Part of a series on creative Real
Estate financing.
Using Crowdfunding to finance real estate projects
Using New Market Tax Credits to finance projects
Let the Purchaser do the Financing
The Internal Revenue Service ("IRS") recently issued
important new guidelines regarding the Historic Rehabilitation
Credit ("HRC") reopening a recently moribund financing
method. The new guidelines provide a safe harbor sought by
investors and developers after an appellate ruling had provided
uncertainty regarding how HRCs could be used to finance the
redevelopment of historic buildings. The recent IRS revenue
procedure, and its convenient framework, will be especially
important in New York, Boston, Philadelphia and San Francisco and
other cities with significant amount of historic property and
limited development space.
Under the Internal Revenue Code, taxpayers are eligible for a 20
percent tax credit for the rehabilitation of a historic building.
Traditionally, developers form a partnership with a tax credit
investor who provides capital to the project in exchange for fixed
risk/loss and the use of all or a portion of the applicable
HRC.
However, in the 2012 decision Historic Boardwalk Hall LLC v.
Commissioner, 694 F.3d 425 (3d Cir. 2012), the Court of
Appeals for the Third Circuit held that a tax credit investor in a
historic rehabilitation project was not a bona fide partner for tax
purposes, and therefore could not be allocated any of the HRC
generated by the project. Specifically, the ruling provided that
the investor in question was not a partner because it had no
meaningful downside risk or any meaningful upside potential in the
business conducted by the purported partnership. Because of the
ruling, investors became way of entering into similar tax credit
financing transactions due to the possibility of IRS
scrutiny.
The new IRS Revenue Procedure 2014-12 clarified the
financing of developments using HRCs by requiring transactions to
be structured so that the investor is tied to the underlying
economics of the deal. To be eligible for the safe harbor, the
following requirements, amongst others, must be met:
- i.) An investor must have at least a 5 percent interest in the partnership;
- ii.) The partnership principal, affiliates or third parties must not substantially protect investor against losses from the partnership's activities;
- iii.) Neither the partnership nor the principal in such partnership may possess a put or call option (or any other right of redemption) with respect to investor's interest;
- iv.) At least 75% of the investor's total expected capital contributions must be fixed in place prior to the building being placed into service; and
- v.) None of the principals or related parties may insure or guarantee that the investor will (a) be able to claim the applicable HRCs or their cash equivalent, (b) receive distributions from the partnership or (c) obtain repayment of any portion of its contribution as a result of the unavailability of HRCs.
As a result of IRS Revenue Procedure 2014-12, developers and
investors have a more concrete understanding of the requirements
that must be met to incorporate HRCs into their financing of a
project. However, the resulting safe harbor also presents a new
array of financing obstacles that investors and developers will
have to work to overcome. Specifically, investors will now have a
seat at the risk table and will be required to frontload the
majority of their investment prior to a development's
completion. Nevertheless, if you are planning to redevelop a
historic building, HRC is an old financing tool that should be
given renewed consideration.
This article is presented for informational purposes only and is not intended to constitute legal advice.