Unwinding Your HTC Transaction

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Jordan Nichols
5 years ago
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2 Unwinding Your HTC Transaction MODERATOR Michael Kressig Novogradac & Company LLP PANELISTS Christina Novotny BakerHostetler Jason Blain InSite Capital Jeremy Schirra Squire Patton Boggs Forrest Milder Nixon Peabody

3 Objectives 1. Developer wants control of project 2. Investor has achieved objectives and wants out 3. Avoid/Mitigate adverse tax consequences 4. Simplify structure

4 50 (d) Income 1. Long tradition of treating 50(d) income as a partnership income item, 99% allocated to the Investor Member, which then increases its basis. As a result, it expects to get a corresponding increase in loss when it puts its interest. 2. IRS published temporary regulations that do NOT allow the income to be added to basis, provide that 50(d) income is a partner (rather than partnership) and also call for either acceleration or recognition after the investor leaves the investment. 3. Effective date is for property placed in service on or after September 19, 2016, but the IRS included a discussion of congressional intent, leaving the impression that the IRS believes that the law is already consistent with the position it takes on the regulations

5 Effective Date of 50 (d) Changes For property placed in service on or after September 19, 2016, the regs apply. But consider: Project is placed in service long before the regulations were published; in this case, the regulations, by their terms, do not apply. Project is placed in service after the regulations were published, but before September 19, 2016; again, the plain wording of the regulations makes them inapplicable, but will taxpayers fear an even more obvious opportunity to tweak the IRS? Taxpayer wishes to voluntarily follow the regulations, rather than take on the IRS. It s quite possible that a more conservative taxpayer would take this position, but how would it report income once it terminates its interests? Or accelerate that income as permitted by the regulations? In each case, the regulations simply do not apply and there is no provision to voluntarily elect an earlier effective date, as is sometimes the case with regulations or other IRS guidance.

6 Charitable Donations of Partnership Interest Donating an interest can be more complicated than might be expected, and it can t be pre-agreed. In a single tier deal, there can be a part-gift/part-sale issue.

7 Developer Tax Considerations - COD In a lease pass-through structure, it is often the case at the time the Investor exercises its put, that there is indebtedness between the LL and MT. In such cases, the Investor s exit by a put of its interest to a party related to the LL can result in Cancellation of Indebtedness (COD) income.

8 Developer Tax Considerations - COD Common situations involving indebtedness between the LL and MT: 1. Prepaid rent ( 467 lease) 2. MT loan of investor equity to LL 3. HTC loan to leverage credit equity in NMTC twinned structure 4. MT liability to ML for unpaid rents.

9 Developer Tax Considerations - COD Cancellation of Debt (COD) Income - Direct: IRC 108(e)(4) provides, to the extent provided in regulations, an acquisition of outstanding indebtedness by a person related to the debtor from a person unrelated to the debtor is treated as the acquisition of the indebtedness by the debtor. To the extent the debt is acquired at a discount, the debtor has COD. - Related Parties for this purpose are defined broadly by IRC 108(e)(4)(B) to include parent or spouse of a child or grandchild and entities under common control pursuant to IRC 414(b) or (c). See IRC 267(b) and 707(b).

10 Example #1 Historic Tax Credit ( HTC ) Pass-Through Structure with Prepaid Rent. This is an example of an HTC pass-through structure where a portion of the Investor s equity was conveyed to the Master Landlord in the form of prepaid rent. Assumptions: -Put counterparty is, or is related to, Sponsor affiliate -$2,000,000 of unamortized prepaid rent at time of investor exit Federal HTC Investor -$100,000 put price $100,00 0 Put 99% price Sponsor Affiliate 99% Sponsor or Sponsor Affiliate 90% Interest 10% Equity Fed. HTC Equity 1% Prepaid rent Master Landlord Master Tenant Property

11 Example #1 Tax Consequences Tax Consequences of Example #1 Exit: ML has between $1,900,000 and $2,000,000 of COD income. Exact amount will depend on how much of the $100,000 put price is allocated to prepaid rent vs. equity interest in LL. MT will allocate its basis in the acquired assets of the MT among the assets acquired (presumed here to be only the prepaid rent and the 10% LL equity interest) based on the regime specified at 1060 and 338. If MT s interest was acquired by the Sponsor affiliate such that it ceases to be a partnership, RR 99-6 applies. Under RR 99-6, MT is deemed to have made a liquidating distribution of its assets to Investor and Sponsor Affiliate (SA) and following the deemed distribution, SA is treated as having purchased the assets deemed to have been distributed to Investor in liquidation of the Investor s interest. SA s basis in the partnership assets deemed to have been purchased from Investor is the put price, grossed up for any assumed liabilities (MT liabilities previously allocated to Investor). More Complicated when debt is involved.

