consult experienced counsel, because even parties confident that they are complying with agency rules often receive adverse OIG findings, which can bring sanctions. These sanctions can range from 2530 flags to administrative and even criminal sanctions. Administrative sanctions can include debarments, suspensions, and fines, such as civil money penalties (CMPs). Suspensions become effective upon issuance of HUD OIG findings and before any appeal may be taken, but debarments become effective only after administrative appeals are exhausted. CMPs are initiated through a letter process. If a target fails to respond to a CMP letter, it may inadvertently waive the right to respond later on, when HUD files a formal administrative complaint.
HUD rules allow the imposition of these sanctions for a variety of violations, but program participants should pay special attention to certain catch-all provisions, which provide that sanctions may be applied for any material breach of a contract related to a HUD project, any violation of an applicable HUD regulation, or the making of any false statement in connection with a HUD-financed project. Sanctions against a person or a company generally extend to all of the subsidiaries and affiliates of that person or company.
Similar rules exist in other non-HUD housing programs. The largest single multifamily housing loan program outside of HUD is at Rural Development (RD), which is part of the U.S. Department of Agriculture (USDA). RD programs are subject to audit and review by the USDA’s Inspector General, also under the Act, but also USDA specific procedures. RD does not utilize 2530s to the same extent as HUD but does have an informal review of borrower qualification to perform new transactions. RD also can assess CMPs.
Affordable housing owners receiving LIHTCs also must meet low-income housing eligibility and compliance requirements under the LIHTC program. This includes cash grants or loans under the recently enacted Section 1602 Credit Exchange Program, and the Tax Credit Assistance Program (TCAP Program) under the American Recovery and Reinvestment Act of 2009.
State agencies are responsible for compliance monitoring for these programs throughout the 15-year compliance period. Compliance issues include: meeting health and safety standards, rent ceilings and income limits, and tenant qualifications. Failure to meet these requirements may result in recapture of the housing credit or, in the case of the Section 1602 Credit Exchange Program, the full amount of the 1602 award minus 6.67 percent (1/15th) for each full year of the building’s 15-year compliance where a Section 1602 recapture event has not occurred.
When noncompliance is identified or there has been disposition of a building (or interest therein), state agencies must notify IRS using Form 8823, “Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition.” In the case of the Section 1602 Credit Exchange Program, where no tax credits are involved, no Form 8823 is sent to IRS to report noncompliance. However, states may use Form 8823 to notify owners of compliance issues. Upon receipt of Form 8823, the IRS sends a Notification Letter to the owner, identifying the type of noncompliance reported on Form 8823. The Notification Letter states that owner may not include any nonqualified low-income units when computing the LIHTC and that the noncompliance may result in recapture of the LIHTC. The Notification Letter instructs the owner to contact the state agency to resolve the matter. Forms 8823 are routinely analyzed by IRS and may result in an audit of an owner’s tax returns.
The Internal Revenue Service recently updated its Guide for Completing Form 8823: Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition as of October 2009. This publication provides in-depth analysis, including examples of the categories of noncompliance as identified on Form 8823. The guide also incorporates the changes to the LIHTC program enacted under the Housing and Economic Recovery Act of 2008, revisions to HUD’s Handbook 4350.3, and the amended IRS utility allowance regulations published in July 2008. (For more information on the new utility allowance rules, see Nixon Peabody Tax Credit Alert, May 17, 2009).
As the affordable housing programs continue to evolve, HUD, RD and IRS vigilance should be expected to continue to be felt through audits and reviews and owners, managers and other housing providers will have to be mindful of ongoing and perhaps new compliance requirements.
For more information, please contact:
Richard Michael Price at 202-585-8716 or firstname.lastname@example.org
Susan P. Reaman at 202-585-8327 or email@example.com
If you’ve been following our renewable energy client alerts, you know that we’re always looking for the larger implications of IRS announcements in the field. After the leading revenue procedure on production tax credits for wind, Rev. Proc. 2007-65, was announced, we speculated that many of its features, particularly the ability to “flip” an investor’s interest from 99 percent down to about 5 percent, would quickly spread to other kinds of tax credit transactions, even though, by its terms, the revenue procedure only applied to wind. Indeed, flips to 5 percent have become routine practice in many partnerships used in tax credit and grant transactions.
