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1 Nicolo Pinoli, CPA Partner Novogradac & Company LLP AUDIO You should be able to hear through your computer speakers or QUESTIONS PANE Need help with audio or other technical support? Questions about webinar content for the panelists? Use the Questions Pane! If you prefer to listen on the phone, select Use Telephone, in the audio pane dial: Phone number Access code RECORDING You will receive an with information to access the recording of this webinar within 2 business days. The recording will be available for your personal viewing for one year! HANDOUT CERTIFICATE OF ATTENDANCE POST-WEBINAR SURVEY If you haven t yet downloaded the handout, the link can be found in the Handouts Pane. Log in individually for the entire program and respond to the polling questions Within 5 business days! Will take two minutes to complete Appears as soon as you exit the webinar nicolo.pinoli@novoco.com 1

2 ADVISORY: This live webinar (and its recording) are available for viewing only to individuals who ve purchased a registration. Although individuals within an organization may choose to watch the webinar in a group, each attendee must be a paid registrant. Paid registrants must not share the link with others. To order additional registrations, go to or contact events@novoco.com. July 10, 2015 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints nicolo.pinoli@novoco.com 2

3 Assumptions for our Discussion Related-party leverage lender is used Creates some flexibility with the timing Leverage Lender 30-year loan Investors Typical leveraged structure is used is a taxable entity Different set of considerations for nontaxable entities (i.e. UBTI) NMTC Subsidy s Uneasy Relationship with Taxation Free money often comes with strings NMTC program not designed to deliver tax-free subsidy Strategies for mitigating taxable income typically just address the timing nicolo.pinoli@novoco.com 3

4 Leverage Lender 7% Int. ($490k/yr) NMTCs A 5.16% Int. ($361k/yr) B 5.16% Int. ($129k/yr) Leverage Lender 7% Int. ($490k/yr) Maximize value? Leave quietly; deliver residual to Preserve industry standing NMTCs 7 Years A 5.16% Int. ($361k/yr) B 5.16% Int. ($129k/yr) Eliminate ongoing reporting and monitoring One last blast of community benefit Capture of back end fees? Residual nicolo.pinoli@novoco.com 4

5 What is the s primary motivation at exit? a. Repay all cash received b. Do a new deal c. Capture the residual value d. Find inner peace July 10, 2015 Once Year 7 arrives Stay with the same deal and repay all loans over the originally documented loan terms Exercise the put or the call and unwind Attempt to negotiate something new nicolo.pinoli@novoco.com 5

6 Leverage Lender Contractual right to sell interest in fund for nominal price ($1k) Usually a limited window of time to exercise (90 days) 7 Years A major point of discussion of today s webinar will be the determination of the FMV price of the investor s interest in the fund. A B Contractual right to purchase the investor s interest in fund for FMV Can exercise if investor doesn t exercise put option Leverage Lender Contractual right to sell interest in fund for nominal price ($1k) Usually a limited window of time to exercise (90 days) 7 Years A B Contractual right to purchase the investor s interest in fund for FMV Can exercise if investor doesn t exercise put option nicolo.pinoli@novoco.com 6

7 Who holds the put option? a. The b. The NMTC investor c. The leverage lender d. The (or its affiliate) July 10, 2015 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints 7

8 Leverage Lender Investor exercises put and sells interest in fund to affiliate of A B Leverage Lender Does this trigger cancelation of debt (COD) income for the? A B owes sub- owes leverage lender Difference $ - $ 9.5 Mil 7 Mil 2.5 Mil Income? nicolo.pinoli@novoco.com 8

9 exit tax Search owes sub- owes leverage lender Difference $ - $ Qualified Real Property Business Indebtedness Exception to general rule that debt forgiveness is income Definition Incurred or assumed by the taxpayer in connection with real property used in a trade or business and secured by 9.5 Mil that real property 7 Mil Must be incurred or assumed by the taxpayer to acquire, 2.5 Mil construct, reconstruct, or substantially improve the property Amount of exclusion is limited to debt in excess of value Results in reduction in depreciable basis Corporate borrowers (and corporate partners in partnership borrowers) are not eligible nicolo.pinoli@novoco.com 9

