IPED HOUSING TAX CREDITS

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IPED HOUSING TAX CREDITS 101San Francisco,
CaliforniaJuly 24-25, 2008Molly R.
BrysonThomas A. Giblin
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Background

• Part of 1986 Tax Reform to Encourage the
  Construction and Rehabilitation of Low-Income
  Rental Housing
• Administered by the Treasury Department and
  Allocated by State Agencies
• Contained in Section 42 of the Tax Code
• Emphasis on Private Sector Involvement (i.e.
  Developing and Managing Projects)
• Objective To Provide Investor Equity to Lower
  Debt Service, Thereby Lowering Rents
• Credit is a Dollar-for-Dollar Tax Reduction
• Credit Amount Based on the Cost of Constructing
  or Rehabilitating Housing Developments

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Program Requirements

• Minimum Percentage of LIHTC Units (20/50 or
  40/60)
• Minimum 30-Year Affordability Commitment
• Maximum Rents Limited for LIHTC Units
• Maximum Income Limited for Households Renting
  LIHTC Units
• Projects Subject to IRS and State
  Regulation/Compliance

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State Allocation Volume Limit

• Credits Are Limited
• In 2000, Congress Raised Cap from 1.25 to 1.50
  in 2001, 1.75 in 2002, and Thereafter Adjusted
  for Inflation
• 2.00 Per Person for 2008
• 2,325,000 State Minimum in 2008

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Volume Limit Rules

• Example
• State With Three Million Population Has
  6,000,000 in Credits in 2008
• Allocated Amount is for One Year of Credit
• 10 Nonprofit Set-Aside
• 50 Test Private Activity Tax-Exempt Bonds
  Subject to Bond Volume Cap No Credit Allocation
  Needed

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Qualified Allocation Plans

• State Must Adopt QAP to Allocate Credits
• QAP Must Set Forth Allocation Priorities
• QAP Must Give Preference To
• Lowest Incomes
• Longest Period of Low-Income Use
• QCT Projects Contributing to a Concerted
  Revitalization Plan
• QAP Must Provide Procedure for Notifying IRS of
  Non-Compliance
• Bond Financed Projects Must Satisfy QAP

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Project Evaluation

• Credit May Not Exceed Amount State Agency
  Determines Is Necessary for Feasibility and
  Viability
• Agency Must Consider
• Sources and Uses
• Amounts Expected to Be Generated by Tax Benefits
• Reasonableness of Development and Operating Costs

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Project Evaluation (Contd)

• Evaluation Occurs at Application, Allocation and
  Completion
• Owner Must Certify as to Amount of Subsidies
• For Tax-Exempt Bond Financed Projects, Issuer
  Must Make Similar Evaluation
• Agency Must Require Market Study Paid by Developer

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Industry Participants

• Congress
• IRS/Department of Treasury
• State Tax Credit Agencies
• Developers/Owners
• Property Managers
• Syndicators/Investors
• GSEs
• Nonprofits
• State/Local Governments
• HUD
• Tenants
• Tax Professionals

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Who Can Use Credits?

• C Corporations Can Use Credits and Losses Against
  Ordinary Income and Taxes
• Limitations on Closely-Held Corporations
• Individuals Limited Under Passive Loss Rules to
  Approximately 9,900/Year at the 39.6 Rate
• Cannot Use Credits Against Alternative Minimum Tax

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Structure
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Key Business Terms

• Projects Owned by Limited Partnership or Limited
  Liability Company
• Limited Partner Generally Owns 99.99 of Tax
  Credits, Losses and Profits
• Limited Partner Pays in Capital Contributions in
  Multiple Installments (Generally 3 or 4), Based
  on Negotiated Benchmarks
• General Partner Guarantees Completion, Amount of
  Credits, and Funding of Deficits

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Tax Credit Development Timeline

• July 2008 Read State QAP. Analyze Prior Winners,
  Meet With Staff.
• July 2008 Pick Site, Plan Type of Project.
• August 2008 Develop Cash Pro Formas and
  Construction Budget. Investigate Loan
  Availability and Interest Rates. Request Market
  Study.
• November 2008 Option Land (With Conditions
  Regarding Zoning, Approvals).
• November 2008 Apply for Soft Loans/Grants, if
  Necessary.
• December 2008 Receive Soft Loan Commitment.

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Tax Credit Development Timeline (Contd)

• March 2009 Apply for Tax Credits.
• May 2009 Receive Reservation of Tax Credits.
• May 2009 Work on Site Plan and Zoning Approvals.
  Submit Applications for Construction and
  Permanent Loans.
• July 2009 Obtain Site Plan and Zoning Approvals.
• July 2009 Purchase Land. Select Equity Investor
  and Execute Letter of Intent. Execute Commitment
  Letter for Debt/Equity.
• November 2009 Submit Cost Certification of 10 of
  Reasonably Expected Basis for Carryover
  Allocation (State Deadlines Vary).
• December 2009 Obtain Carryover Allocation.

