State of the States MODERATOR Warren Sebra Novogradac & Company LLP PANELISTS Andrew Sparacia globalx Steve Stogel DFC Group Inc. Steve Mount Squire Patton Boggs (U.S.) LLP Katrina Thompson Barnes & Thornburg LLP Renee Kuhlman National Trust for Historic Preservation
States with Tax Credits State Historic Tax Credits (HTCs) Visit our HTC Resource Center for up to date information on state Historic Tax Credit Programs www.novoco.com/resource-centers/historic-tax-credits Legislation introduced to create an HTC Program for that state Indicates a Historic Tax Credit Program for that state
Historic Tax Credit Activity in the States FY02-FY16 State Rankings by HTC Qualified Rehabilitation Expenditures (QREs) State Ranking QREs MO 1 $5,092,675,463 MA 2 $3,500,894,212 NY 3 $3,398,655,820 PA 4 $3,198,260,007 VA 5 $3,150,292,726 IL 6 $2,822,203,751 OH 7 $2,490,798,983 CA 8 $2,340,730,545 LA 9 $2,151,478,178 MI 10 $1,838,059,365 FY02-FY16 State Rankings by # of Projects State Ranking # of projects MO 1 1438 VA 2 1286 OH 3 982 LA 4 782 NC 5 653 PA 6 613 MD 7 505 NY 8 491 MA 9 452 GA 10 410
Historic Tax Credit Activity in the Cities FY02-FY16 City Rankings by HTC Qualified Rehabilitation Expenditures (QREs) State City Ranking Project #s QREs MO St. Louis 1 900 $3,156,015,506 IL Chicago 2 90 $2,476,742,452 NY New York 3 116 $2,069,019,977 PA Philadelphia 4 304 $2,007,855,954 LA New Orleans 5 655 $1,908,222,608 VA Richmond 6 692 $1,661,257,557 MD Baltimore 7 409 $1,486,977,275 OH Cleveland 8 178 $1,357,611,796 MA Boston 9 136 $1,272,504,617 MO Kansas City 10 181 $1,265,066,165 FY02-FY16 City Rankings by # of Projects State City Ranking Project #s QREs MO St. Louis 1 900 $3,156,015,506 VA Richmond 2 692 $1,661,257,557 LA New Orleans 3 655 $1,908,222,608 MD Baltimore 4 409 $1,486,977,275 OH Columbus 5 341 $164,415,635 PA Philadelphia 6 304 $2,007,855,954 OH Cincinnati 7 288 $437,092,927 MO Kansas City 8 181 $1,265,066,165 OH Cleveland 9 178 $1,357,611,796 GA Savannah 10 148 $77,883,421
Elements of State Tax Credit Programs Caps Transferability Rate Eligible Claimants Rehabilitation Standards Minimum investment
Elements of State Tax Caps Annual Aggregate Cap Individual Aggregate Cap Transferability Credit Programs Outright sale Disproportionate allocation Refundable Carry-back Rate and Eligibility Percentage of QREs (typically ranges from 5-30%) Scope of eligible buildings (commercial and residential) Specified standards (NPS; ties to federal credit requirements) Range of eligible claimants
Tax Credit Deal Structure
Structure Considerations Transaction Cost Efficiency Transaction Simplicity/Complexity Rev Proc. Compliance Tax/COD Issues at Exit Leveraged HTC equity goes to the project in form of an NMTC loan Control Issue
Structure Considerations Potential Leverage Sources Need for 7 year forbearance, no direct lien on project s assets True debt analysis Project needs to show ability to repay all debt Leveraging market rate vs soft debt Refinancing assumptions for market rate debt Potential longer repayment terms for soft debt
Georgia Rehab Tax Credit Annual State Cap-$25 million cap on credits allocated to projects receiving more than $300,000 in credits. Applications received that breach this cap are given priority in following year. Transaction Cap-$5 million. $10 million in cases where a project creates 200 or more full-time, permanent jobs or $5 million in annual payroll within two years of the placed in service date. $100,000 cap on credits received for rehabilitation of historic homes. Credit-25% of qualified expenditures No Bifurcation from the federal HTC Compliance period-5 years Credit may be carried forward 10 years Application-Apply for the state credit and federal credit separately. Before claiming credits, taxpayer must submit an application to the Georgia Department of Revenue for preapproval of credits. This application must include precertification from the Georgia Department of Natural Resources certifying that improvements to the certified structure are consistent with the department s standards of rehabilitation. Qualified rehabilitation expenditures may only be counted once in determining the amount of tax credits, and only one entity may claim credits for qualified rehabilitation expenditures associated with an individual project.
Federal Income Tax Treatment of State Tax Credits Transferable credits used by purchaser for value Transferable credits used by qualifying party Non-transferable credits (also know as allocable credits )
Transferable Credits Used by Purchaser for Value Seller of credit has ordinary income equal to purchase price (due to zero basis). [CCA 200211042] Purchaser has income to extent that amount of state tax offset exceeds purchase price. [Code 61] Purchaser is entitled to deduction under Code 164. [PLR 200348002; CCA 200445046]
Non-Transferable Credits (or Transferable Credits Used by Qualifying Party) No income on receipt or use, except to extent of refund received for refundable credits. [Rev. Rul. 79-315; CCA 200211042; CCA 200451041] No deduction under Code 164. [CCA 200211042; CCA 200451041] Allocation of credits to owners of pass-through entity should not be treated as a transfer of credits.
CCA 200704030 Allocation of nontransferable credit recharacterized as transfer for value. Investors held not to be true partners for federal tax purposes. Transfer deemed to be a disguised sale of credit under Code 707(a)(2)(B).
