IPED HOUSING TAX CREDITS 101 Phoenix Arizona February

IPED HOUSING TAX CREDITS “ 101” Phoenix, Arizona February 22 -23, 2007 Molly R. Bryson Thomas A. Giblin

Background • Tax Reform of 1986 • Section 42 of IRC of 1986 – Housing Program in the Tax Code – Statute Amended Several Times, Including in 2000 • Objective to Provide Investor Equity • Credit is a Dollar-for-Dollar Tax Reduction

Calculating Credits/Defining Terms • Applicable Percentage times Qualified Basis = Annual Credit Amount

Applicable Percentage • Two Credits: – 70 Percent Present Value Credit (the “ 9% Credit”) – 30 Percent Present Value Credit (the “ 4% Credit”) • Credit Rates – 8. 11% (9% Credit) & 3. 48% (4% Credit) – February 2007 – Lowest rates in July 2003 – 7. 78% and 3. 33%

Applicable Percentage (cont’d) • “Lock-in Election” upon receiving a binding commitment from the state to allocate credits (or when tax-exempt bonds issued) OR when building placed in service

4% New Construction/Substantial Rehabilitation Credit • “Federally Subsidized” – Building Receives Tax-Exempt Bonds or Below Market Federal Loan • “Below Market Federal Loan” – Interest Rate Below AFR (Approximately 4. 86% in 2/2007 for Long-Term Loans Compounded Annually) – From Federally Appropriated Funds

Exceptions From Federally Subsidized Definition • • • HOME Loan if 40% at 50% Targeting CDBG Loan AHP Loan is Subtracted from Eligible Basis Section 8 NAHASDA of 1996 if 40% at 50% Targeting

4% Acquisition Credit • • Existing Buildings/Acquisition Costs Purchase from “Unrelated Party” Ten-Year Rule Waiver of Ten-Year Rule from Treasury

4% Acquisition Credit (cont’d) • Certain Placements in Service Ignored – Carryover Basis – Acquired from Decedent – Placement in Service by Governmental Unit or Non. Profit Entity – Foreclosure

Substantial Rehabilitation Requirement • Greater of: – $3, 000 per Low-Income Unit, or – 10% of Adjusted Basis • “Separate New Building” • Can Receive 4% plus 9% Credits

9% New Construction/Substantial Rehabilitation Credit • If Not Federally Subsidized

Basis Calculations • Start with “Eligible Basis”, then “Qualified Basis”

“Eligible Basis” • New Construction = Adjusted Basis • Acquisition = Acquisition Cost • Substantial Rehabilitation = Capitalized Rehabilitation Expenditures over 24 months • Must Subtract Federal Grants • 130% Increase in “QCTs” and “DDAs”

“Qualified Basis” • “Applicable Fraction” times “Eligible Basis” equals “Qualified Basis” • “Applicable Fraction” is the Lower of: – Number of Occupied “Low-Income Units” divided by the Total Number of Units, or – “Floor Space Fraction”

“Low Income Units” • Threshold of 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 1 st Credit Year • HUD Publishes Area Income Figures Annually

Low Income Units (cont’d) • Adjustments for Family Size like Section 8 – – Family of 4 Qualifies at 60% (50%) AMI Family of 3 Qualifies at 54% (45%) AMI Family of 2 Qualifies at 48% (40%) AMI Single Household Qualifies at 42% (35%) AMI

“Rent Restricted” • Rent (including utilities) Cannot Exceed 30% of Qualifying Income for Assumed Family Size; Based on Bedrooms Per Unit • Occupancy Assumptions: – One Person for Studio – 1. 5 Persons per Bedroom

Rent Calculation Example • • • Median Income = $60, 000 Two Bedroom Unit 3 Person (2 BR x 1. 5) Income Limit = $32, 400 30% of Income Limit = $9, 720 Monthly Rent (1/12) = $810

Additional Rent Rules • 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)

Example of Tax Credit Calculation • • • 100 Unit Project/70 Low-Income Units TDC (Including Land) = $5. 5 M Land Value = $500 K Eligible Basis = $5. 0 M Qualified Basis = $3. 5 M ($5. 0 M x 70%)

Example Tax Credit Calculation (cont’d) • • Applicable Percentage = 8. 11% (Not Federally Subsidized) Annual Credit = $283, 850 ($3. 5 M x 8. 11%) 10 Year Credits = $2, 838, 500

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 90 Cents Per Tax Credit Dollar, Equity Equals $2, 554, 394 ($2, 838, 500 x 99. 99% x 0. 90)

Equity Calculation (cont’d) • If Bond Financed “ 4% Deal”, Equity Equals $1, 096, 090 • ($5, 500, 000 - $500, 000) x 70% x 3. 48% x 10 x 0. 90 x 99. 99% = $1, 096, 090

Structure Investor LP $$$ Syndicator GP Local GP Investment Partnership LP Operating Partnership Developer

Key Business Terms • Projects Generally Owned by Limited Partnership or Limited Liability Company • Limited Partner Generally Owns 99. 99% of Tax Credits, Losses & 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

Who Can Use Credits? • Individuals Limited Under Passive Loss Rules to Approximately $9, 900/Year at the 39. 6% rate • C Corporations Can Use Losses and Credits Against Ordinary Income and Taxes • Cannot Use Credits Against AMT • Limitations on “Closely-Held” Corporations

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

Recapture • Recapture on Non-Compliance: – Accelerated Portion of Credit Recaptured (1/3 of Credit 1 st 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)

Recapture (cont’d) • Recapture on Change of More Than 1/3 in Ownership of Sale of Project • Bond Posting Procedure • New Owner Steps into Seller’s Shoes Upon Sale of Project

Extended Use • Recorded “Extended Use Commitment” • “Extended Use Period”: – At Least 30 Years, May be Longer to Gain Points • Termination (with three-year vacancy de-control) – Upon Foreclosure – “Qualified Contract”

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

Qualified Contract (cont’d) • “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

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

STATE ALLOCATION VOLUME LIMIT • Congress Raised Cap in 2000 From $1. 25 to $1. 50 in 2001, $1. 75 in 2002, Then Adjusted for Inflation • $1. 95 Person for 2007 • $2, 275, 000 State Minimum in 2007

Volume Limit Rules • Example: – State With Three Million Population has $5, 850, 000 in Credits in 2007 • Amount is for One Year of Credit • 10% Non-Profit Set-Aside • 50% Test: Private Activity Tax-Exempt Bonds Subject to Bond Volume Cap; No Credit Allocation Needed

“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

Additional QAP Rules • QAP Must Provide Procedure for Notifying IRS of Non-Compliance • Bond Financed Projects Must “Satisfy” QAP

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

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

State Allocation Process • “Carryover Allocation” – 10% of “Reasonably Expected Basis” Must be Incurred by 12/31 of Allocation Year or 6 Months After Allocation, if Allocation After 6/30 – Building Must be Placed in Service by 12/31 of 2 nd Year After Carryover – Carryover Basis Includes Costs of Land Depreciable Property

Carryover Allocation Document • Must be Issued by State Agency by 12/31 of Allocation Year • 10 Elements Required in Document • Agency Must Later Issue Forms 8609 After Buildings Complete • State May Carry Forward Unused Credits for One Year; Then Goes to National Pool