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Tax Credit Development Timeline (Contd)

• January 2010 Close on Equity Investment and
  Construction Loan. Begin Construction.
• November 2010 Finish Construction. Begin
  Leasing.
• January 2011 Start First Year of Credit Period.
  Continue Leasing. Submit Cost Certification for
  Forms 8609.
• April 2011 Achieve Full Lease-up and Beginning of
  Break-Even Period. Obtain Forms 8609.
• September 2011 Close Permanent Loan and Achieve
  Final Equity Contribution.
• December 31, 2011 Place All Buildings in Service.

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Calculating Credits/Defining Terms

• Annual Credit Amount Applicable Percentage X
  Qualified Basis
• Annual Credit Amount Available for 10 Years
• Credit Period Begins When a Building is Placed in
  Service Unless the Taxpayer Elects to Defer the
  Start of the Credit Period to the Next Taxable
  Year
• First Year Credit Reduced to Reflect Qualified
  Occupancy During First Credit Year

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Applicable Percentage

• Two Credits
• 70 Percent Present Value Credit (9 Credit)
• 30 Percent Present Value Credit (4 Credit)
• Credit Rates
• 7.93 and 3.40 for July 2008
• Lowest Rates for July 2003 (7.78 and 3.33)
• Owner Elects to Set Applicable Percentage
  Either(i) When Receiving a Binding Commitment
  From the State (or When Tax-Exempt Bonds Issued)
  (a Lock-in Election), or (ii) When Building
  Placed in Service

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9 Credit vs. 4 Credit
New Construction Rehabilitation Acquisition
9 Credit Yes Yes No
4 Credit Yes Yes Yes
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4 Credit for New Construction or Substantial
Rehabilitation

• Federally Subsidized New Construction or
  Rehabilitation Expenditures
• Building Receives Tax-Exempt Bonds or Below
  Market Federal Loan
• Below Market Federal Loan
• From Federally Appropriated Funds
• Interest Rate Below AFR (in July 2008 for
  Long-Term Loans Compounded Annually, AFR 4.60)

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Exceptions From Federally Subsidized Definition

• HOME Loan if 40 at 50 Targeting (in Each
  Building)
• Community Development Block Grant (CDBG) Loans
• Affordable Housing Program (AHP) Loans
• Loan or Bond is Subtracted From Eligible Basis
• Section 8
• Native American Housing Assistance and
  Self-Determination Act (NAHASDA) of 1996 if 40
  at 50 Targeting (in Each Building)

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4 Credit for Acquisition

• Based on the Acquisition Cost of an Existing
  Building
• Purchase From an Unrelated Party
• Ten-Year Rule
• Certain Placements in Service Ignored
• Carryover Basis
• Acquired From Decedent
• Placement in Service by Governmental Unit or
  Nonprofit Entity
• Foreclosure
• Waiver of Ten-Year Rule From Treasury

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Substantial Rehabilitation Requirement

• Expenditures During a 24-month Period Selected by
  the Taxpayer Must Equal the Greater Of
• 3,000 Per Low-Income Unit, or
• 10 of Adjusted Basis
• Separate New Building

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9 Credit for New Construction or Substantial
Rehabilitation

• If Not Federally Subsidized

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Basis Calculations

• Start With Eligible Basis, Then Qualified Basis

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Eligible Basis

• New Construction Adjusted Basis (Generally,
  Development Cost Less Land)
• Acquisition Acquisition Cost
• Substantial Rehabilitation Capitalized
  Rehabilitation Expenditures (24-Month Rule)
• Must Subtract Federal Grants
• 130 Increase in Qualified Census Tracts (QCTs)
  and Difficult Development Areas (DDAs)

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Qualified Basis

• Qualified Basis Applicable Fraction X Eligible
  Basis
• Applicable Fraction is the Lower of
• Number of Occupied Low-Income Units Divided by
  the Total Number of Residential Units, or
• Floor Space Fraction

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Example of Tax Credit Calculation

• 100 Unit Project/70 Low-Income Units
• Total Development Costs (Including Land) 5.5m
• Land Value 500k
• Eligible Basis 5.0m
• Qualified Basis 3.5m (5.0m X 70)

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Example Tax Credit Calculation (Contd)

• Applicable Percentage 7.93 (Not Federally
  Subsidized)
• Annual Credit 277,550 (3.5m X 7.93)
• 10-Year Credits 2,775,500

