Transcript LIHTC Accounting Overview CohnReznick

Affordable Housing:
LIHTC Accounting Overview
July 30, 2014
Ta x C r e d i t s 1 0 1
TOPIC
Welcome and Overview
Project Proforma
Roles, Motivations and Responsibilities of Developer and Investor
10% Test
50% Test
Cost Certification
Life Cycle of Credit Deal: Compliance, Asset Management, Disposition
2
Overview of
L o w I n c o m e H o u s i n g Ta x C r e d i t s
3
W h a t i s a L o w - I n c o m e H o u s i n g Ta x
Credit?
Authorized under Section 42 of the Internal Revenue Code
Designed to help fund low-income housing
Investors purchase tax credits from developers of low-income housing. The
money paid by investors is contributed to the project as equity.
4
Ty p e s o f L I H T C s
9% Credit
New construction or substantial rehabilitation – awarded through
competition
4% Credit
New construction or substantial rehabilitation awarded in conjunction with
tax-exempt bonds
5
H o w D o Yo u G e t Ta x C r e d i t s ?
Developer applies to housing credit agency (HCA) for reservation of
credits
9% credits are awarded through competition
4% credits are awarded “as of right” in conjunction with tax exempt bonds
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Role of Housing Credit Agency
“HCA”
HCAs are responsible for selecting developments to allocate the Credit,
“underwriting” the Credit (sizing it according to financial needs of the
project), reporting Credit activity to the IRS, and monitoring for
compliance with federal regulations.
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Qualified Allocation Plan “QAP”
HCA guidelines must be published in annual Qualified Allocation Plans
(“QAPs”), which detail selection criteria and compliance monitoring
rules. Most HCAs select projects through competitive cycles (at least one
per year), with various threshold and scoring criteria.
Selection criteria includes project characteristics, owner characteristics,
location, market feasibility, energy efficiency, income targeting, and
affordability periods.
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Ta x E x e m p t B o n d s
Tax-Exempt Bond Financed Developments
Developments with at least 50% of aggregate basis financed with taxexempt bonds are eligible.
Credits are awarded “as of right.”
Projects do not compete. Must meet QAP and underwriting criteria.
Applicable Tax Credit Percentage is published monthly by U.S.Treasury,
and is a “floating” rate at or below 4%.
August 2014 applicable tax credit percentage is 3.25%
Frequently used to finance acquisition and rehabilitation of existing
properties (e.g., “Preservation” deals).
Project size usually 100 units or more
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Low Income Use Restriction
Minimum Requirement: rent and income restrictions must remain in place
for a 15-year Compliance Period, plus an additional 15-year Extended
Use Period.
Property owners may elect to “opt-out” of the Extended Use Period with
HCA approval under certain circumstances; Qualified Contract.
Many QAP’s have longer use restrictions and prohibit opting out early.
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Eligible Basis
Eligible basis = adjusted basis of building at end of 1st year of credit period
Includes common areas
30% boost in QCTs or DDAs
Projects located in HUD-designated Qualified Census Tracts or difficult to
develop areas receive a 30% increase on eligible basis
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Eligible Basis (cont.)
Costs that ARE included:
• Engineering & architecture
• Survey
• Appraisal
• Construction costs
• Market study
• Impact fees/permits
• Inspections
•
•
•
•
•
•
Tenant relocation
Accounting & legal
Environmental
Depreciable land improvement
Developer fee
Construction period interest, loan
fees, insurance, real estate taxes
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Eligible Basis (cont.)
Costs that ARE NOT included:
• Land
• Permanent loan fees
• Marketing and lease-up costs
• Tax credit fees
• Reserves
• Syndication fees
• Commercial or income-producing space
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Community Service Facilities
Generally, costs included in basis are limited to space used exclusively
for low-income tenants.
In qualified census tracts, basis may include costs of providing a
community service facility for use primarily by low-income residents
of the area. They do not have to be tenants. There are limitations on
the percentage of basis that may be eligible for tax credits for
community service facilities. Consult your tax credit advisor.
