Special Issues for Projects Involving Nonprofits IPED Housing

Special Issues for Projects Involving Nonprofits IPED Housing Tax Credits “ 101” October 16 -17, 2008 Molly R. Bryson Thomas A. Giblin

Examples of Nonprofit Participation in Tax Credit Projects • General partner, or co-general partner with a for-profit • Developer or property management agent • Lender • Social service provider • Lessor under ground lease (or managing general partner) to qualify for property tax exemption/abatement • Holder of right of first refusal under § 42(i)(7) 2

Obtaining and Maintaining 501(c)(3) Status: Background • Difference between nonprofit under state law and federal law • Tension between: • the tax credit program, which encourages nonprofit involvement and joint ventures with for-profit organizations; and • the IRS concern that nonprofits would be taken advantage of • Serving charitable purpose vs. benefiting a for-profit • long history of what the IRS and courts will not allow • obtaining 501(c)(3) status has been challenging and time-consuming 3

Obtaining and Maintaining 501(c)(3) Status: IRS Memo Dated 4/25/06 • IRS memo outlines many factors, but failure of one is not fatal • Limit the amount and length of the operating guarantee (6 months of expenses; 5 years from break-even) • Use a fixed price construction contract • Treat the payment on a tax credit guarantee as a capital contribution or loan (rather than outside the partnership) • Limit the amount of tax credit guarantee (to extent of fees) • Limit the repurchase price to 100% of capital contributions • Remove only for cause after a reasonable cure period • Hold a right of first refusal to purchase the project 4

Federal Grants • Often awarded to exempt organizations • Reduce eligible basis • Result in taxable income to the partnership receiving the grant • Instead, structure grant award to exempt organization followed by a loan to the partnership – partner non-recourse debt: potential issue if investor’s capital account goes negative – 79/21 solution (use of a second unrelated exempt organization as minority stockholder of the general partner) 5

Tax-Exempt Use Property • 40 -year depreciation of residential real estate (may be ok) • Qualified allocation (0. 01% interest in all tax items, including cash flow and sale/refinance proceeds) – be alert to incentive fees • For-profit subsidiary of the nonprofit serves as general partner and makes a Section 168(h)(6) election, which results in taxable income to the subsidiary but 27½-year depreciation – election made on tax return – also attached to exempt parent’s tax return – must state it is a 168(h)(6) election 6

Nonprofit Set-Aside • Each state tax credit agency must set aside at least 10% of its annual credit ceiling each year for projects involving qualified nonprofit organizations • Many states provide preferences for nonprofit sponsored projects by assigning “points” to projects with nonprofit involvement • Whenever there is nonprofit involvement, need to determine whether the tax credit agency actually awarded credits from the nonprofit set-aside 7

Nonprofit Set-Aside (cont’d) • Nonprofit organization must be exempt from federal income tax under Section 501(c)(3) or 501(c)(4) of the IRC • One of the organization’s exempt purposes must include the fostering of low-income housing • Nonprofit cannot be “affiliated with or controlled by” a forprofit organization • Nonprofit must own an interest in the project (directly or indirectly) • Nonprofit must materially participate in the development and operation of the project throughout the compliance period 8

Right of First Refusal Under IRC Section 42(i)(7) • Added to IRC Section 42 in 1990 to facilitate nonprofit ownership of tax credit properties at the end of the 15 -year compliance period • Eligible holders and minimum purchase price are specifically set forth in IRC Section 42(i)(7) 9

Eligible Holders of a Right of First Refusal Under IRC Section 42(i)(7) • Tenants of the project (in cooperative form or otherwise) • Resident management corporation of such building • Qualified nonprofit organization • Government agency 10

Determining Minimum Purchase Price Under IRC Section 42(i)(7) • Minimum purchase price is equal to the sum of: 1) the principal amount of the outstanding indebtedness secured by the buildings (other than indebtedness incurred during previous 5 years), plus 2) all Federal, state and local taxes attributable to such sale 11

Right of First Refusal: General Observations • A right of first refusal is not an option. Needs to be triggered by a bona fide third party offer • A right of first refusal can be granted at any time during a project’s lifecycle • Parties may come together in year 15 to negotiate fair price • Congress expected minimum purchase price to be favorable to nonprofits 12

Business Considerations When Granting a Right of First Refusal • The statutory purchase price is a minimum price. • Statutory purchase price does not include: – accrued but unpaid fees to limited partners – unpaid limited partner loans – unpaid tax credit adjusters 13

Business Considerations When Granting a Right of First Refusal (cont’d) • Need to understand how sales proceeds are distributed under the partnership agreement • Right of first refusal should terminate if an affiliate general partner withdraws or is removed • Need to determine a specific term for the right of first refusal • Loan documents should contemplate a sale in year 15 11176607. 1 14