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Common Areas

• Eligible Basis Includes Cost of Common Areas and
  Tenant Facilities to the Extent Such Facilities
  Are Made Available to all Residents Without
  Additional Charge
• Common Areas Include Community Rooms, Garages,
  Laundry Rooms and Pools/Playgrounds
• Common Areas/Tenant Facilities Must Be Used
  Exclusively by Tenants of the Tax Credit
  Property
• Community Service Facility Exception Cost of
  Construction Community Service Facility May Be
  Included in Eligible Basis Even if Non-Residents
  Use the Facility

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Manager Units

• Eligible Basis Includes Cost of Constructing
  Units Occupied by a Full-Time Resident
  Manager/On-Site Maintenance Personnel
• Manager Units Are Excluded From the Applicable
  Fraction When Determining a Buildings Qualified
  Basis

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Determining Eligible Basis in Mixed Use Buildings

• Mixed Use Buildings May Qualify for Tax Credits
  but the Eligible Basis Must be Reduced by the
  Cost of any Non-Residential Rental Property
• Cost of Common Areas Allocated Between
  Residential/Non-Residential Use According to any
  Reasonable Method that Properly Reflects the
  Proportional Benefits to Be Derived by the
  Residential/Non-Residential Property
• Common Approach Allocating Cost of Common
  Elements Based on Relative Square Footage of
  Residential/Commercial Property

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Equity Calculation

• Pricing Primarily Based on Total Amount of
  10-Year Credits Available to Investor and Market
  Conditions
• Expressed as Cents Per Tax Credit Dollar
• In Above Example, if Investor Will Pay 0.80 Per
  Tax Credit Dollar, Equity Equals 2,194,980
  (2,744,000 X 99.99 X 0.80)
• Equity Generally Paid in Several Installments
  (Often 3 or 4 Installments) Based Upon Negotiated
  Benchmarks
• If Bond-Financed 4 Deal, Equity Equals 951,905
  ((5,500,000 - 500,000) X 70 X 3.40 X 10 X
  0.80 X 99.99)

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Income-Restricted

• Minimum Set-Aside Election of
• 20 of Units at 50 of Area Median Income
  (AMI), or
• 40 of Units at 60 of AMI
• Election Upon Placement in Service
• Must Meet Minimum by End of First Credit Year
• HUD Publishes Area Income Figures Annually

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Rent-Restricted

• Rent (Including Utilities) Cannot Exceed 30 of
  Qualifying Income for Assumed Family Size Based
  on Bedrooms Per Unit
• Rent Limits Change Annually With Publication of
  New Area Median Incomes
• Rent Will Not Decrease Below Original Floor
• Gross Rent Does Not Include Section 8 (or Similar
  Rental Subsidies)
• Gross Rent Must Include Utility Allowance for
  Tenant-Paid Utilities (i.e., Deduct From Rent to
  Owner)

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Continued Compliance

• 15-Year Compliance Period
• Continued Tenant Qualification
• 40 Increase Above Eligibility OK
• Vacant Units/Over-Income Units OK if Next
  Available Unit Rule Followed

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Understanding The Affordability Commitment

• 30-Year Affordability Commitment
• 15-Year Tax Credit Compliance Period
• 15-Year Extended Use Period
• Early Termination of 30-Year Affordability
  Commitment
• Foreclosure (or Instrument in Lieu of
  Foreclosure)
• Qualified Contract Process
• Extended Use Agreements

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Qualified Contract

• State to Find Buyer if Requested by Owner After
  14th Year Pursuant to Qualified Contract
• Contract
• Outstanding Debt
• Adjusted Investor Equity
• Other Capital Contributions, Less
• Cash Available for Distribution

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Qualified Contract (Contd)

• Adjusted Investor Equity Initial Investor
  Equity to Project Inflated by COLA (Up to 5 Per
  Year)
• If No Buyer Found Within One Year, Property May
  Be Sold or Converted to Non-Low-Income Housing,
  Subject to 3-Year Vacancy Decontrol
• IRS Issued Proposed Regulations in June 2007
  Comments Received and Under Review Public
  Hearing Held

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Recapture

• Recapture on Non-Compliance
• Accelerated Portion of Credit Recaptured (1/3 of
  Credit First 10 Years, Decreasing Through Year
  15)
• If Minimum Set-Aside Fails, All Accelerated
  Credits Recaptured
• Otherwise, Unit-by-Unit (Extent of Decrease in
  Qualified Basis)

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Recapture (Contd)

• Recapture on Change of More Than 1/3 in Ownership
  or Sale of Project
• Bond Posting Procedure
• New Owner Steps Into Sellers Shoes Upon Sale of
  Project

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Compliance Monitoring

• State Credit Agencies Monitor Projects
• Owners Recordkeeping Requirements
• Number of Low-Income and Total Units
• Income Certifications/Annual Re-Certifications
  and Backup Verifications
• Qualified Basis and Eligible Basis Amounts
• Rent Amounts
• Owner Annual Compliance Certifications

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