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Rent Rules
Rent + utility allowance (gross rent) cannot be > 30% of household income
Qualifying income based on family size and # of bedrooms
Gross rent does not include Section 8 or other subsidies
Rent limits change annually when HUD publishes new Area Median
Incomes (AMIs)
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Income Limits
Minimum set aside: certain % of units restricted for % of AMI
20/50: 20% of units at 50% of AMI
40/60: 40% of units at 60% of AMI
NYC only: 25/60: 25% of units at 60% of AMI
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Recapture for Non-Compliance
Decrease in qualified basis
Not meeting minimum set-aside
Low-income occupancy decreases
Sale or foreclosure
Eminent domain
Damaged building out of service (e.g. Sandy casualty losses)
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Role of the Investor
Purchases tax credits and tax benefits
Current price is approximately $.90 for $1.00 of tax credits
Investors may pay more for credits in areas eligible for CRA credit
Investors may pay less for credits in areas deemed higher risk
Becomes 99.99% limited partner in project ownership entity
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Ty p i c a l O w n e r s h i p S t r u c t u r e
G eneral P artner
N o m in a l
E q u ity In ve stm e n t
T ax C red it Investo r
1 % C re d its,
P ro fits & Lo sse s
9 9 % C re d its,
P ro fits & Lo sse s
$ $ E q u ity
O p erating P artnership
D e ve lo p m e n t
Fee
D evelo p er
Rent
M o rtg ag e
T enant G ro u p
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Financial Model
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Project Summary & Assumptions
Construction start & placed in service dates
Occupancy (lease-up)
Debt & equity
Operating income & expenses
Development budget (sources & uses)
Tax credit assumptions (4%-9%, 30% basis boost, tax credit pricing)
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Project Income
Unit mix
• Bedrooms
• Number of units
• Target median income %
LIHTC rent limits
Proposed rents
• Cannot exceed LIHTC rent limits
• Market study
Vacancy allowance
Tenant paid utilities
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Project Expenses
Administrative
• Management fees (% of effective gross income)
• Monitoring fees
• Annual audit/tax
Utilities
Operating expenses
• Realistic per unit cost
Replacement reserves
• Typically $250 - $300 per unit per year
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Operating Pro Forma
Income Trend
Expense Trend
Vacancy Allowance
Management Fee
2%
3%
7%
5%
Income
Gross Project Income
Vacancy Allowance
Effective Gross Income
Year 1
874,800
(61,236)
813,564
Year 2
892,296
(62,461)
829,835
Year 3
910,142
(63,710)
846,432
Year 4
928,345
(64,984)
863,361
Year 5
946,912
(66,284)
880,628
Expenses
Total Expenses
Net Operating Income
540,974
272,591
556,796
273,039
573,085
273,347
589,854
273,506
607,118
273,510
Debt Service Financing
Private Loan
Cash Flow
Debt Coverage Ratio
238,647
33,944
1.14
238,647
34,393
1.14
238,647
34,701
1.15
238,647
34,860
1.15
238,647
34,863
1.15
Cash Flow Financing
HOME
Remaining Cash Flow
16,972
16,972
17,196
17,196
17,350
17,350
17,430
17,430
17,432
17,432
Def Dev Fee Balance
Def Dev Fee Payment
Def Dev Fee Balance
691,244
(16,972)
674,272
674,272
(17,196)
657,076
657,076
(17,350)
639,726
639,726
(17,430)
622,296
622,296
(17,432)
604,864
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Development Budget - Uses
Acquisition costs
• Land
• Existing building (rehab)
Construction costs (hard costs)
• General requirements
• Builder’s profit & overhead
• Hard cost contingency
Soft costs
• Development related
• Financing (construction/perm)
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Development Budget – Uses
(cont.)
Soft costs
• Syndication
• Tax credit related
Developer fee
• Max developer fee limits (state)
Reserves
• Operating
• Rent-up
• Escrows
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Development Budget - Sources
Construction financing
• Construction
• Permanent
Debt
• Permanent debt
• Cash flow financing
• Grants
Equity
• LIHTC equity
• State tax credit equity
Deferred developer fee
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Ta x C r e d i t E q u i t y
Eligible Costs
QCT/DDA Boost (130%)
14,405,812
x
Eligible Basis
Applicable Fraction
14,405,812
x
Qualified Basis
Applicable Percentage
x
x
Tax Credit Equity
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12,965,231
x
Total Investor LIHTCs
Tax Credit Price
9.0%
1,296,523
Total LIHTCs Over Period
Investor Ownership %
100%
14,405,812
Annual LIHTC Eligible
10 years
100%
99.99%
12,963,934
x
.95
12,315,738
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Investor Metrics
Investor IRR
• Schedule of benefits
o Losses
 Depreciation
o Tax credits
• Distributions (cash flow)
• Capital contributions
o Quarterly compounding
Capital account
• Minimum gain
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T h e 1 0 % Te s t
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W h y C o n d u c t a 1 0 % Te s t ?
If a project is not placed in service in the year of credit allocation, the
project must apply for a Carryover of the Allocation. This process is
specific only to competitive LIHTCs. LIHTCs in conjunction with tax
exempt bonds are exempt.
The 10% Test is part of the Carryover Allocation Application to demonstrate
progress toward project completion.
Typically, the HCA requires an Independent Accountant’s Report. The form
of report is dictated by the HCA and may vary from state to state.
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W h a t i s a 1 0 % Te s t ?