This brings us to the latest publication on the topic from Treasury, Announcement 2009-69. It updates and modifies Rev. Proc. 2007-65 in four ways, and we expect at least one of the rules of this announcement to spread to a broad range of transactions.
The four parts of Announcement 2009-69:
- It makes clear that 2007-65 is a “safe harbor” and not an “audit guideline.”
- It provides the ability to set a fair market value purchase price for the facility before the time of exercise.
- It assures that individuals with passive income from other sources can use wind credits to reduce their tax liability from those other sources.
- It makes clear that non-compliance with 2007-65 will not subject a transaction to “close scrutiny.”
The new rule about fair market value should get your special attention. In this announcement, Treasury has greatly eased the burden on structuring exit strategies for wind transactions, and, if our prior experience with wind rulings continues to apply, this may ultimately result in modified exit strategies for most other tax credit transactions as well.
What does the Announcement say about fair market value?
The announcement provides that the developer, the investor, or any related party may have a “contractual right” to purchase the wind farm, any property included in the wind farm, or an interest in the project company (i.e., the partnership or limited liability company that owns the wind farm) if the following requirements are met:
- The contractual right must be negotiated for valid non-tax business reasons.
- The negotiation must be at arm’s length by parties with material adverse interests.
- The purchase price must be not less than “fair market value,” which is determined either:
- at the time of exercise, or
- at an earlier time, provided the parties reasonably believe, based on all facts and circumstances at the time the price is determined, that the price will be not less than fair market value at the time the right may be exercised.
In addition, the announcement keeps the rule from Rev. Proc. 2007-65 that does not allow the developer or a related party to have such a contractual right earlier than five years after the facility is placed in service.
Thinking about Announcement 2009-69
I intentionally parsed the fair market value test into several pieces to help us consider its implications.
First, there’s the requirement that the contractual right must be negotiated for valid non-tax business reasons. This requirement should be easy enough to meet. It’s hard to imagine a renewable transaction where, at the very least, the developer or the host would not like to regain sole control of the facility. From the investor’s end, having the ability to convert an illiquid partnership interest into cash also seems a valid non-tax business objective.
Second, the negotiation must be at arm’s length by parties with material adverse interests. If the negotiation were between the owner partnership and the host-user, this requirement should be easily met. The developer would be accepting a single payment (or an installment payout) in lieu of payments for the sale of energy, and the host-user would be seeking the opposite. Thus, the two have “material adverse interests.. However, by its terms, the announcement applies to a different group of people, i.e., the developer, the investor, and their related parties. When a buyout of the investor is involved, the argument may be a bit harder to maintain—the typical investor desires a set of tax benefits, and is then willing to withdraw. Indeed, it’s often the tax advisor who insists on “profit motive” or a minimum 5-percent interest based on Rev. Proc. 2007-65. Still, the investor does have an adverse interest—if it stays in the transaction, it should get a string of payments, and the IRS has already determined that a 5-percent interest is “sufficient.” So, even between the developer and the investor, negotiating a buyout for this right should be a negotiation between parties with material adverse interests.
Third, and here’s the most important part of the announcement, the parties can set the price in advance, if they reasonably believe it will be the future fair market value. Note that the announcement does not provide guidance as to “reasonable belief”—in particular, it doesn’t require a professional valuation. That’s not to say that a professional valuation isn’t a good idea, especially when a lot of money or tax credits are at stake, but it does indicate that the parties should be able to run a set of projections, showing a range of values of the purchaser’s future rights or obligations and then negotiate a price based on that analysis. For example, the projections might show what a host could expect to pay for electricity, or an investor might expect to get in distributions, determine an appropriate rate of return, and then present value the stream of projected payments or distributions to come up with a value, or at least the starting place for an “arm’s length negotiation.”
What are the implications of the announcement?