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner and Progeny
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner Virginia Historic Tax Credit Fund 2001 LP v. Commissioner is an important case concerning federal tax consequences of state tax credit transactions This case was decided by the Federal Appeals Court for the Fourth Circuit (Virginia, West Virginia, North Carolina, South Carolina and Maryland) on March 29, 2011 Three subsequent cases have dealt with the same subject matter
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner This case concerns the federal income tax treatment of certain aspects of a state credit transaction What does federal tax law have to do with state tax credits? State law controls the requirements for qualifying for the credit and the manner of using it. Federal tax law applies to the cash contributions
May 2002 $7,000 option payment Fund $6.99m Capital Contribution 1% 282 Investors Nov. 2001- May 2002 $5.13m Capital Contribution 0.01% $9.2m credits Developer Partnership
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The IRS challenged the federal tax treatment of the capital contributions to the upper tier Fund There were two prongs to the attack: The state credit investors were not bona fide partners in the Fund The contribution of money and related allocation of state credits was a disguised sale under Internal Revenue Code section 707
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The Circuit Court did not discuss the Commissioner s first argument, i.e., that the investors were not bona fide partners Instead, it found that the capital contributions by the investors and the related receipt of state tax credits were disguised sales pursuant to Code Section 707
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner Code Section 707(a)(2)(B) provides that: If there is a transfer of money to a partnership by a partner There is a related transfer of property by the partnership to the partner, and The transfers when viewed together are properly characterized as a sale of property, Then the IRS can re-characterize the payment and related transfer of property as a sale
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner Treas. Reg. sec. 1.707-3 provides a standard for determining if a sale occurred, viz., The transfer of money would not have been made but for the transfer of property, and In cases where the transfers are not simultaneous, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations There is a rebuttable presumption that transfers within two years of each other are sales
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The regulations list ten factors that indicate if a sale occurred. The Court discussed the following factors it deemed to be potentially applicable to this fact pattern: The timing and amount of the subsequent transfer are determinable at the time of the earlier transfer The transferor has a legally enforceable right to the subsequent transfer The partner s right to receive the property is secured in any manner The transfer of money is disproportionately large in relationship to the partner s general interest in partnership profits The partner has no obligation to return the property to the partnership
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The disguised sale rules would not apply unless the state tax credits were property The Court found that the state credits were property based on an analysis of traditional definitions
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The Court considered the factors listed above, and concluded that a disguised sale had occurred The Fund therefore had taxable income
Virginia Historic Tax Credit Fund 2001 LP v. Commissioner The Virginia Historic Tax Credit case has been followed by three subsequent cases: Tempel v. Comm'r, 136 T.C. 341 (2011), aff'd sub nom. Esgar Corp. v. Comm'r, 744 F.3d 648 (10th Cir. 2014) Route 231, LLC v. Comm'r, 810 F.3d 247 (4th Cir. 2016))
State Tax Credit Purchasers/Investors
Not all state historic rehabilitation tax credits are created equal: 1. Transferability Certificates Allocated Refundable 2. Recapture Developer or End User 3. Carry Forward
Pricing Certificate vs. Allocated $.80 s vs. $.70 s
Terms Certificate vs. Allocated Pay in schedule Closing costs Due diligence
Types of Investors Corporate vs. Individuals Direct Buyers vs. Investor Funds
Types of Income That is Offset Income Tax Premium Tax Franchise Tax Bank Tax
Federal Investor vs. State Purchase/Investor Income Allocation Underwriting Issues Credit Underwriting
Key Legal Citations Revenue Procedure 2012-14 Three times the Revenue Procedure made note of state tax credits: i. This Revenue Procedure does not apply to... state credit transactions. ii. iii. "It does not indicate the circumstances under which the Service may challenge...the circumstances under which a transfer of state credits by a partnership may be treated as a disguised sale..." "The Treasury Department and Service do not intend the inclusion of any particular criteria in the Safe Harbor to be an indication... of our views of the significance of that criterion with respect to any... state tax credit transactions.. Issued late 2013, and amended early 2014, to provide a safe harbor for partner status Negotiation with Treasury and IRS were done by the Historic Tax Credit Coalition. 36
Key Legal Citations (Continued) Gateway Hotel Partners, LLC v. Commissioner, TC Memo 2014-5 Final decision just entered. The structure the MO HTC certificate was a distribution of property against a GP capital account. Partial win for the taxpayer. Route 231 LLC v. Commissioner TC Memo 2014-30 Held the VA conservation tax credits, transferable as allocations, were property, and a disguised sale occurred. Tempel v. Commissioner, 10th Circuit, 2014 Upheld the IRS that Colorado easement tax credits were taxable on property with zero basis on the date of the gift. SWF Real Estate, LLC, TC Memo 2015-63 Held the VA Conservation Credits were a disguised sale, and year of realization was the year the credit documents were recorded and funded, not the next calendar year when the certificates were issued under economic benefit test. 37
Emerging Legal Principles Tax Principles Emerging State Tax Credits have a Federal Tax Incidence Income Realization by the Development Partnership or a Partner must follow Special Allocation of Income under 702 The total gain needs to be 100 cents as state tax credits have a zero basis The 704(b) Rules apply No Loser Rule Year of Realization HTCs received over multiple years 38
State of the States MODERATOR Warren Sebra Novogradac & Company LLP PANELISTS Andrew Sparacia globalx Steve Stogel DFC Group Inc. Steve Mount Squire Patton Boggs (U.S.) LLP Katrina Thompson Barnes & Thornburg LLP Renee Kuhlman National Trust for Historic Preservation