12 Example #1 Tax Consequences (cont.) If Investor s interest is acquired by an affiliate of SA, such that it continues to be a partnership, a 743 mandatory step-down may be required. 743(d): For purposes of this section, a partnership has a substantial built-in loss with respect to a transfer of an interest in the partnership if (A) the partnership s adjusted basis in the partnership property exceeds by more than $250,000 the fair market value of such property, or (B) the transferee partner would be allocated a loss of more than $250,000 if the partnership assets were sold for cash equal to their fair market value immediately after such transfer. Effect of 743 stepdown is lower depreciation deductions going forward with respect to the MT s 10% interest in the LL.

13 Example Unwind Scenario #2 (Loan of HTC Equity to Affiliate Leverage Lender) In this example, Master Tenant transfers some of the federal HTC equity to a Leverage Lender that is a Sponsor affiliate in a twinned HTC/ NMTC transaction by way of a loan. Master Tenant Loan (Portion of HTC Equity) Leverage Lender (Sponsor Affiliate) Leverage Loan 99.99% Investment Fund Federal HTC Investor ~99% Sub-CDE Sponsor Affiliate QLICI Loan Sponsor Affiliate 90% Interest Fed. HTC Equity ~1% 10% Interest Master Landlord Master Tenant Property

14 Example Unwind Scenario #2 (Loan of HTC Equity to Affiliate Leverage Lender) (cont d) When the Federal HTC Investor exits and the Sponsor takes over the 99% interest in Master Tenant, the Master Tenant (obligee under HTC Loan) is now related to affiliate Leverage Lender (obligor under HTC Loan). Assumptions: --Put counterparty is, or is related to, Sponsor affiliate -$2,000,000 outstanding balance of MT HTC loan at time of investor exit -$100,000 put price Leverage Lender (Sponsor Affiliate) Sponsor Affiliate Leverage Loan 99.99% Investment Fund Sub-CDE QLICI Loan Master Tenant Loan (Portion of HTC Equity) Sponsor or Sponsor Affiliate 99% Sponsor Affiliate 90% Interest 1% Master Landlord 10% Interest Master Tenant Property

15 Example #2 Tax Consequences Tax Consequences of Example #2 Exit: MT will allocate its basis in the acquired assets of the MT among the assets acquired (presumed here to be only the HTC loan and the 10% LL equity interest) based on the regime specified in 1060 and 338. If MT s interest was acquired by the Sponsor affiliate such that it ceases to be a partnership, RR 99-6 applies. See discussion at Example #1 If Investor s interest is acquired by an affiliate of SA, such that it continues to be a partnership, a 743 mandatory step down may be required. Effect of 743 stepdown is that MT s basis in the HTC loan is stepped down to put price of ~$100,000.

16 Example #2 Tax Consequences (cont.) Amount of COD Income potentially dependent on if Master Tenant is liquidated or not for FIT purposes (i.e., do we have a direct or indirect acquisition under Section 108 Regulations?). Direct Acquisition Affiliate leverage lender has ~$1,900,000 of COD Income Exact amount will depend on how much of the $100,000 put price is allocated to MT HTC loan vs. equity interest in LL. We assume it will all be allocated to the MT Loan. Indirect Acquisition Depending on terms of MT Loan, amount of COD Income potentially could be lower.

Example Unwind Scenario #3 (MT is indebted to Landlord) This example illustrates the potential impact to the Sponsor/Sponsor affiliate when the MT is indebted to the ML at the time the Investor exits.

17 Example Unwind Scenario #3 (MT is indebted to Landlord) This example illustrates the potential impact to the Sponsor/Sponsor affiliate when the MT is indebted to the ML at the time the Investor exits. Assumptions: --Put counterparty is, or is related to, Sponsor affiliate -MT owes $500,000 of unpaid Master Lease rent to Landlord at time of Investor exit. -MT has no equity interest in LL. -Fed HTC equity was used to acquire FFE -$100,000 put price Federal HTC Investor Sponsor Affiliate 20% Interest Master Tenant 99% 99% Sponsor Affiliate Private Equity Investor 80% Interest Master Landlord Unpaid lease payments $500,000 Master Tenant 1% Property

18 Example #3 Tax Consequences Tax Consequences of Example #3 Exit: In this case the Investor interest acquired was that of the obligee rather than the obligor. So no COD concerns, right? Maybe

19 Developer Tax Considerations - COD Cancellation of Debt (COD) Income - Indirect Acquistion: A transaction in which a holder of debt becomes related to the debtor, if the holder acquired the debt in anticipation of becoming related to the debtor. Determination is based on facts and circumstances Holder is treated as having acquired the debt in anticipation of becoming related to the debtor if holder acquired the debt within six months of becoming related to the debtor. If holder acquired the debt six months or more, but less than 24 months from becoming related to the debtor, debtor must disclose in a statement filed with its tax return, facts pertinent to the transaction supporting the debtor s position that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor. if a debtor fails to provide the disclosure required by this paragraph (c)(4), the holder is presumed to have acquired the indebtedness in anticipation of becoming related to the debtor unless the facts and circumstances clearly establish that the holder did not acquire the indebtedness in anticipation of becoming related to the debtor.