A 10% Test supports Accumulated Basis* in a project. Accumulated Basis
must be at least 10% of the Reasonably Expected Basis* of the project
on a specific date.
*Accumulated Basis: Total costs incurred to date which represent
project’s depreciable basis plus land.
*Reasonably Expected Basis: Project’s depreciable basis plus land costs.
This amount is generally stipulated by the Owner as part of the
Carryover Allocation.
* Note: terminology varies by HCA
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The 10% Calculation
dl
10% <
Accumulated Basis (land + depreciable basis)
Reasonably Expected Basis
(total expected land + depreciable basis)
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W h a t i s i n v o l v e d i n a 1 0 % Te s t ?
The Independent Accountant will test, on a sample basis, costs presented
by the Owner as Accumulated Basis. Testing could include:
• Sampling of invoices or other documentation.
• Confirmation of costs incurred with third party vendors.
• Recalculation of fees to determine inclusion in accordance with terms.
Relevant project documents will be obtained, reviewed and retained as
part of the engagement documentation.
Additional specific procedures required by the HCA, if applicable.
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5 0 % Te s t : P r o j e c t s F i n a n c e d w i t h
Ta x E x e m p t B o n d s
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Background on Bond Financing
HCAs allocate competitive LIHTCs to projects based on their annual LIHTC
volume cap allocation received from the U.S. Treasury.
An exception to this rule relates to projects financed with Tax -Exempt
Bonds. LIHTCs awarded as of right to projects financed with Tax-Exempt
Bonds do not count against the HCAs’ LIHTC volume cap allocation.
As of right 4% LIHTCs are non-competitive. Projects must only meet
requirements under the State’s QAP and tax exempt bond rules.
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W h a t i s t h e 5 0 % Te s t ?
The 50% test is calculated by dividing the Bond Proceeds by the
Aggregate Basis of the Project. For these purposes:
• Bond Proceeds: Include only the amount of bonds used to finance the
acquisition, hard construction and soft costs of the project. Generally this will
equal the mortgage amount. Bond Proceeds do include interest earned on
the bonds or bond reserve funds.
• Aggregate Basis: Includes the Project’s depreciable basis and land costs.
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T h e 5 0 % Te s t
Bond Proceeds
50% <
____________________
Aggregate Basis
(of building and land)
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Other Bond Nuances
For a bond financed project to obtain LIHTCs the bonds must be volume
cap bonds, a separate application and allocation process from an
issuing agency. Tax exempt bond volume cap is allocated annually by
the U.S. Treasury to issuing agencies.
The Project must meet the 95/5 Test. This test is often called the “good
cost / bad cost” test and is typically performed by an Independent
Accountant. For these purposes some examples are:
• Good Costs: Building and land, common space, resident recreation and
parking facilities related to the rental residential units.
• Bad Costs: Commercial space, financing fees, bond issuance costs, some
costs incurred prior to bond inducement.
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M e e t i n g t h e 5 0 % Te s t
If the Project meets the 50% Test, the Project may claim 100% of the 4%
credits on the total amount of eligible basis.
Example:
Volume Cap Bonds
Aggregate Basis
50% Test Ratio
Land in Aggregate Basis
10,000,000
19,900,000
50.2513%
2,000,000
Eligible Basis
17,900,000
Eligible under 50% Test
100.0000%
Final Eligible Basis
17,900,000
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W h a t H a p p e n s i f a 5 0 % Te s t
Fails?
If the Project does not meet the 50% Test the Project is limited to 4%
credits on the amount of eligible basis times the final ratio. This has a
severe impact on the available credits!
Example:
Volume Cap Bonds
Aggregate Basis
50% Test Ratio
Land in Aggregate Basis
Eligible Basis
10,000,000
20,100,000
49.7512%
2,000,000
18,100,000
Eligible under 50% Test
49.7512%
Final Eligible Basis
9,004,975
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To p r e v e n t f a i l i n g 5 0 % Te s t
Alternative methods for calculating capitalization of project costs; i.e.,
construction interest capitalization, 266ii election, etc.. This is typically
the first alternative evaluated.
Reduction of Aggregate Basis costs via funding at General Partner level
through GP guarantees of maximum project costs for construction.
Obtain an additional allocation of volume cap bonds to increase the
numerator in the calculation. These bonds would be used to pay
qualified costs and typically repaid with permanent sources such as
equity or other debt.
Reduction of developer fee until the 50% ratio is met -- typically the last
resort!
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R e p o r t i n g f o r 5 0 % Te s t s
50% Tests are reported in different ways depending on the HCA. Reports
are generally required to be prepared by an Independent Accountant.
Two options are typical:
• Report as part of the final 8609 cost certification: In this option there is
a separate provision in the HCA’s reporting format which includes a
calculation and report on the 50% status.