10 Qualified Real Property Business Indebtedness $9.5M $9M $500k $9.5M DEPR owes sub- owes leverage lender Difference 108 Exception COD Income $ - $ - $ 9.5 Mil 7 Mil 2.5 Mil 500 k 2 Mil 39yrs Basis Reduction QLICI Debt FMV of Property Adj Basis of Property IRC 108 allows the to reduce the amount of COD income by the amount that the QLICI debt exceeds the fair market 7 Years value of the property. However, to qualify for this reduction in taxable income, the is required to reduce its depreciable basis in the depreciable property and, therefore, forego its ability to recover those costs through depreciation. Qualified Real Property Business Indebtedness $9.5M $8M $1.5M $9.5M DEPR owes sub- owes leverage lender Difference 108 Exception COD Income $ - $ - $ 9.5 Mil 7 Mil 2.5 Mil 1.5 Mil 1 Mil Basis Reduction QLICI Debt FMV of Property Adj Basis of Property 7 Years nicolo.pinoli@novoco.com 10

11 Qualified Real Property Business Indebtedness $9.5M $9.5M $3M $6.5M DEPR owes sub- owes leverage lender Difference 108 Exception COD Income $ - $ - $ 9.5 Mil 7 Mil 2.5 Mil 3.0 Mil -0.5 Mil ZERO QLICI Debt FMV of Property Adj Basis of Property $2.5M Basis Reduction 7 Years Who commonly holds the call option? a. The b. The NMTC investor c. The leverage lender d. The (or its affiliate) July 10, 2015 nicolo.pinoli@novoco.com 11

12 FRIEND Put to someone other than? Does this trigger COD income? 754 adjustment at and? Structuring strategies: Could the Friend of annually forgive portions of the B loan in bitesized pieces? A B FRIEND Put to someone other than? A B IRS Chief Counsel Memo F Page 2 nicolo.pinoli@novoco.com 12

13 FRIEND Put to someone other than? A B IRS Chief Counsel Memo F Page 7 FRIEND Put to someone other than? The Vancouver Clinic, Inc. v. United States FICA and Interest! U.S. District Court Advance $12k - $35k Advance $12k - $35k Must pay back if employed < 5 yrs A B Y1 Y2 Y3 Y4 Y5 Interest = PRIME Never Required No income tax withheld No payroll tax withheld No reporting on W-2 By end of 2013 clinic would have Forgiven 74% of 2007 funds Forgiven 83% of 2008 funds Forgiven 97% of 2009 funds nicolo.pinoli@novoco.com 13

14 Does the B conversion trigger COD income? Does the put trigger a 754 adjustment? Structuring strategies: What are the terms of the equity interest? What if is a single-member LLC? A B Should you convert B to equity before put is exercised? Strategy: A taxpayer can use a cost segregation study (or similar methodology) and examine its list of depreciable assets and discover that shorter useful lives apply. The rules allow the taxpayer to catch up all previously unclaimed depreciation in the current year. nicolo.pinoli@novoco.com 14

15 39 yrs SL 15 yrs 150% DB 7 yrs DDB $500K $500K * ** $1 million Year 39-yr 15-yr 7-yr Totals 18,190 25,640 25,640 25,640 25,640 25,640 25, ,030 * ** ** 25,000 47,500 42,750 38,475 34,628 31,165 29, ,043 71, ,449 87,464 62,474 44,624 44,624 44, , , , ,701 Difference of $554,701 represents additional depreciation that can be taken in Year 8 Assume assets placed in service in April (mid-month convention) Assume half-year convention Leverage Lender Y1 Y8 Y30 Y1-7 Y8 1. Work with reputable partners you can trust 2. Add features to the deal to constrain the value of the investor s interest in the fund A B Shorter leverage loan amortization = leverage loan amortizes faster than QLICI loans; sweeps most (or virtually all) of fund cash 3. Add features to incentivize the investor to exercise put nicolo.pinoli@novoco.com 15

16 Leverage Lender Y1 Y8 Y25 Y30 Y Work with reputable partners you can trust 2. Add features to the deal to constrain the value of the investor s interest in the fund Accrued interest = leverage loan gets bigger over time, which reduces residual cash flow once the loans start amortizing A B 3. Add features to incentivize the investor to exercise put Leverage Lender Y1 Y8 Y30 A B 1. Work with reputable partners you can trust 2. Add features to the deal to constrain the value of the investor s interest in the fund Accrued interest = leverage loan gets bigger over time, which reduces residual cash flow once the loans start amortizing Shorter leverage loan amortization = leverage loan amortizes faster than QLICI loans; sweeps most (or virtually all) of fund cash 3. Add features to incentivize the investor to exercise put nicolo.pinoli@novoco.com 16