20 Developer Tax Considerations If on the date the holder becomes related to the debtor, the debt represents > 25% of the FMV of the total gross assets of the holder or holder group s assets, the debtor must make the same disclosures described above unless the debtor reports its income on the basis that the holder acquired the indebtedness in anticipation of becoming related to the debtor. NOTE: It is not uncommon that the tenant is underperforming and consequently unable to make the full amount of lease payments called for under the master lease agreement. In such cases, if the tenant s cumulative liability to the landlord from payment shortfalls has increased in the 24 months prior to exit, the tenant may unknowingly find itself subject to these disclosure requirements. In such cases there may be mitigating actions that can be taken prior to the exit to avoid this requirement. (e.g. MM of tenant contributes funds to the MT which are used to pay any increases in the liability that arose in the previous 24 months).

21 Example #3 Additional Observations Note: To the extent there is COD income recognized in Example #3, it here may be a corresponding bad debt deduction at the Landlord level. If the post-put ownership of the Landlord and MT are identical, or nearly so, the Sponsor may be indifferent to these consequences. However, in Example #3, the sponsor/sponsor affiliate would be allocated 100% of the income but likely only 80% of the offsetting deduction. Possible mitigation strategies: Assign the put to the Landlord and have it acquire the MT interest, collapsing the structure. (PE Investor may not agree to this as it has an 80% interest in the receivable and presumably no obligation for the liability) Repay the loan. (Depending on the Sponsor s capital account and basis in the Landlord and the Landlord s cash flow waterfall this may result in the proceeds going to the PE Investor in a manner even less desirable to the Sponsor than the tax consequences)

22 Qualified Real Property Business Indebtedness COD Exclusion IRC 108(a)(1)(D) provides taxpayers who are not C Corporations the opportunity to exclude COD income from taxation under certain circumstances where the debt is Qualified Real Property Business Indebtedness. QRPBI is indebtedness (A) which was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property, (B) which was incurred or assumed before January 1, 1993, or if incurred or assumed on or after such date, is qualified acquisition indebtedness(1), and (C) with respect to which such taxpayer makes an election to reduce the depreciable basis of other depreciable real property of the taxpayer in lieu of reporting the COD income as taxable. (1) "Qualified acquisition indebtedness" is either (i) debt incurred or assumed to acquire, construct reconstruct, or substantially improve real property that is used in a trade or business and secures the debt, or (ii) debt resulting from the refinancing of qualified acquisition indebtedness, to the extent that the amount of the debt does not exceed the amount of the debt being refinanced.

23 Qualified Real Property Business Indebtedness COD Exclusion (cont.) The amount excluded shall not exceed the excess (if any) of - (i)the outstanding principal amount of such indebtedness (immediately before the discharge) over (ii) the fair market value (as of such time), reduced by the outstanding principal amount of any other QRPBI secured by such property (as of such time) The amount excluded shall not exceed the aggregate adjusted basis of depreciable real property.

24 Qualified Real Property Business Indebtedness COD Exclusion (cont.) Example Taxpayer owns Building w/ current FMV and adjusted tax basis of $150,000. First Mortgage of $110,000 (QRPBI). Second Mortgage of $90,000 (QRPBI). Second Mortgage is reduced to $30,000 (i.e., discharge of $60,000). QRPBI Exclusion Limitations Excess of Value Limitation $90,000 $40,000 ($150,000 - $110,000) = $50,000 Overall Basis Limitation $150,000 QRPBI Exclusion $50,000 excluded; $10,000 of recognized COD income.

25 Qualified Real Property Business Indebtedness COD Exclusion (cont.) Observations re: QRPBI exclusion: Available only in certain circumstances as described in previous slides Debt must be secured by the property If there is a concern on the front end that debt may be forgiven or deemed forgiven, borrower may want to give the lender a security interest in the property if practicable (e.g. QLICI loans). Limited in all cases by FMV of secured property. The excluded COD cannot exceed the excess of such debt immediately prior to the debt cancellation (or deemed cancelled) over the FMV of the property.

26 Unwinding Your HTC Transaction MODERATOR Michael Kressig Novogradac & Company LLP PANELISTS Christina Novotny BakerHostetler Jason Blain InSite Capital Jeremy Schirra Squire Patton Boggs Forrest Milder Nixon Peabody

Discussion of Current Issues

Discussion of Current Issues Tax Practitioners Roundtable MODERATOR Thomas Boman Novogradac & Company LLP PANELISTS Amanda Rosenberg Chadbourne & Parke LLP Scott DeMartino Dentons Robert Dodson Squire