We should expect the announcement to lead to some important changes in how business deals are done. In particular:
- Ability to set the price in advance. Of course, this is the key implication of the ruling, and the question is how far this rule might extend. While there continue to be places in the regulations and legislative history that refer to “fair market value at the time of exercise,” the announcement has changed the timing significantly, at least for transactions within its scope, i.e., wind production tax credit deals where a purchase right is held by a developer or investor. Now, as noted earlier, the collateral question is whether this standard will migrate to other tax credit transactions, and to other parties. For example, if fair market value “reasonably” determined in advance works for wind PTC deals, then shouldn’t it also work for wind ITC deals (where the tax credit is 30 percent of the cost of the facility)? If it works for wind, shouldn’t it work for solar, biomass, or geothermal? If it works for a developer or investor, shouldn’t it work for a host of the project or purchaser of the electricity? After all, shouldn’t the definition of “fair market value” be the same, regardless of the kind of energy or the person exercising the purchase right? Accordingly, we’ll be watching to see whether this safe harbor becomes a more universal standard.
- Tax exempts and governments. If you’ve been a regular reader of our alerts or seen us speak at conferences, you’ve heard about the implications of Section 7701(e)(4) of the Code. That’s the section that distinguishes between leases and service contracts, and effectively provides a safe harbor from the “tax-exempt use” rules of the Code if four tests are passed, one of which is that the service recipient not have an option to purchase, or be required to purchase, all or part of a facility “at a fixed and determinable price (other than for fair market value).” This is a special area of interest under the “Set the Price in Advance” heading. If the rules of the new announcement apply to a Section 7701(e)(4) determination, then a tax-exempt user or a governmental user could have a pre-set option price, provided that price is determined in accordance with the rules described above. Obviously, this would be a major boon to the structuring of tax-exempt and governmental projects.
- “Not less than” pricing. The announcement provides that the purchase price must be “not less than” fair market value. Because several tax rules require that the price be fair market value, tax advisors and their clients have worried about whether the seller can set a “minimum price” (e.g., one that guarantees a certain rate of return) that might be higher than fair market value. While many transactions are already using such prices, the announcement plainly allows them.
Calls vs. other purchase rights. By virtue of amending Rev. Proc. 2007-65, the announcement only applies to “calls” held by developers and investors. But it’s hard to see why a call couldn’t also run to a service recipient. Furthermore, tax advisors have sometimes extended “put” rights to other people, provided the right is tied to fair market value. In view of the announcement, should it be possible for a service recipient to have a call to acquire the facility, and the owner of the facility to have a similar put, each at a reasonable, pre-determined fair market value?
Perhaps not. Because Rev. Proc. 2007-65 expressly doesn’t allow puts, this line of reasoning merits more thought. But it is hard to see why a fair market value methodology should be okay for calls, but not for other kinds of transactions.
Of course, there are larger implications if the parties can assure a purchase and sale of the facility for a purchase price set in advance. This would go beyond mere puts and calls. For example, tax advisors have worried about whether providing a definite obligation to acquire property turns a service relationship into an installment sale. In other words, if the host buys electricity from the owner of the facility for five years, followed by a definite obligation to purchase the facility for a known price in year six, is this arrangement really a sale of the facility in the first year, with contingent payments in the first five years, followed by the final payment in year six? Similarly, if an investor is admitted to a partnership for five years, with a fixed exit price in year six, is this still a partnership relationship that entitles the investor to be allocated tax credits for the years when it’s a partner? Even under the announcement, these kinds of transactions appear problematic.
Now, as previously noted, it must be remembered that the Revenue Procedure and, therefore, the announcement are expressly limited to Section 45 production tax credits for wind facilities. This means that you should work with your tax advisor to determine whether a particular non-wind-PTC transaction should be structured in reliance on the announcement. Still, you have to wonder how the IRS will be able to provide a compelling argument as to why fair market value can be set in advance for these kinds of facilities and credits, but not others. Of course, the production tax credit, which is based on sales of electricity, has the potential to vary over the 10-year period of the credit, but that shouldn’t affect whether fair market value can be set in advance. Finally, each transaction should be structured and documented with care, to assure that the parties really are negotiating at arm’s length for non-tax reasons, and that their fair market value price is “reasonable.” We wouldn’t rule out using professional valuations, or at least valuation guidelines (for determining internal rate of return, and similar components of a valuation analysis), as the situation warrants.
- To refresh the reader’s memory, a “call” is the right of a buyer to force the owner to sell, and a “put” is the right of an owner to force a buyer to buy.
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