17 How long is the NMTC compliance period? a. 5 years b. 7 years c. 15 years d. 100 years July 10, 2015 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints nicolo.pinoli@novoco.com 17

18 $3M Basis in $2.999 Mil loss, right? Sales price: $1k Basis in ($900k) Sales price: $1k $901k GAIN NMTCs 18

19 Basis in ($900k) Sales price: $300k $1.2 Mil GAIN NMTCs Exit Strategies for Investor How to capture value? Don t exercise the put Don t allow special features that minimize the value of your position How to deliver value to? Exercise your put nicolo.pinoli@novoco.com 19

20 $3.9M Plan up-front to have gain; price your interest accordingly $6.1M NMTCs Basis in QLICI s Liquidates A B A NMTCs B $3.9M Liquidates 332 $10M $6.1M Basis in QLICI s ( is a Corporation) Plan up-front to have gain; price your interest accordingly In some cases, taxation of sub- as a C-Corp may provide for some favorable treatment 332 liquidation may allow the investor to exit the transaction without experiencing the NMTC basis reduction Conversion from a partnership to a corporation will result in basis reduction taken to date being applied to the assets of the sub- under IRC 732(f) Takeaway is to not wait to convert, if that is your strategy nicolo.pinoli@novoco.com 20

21 For every $1.00 in NMTCs, the investor s basis is reduced by: a. $0.25 b. There is no basis reduction c. $0.50 d. $1.00 July 10, 2015 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints nicolo.pinoli@novoco.com 21

22 Leverage Lender A B Leverage Lender A B liquidates, distributing A and B s to nicolo.pinoli@novoco.com 22

23 Leverage Lender A assigns A to Leverage Lender in satisfaction of Leverage B Leverage Lender liquidates, distributing B to A B nicolo.pinoli@novoco.com 23

24 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints Q50: What happens when a subsidiary- has completed the 7 year NMTC compliance period? A B nicolo.pinoli@novoco.com 24

25 Q50: What happens when a subsidiary- has completed the 7 year NMTC compliance period? A B Provide the following: 1. Name 2. Allocation Control Number 3. Name & Certification Number 4. Date of Dissolution Q51: What happens after an allocatee completes its 7 year compliance period after issuance of its last? A B nicolo.pinoli@novoco.com 25

26 Outline Leveraged Structure Overview Participant Motivations Taxation and Strategies Investor Taxation and Strategies Collapsing the Structure Liquidation Reporting Requirements Helpful Hints Helpful hints when planning for the exit Pre-Close Begin with the end in mind! Most available alternatives for smoothing the exit are difficult or impossible to capture once the ink is dry Best time to negotiate the exit is before closing You get the deal you document, not the deal you negotiate Close Y1 Y2 Y3 Y4 Y5 Y6 Y7 26

27 Helpful hints when planning for the exit Right after closing, sit down and write yourself a letter/memo to document what you should do when you get to Year 7. Close Y1 Y2 Y3 Y4 Y5 Y6 Y7 Helpful hints when planning for the exit should keep track of deadlines Does the investor have a put exercise window? Does investor remember that? Recommend reminding the investor when the window opens Is there a window to exercise the call? Stay in touch with investor over time; changes in personnel, mergers, etc. might make some significant changes in expectations about the put; people on other side of the table at Year 7 may look very different than the people with whom you closed the deal days days Close Y1 Y2 Y3 Y4 Y5 Y6 Y7 nicolo.pinoli@novoco.com 27

28 Helpful hints when planning for the exit and the loan Is there a large repayment of principal on a loan at end of Year 7? If so, better plan ahead, either to raise cash, or to line up lenders who will make refi loans. If you re going to have trouble make the payment and/or getting the refi loan, you should start exploring alternatives with your business partners as early as possible. Workouts take time! days days Close Y1 Y2 Y3 Y4 Y5 Y6 Y7 When should you start to plan for the exit? a. 6 months in advance of your exit b. 15 minutes in advance of your exit c. Before you close d. After year 7 July 10, 2015 nicolo.pinoli@novoco.com 28

29 Wrap-Up/Conclusion It s never too early to start planning Only the paranoid survive Free money usually is taxed; free money with no taxable income is hard to come by Importance of working with skilled professionals cannot be overstated Nicolo Pinoli, CPA Partner Novogradac & Company LLP nicolo.pinoli@novoco.com nicolo.pinoli@novoco.com 29