• Report in a separate letter: In this option there is a separate report
stipulated by the HCA which specifically addresses the 50% test.
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The Independent Accountant’s
Report
Report typically in form of an Agreed Upon Procedures (AUP) report
performed by an Independent Accountant
Specific procedures required by the HCA are reported upon by the
Independent Accountant
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8609 Cost Certification
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What is a Cost Certification?
CPA’s audit of project costs. Required by HCA’s to certify eligibility for LIHTCs.
Each HCA has specific information required to be included. Typically required:
schedules of total and eligible costs by project and building, calculation of
credits, sources and uses of funds, gap analysis and project proformas.
Upon final issuance of the cost certification, as a part of the final application
package, which usually includes additional materials, forms 8609 will be issued
to the owner.
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New Construction vs. Acquisition
Rehab
New Construction: Involves construction of a project “from the ground up.” In
these circumstances, there was either vacant land with no existing building, or
all existing structures were demolished and a new structure constructed.
Acquisition / Rehabilitation: Involves acquiring an existing project and
rehabilitating the structure. This can involve rehabilitation around tenants,
tenants do not vacate units, or vacate units on a daily basis; or units can be
taken out of service, tenants are relocated during rehabilitation.
The nature of the construction/rehabilitation has direct effects on the ability to
capitalize costs as eligible as well as the method for determining credit rates.
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Acquisition Rehab – Additional
Considerations
Minimum Rehab Test: Rehabilitation of the Project must meet minimum
requirements: $6,200 per unit or 20% of adjusted acquisition basis, or whatever is
stipulated in the relevant QAP
Purchase from an unrelated party: Acquisition of the Project must be from an
unrelated party for tax purposes.
10 Year Rule: The project must not have been placed in service within 10 years
previous to acquisition (certain exceptions apply).
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Eligible Costs (Refresher)
Costs that ARE included (wholly
eligible):
•
•
•
•
•
Engineering & architecture
Survey
Appraisal
Market study
Impact fees/permits
• Depreciable land improvement
• Tenant relocation
• Inspections
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Acquisition Analysis
New Construction: Generally limited to ineligible land costs
Acquisition/Rehab: Must create or obtain a purchase price analysis to establish
basis in acquired assets:
In most cases an independent appraisal is used to support allocation of
acquisition cost to land and building (potentially furniture & fixtures and
existing leases, etc.)
In complex transactions involving commercial space, long term tenants, or
related parties, a 3rd party specialist may need to perform a purchase price
allocation
Basis related to acquired building is eligible for 4% acquisition credits.
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Construction Costs
Construction costs related to residential rental units, common space, tenant
amenities (non-commercial) and depreciable land improvements are eligible.
Construction costs related to demolition (non-rehab), commercial space,
permanent land improvements are not eligible.
Contractor fees for overhead, general requirements and profit are limited –
subject to specific limits prescribed by the HCAs. See QAP for year of
allocation.
Related party contractors require additional documentation for testing purposes
to support costs (job costs, etc.).
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Developer Fees
Developer Fees are eligible to the extent of underlying developer activity, which
can be determined via review of the developer agreement and direct inquiry.
Developer Fee may be allocated to:
Acquisition / Rehab and Commercial / Residential
Development and construction related services: eligible
Financing related activity (acquisition of debt/equity): partially eligible (equity
related = ineligible)
Developer fees are also subject to specific limits prescribed by the HCA.
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Legal Fees
Similar to Developer Fees, legal fees are eligible to be capitalized based on the
underlying characteristics for which they were rendered.
Fees are treated similarly to those underlying costs. For example, if related to
organizational/partnership or syndication costs, legal fees are 100% ineligible.
Financing fees are amortized over the life of the related financing instrument.
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Monthly Capitalization (for
periodic costs)
The amount of a specific cost to be capitalized for a specific month; i.e., eligible,
can be determined by the proration of the project which is out of service.
New Construction: This scenario is straight forward, at inception, 100% of units are
out of service, decreasing to 0% as the Project is completed.
Rehabilitation: Capitalization is determined by units out of service at the
beginning of each month. Factors such as whether the project has in place
tenants at acquisition, rehabs around tenants, etc. all factor in to capitalization
determination
Note: “out of service” indicates that the unit is NOT ready and available for its
intended use
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Monthly Capitalization – New
Construction Example
Example: Uniform units.
Units out of service
100
80
60
40
20
0
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Monthly Capitalization –
Rehabilitation Example
Example: Uniform units with existing tenants in place, units taken offline.
Units out of service
100
80
60
40
20
0
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Monthly Capitalization –
Rehabilitation (cont.)
Project is vacant at acquisition: monthly capitalization will work like New
Construction.
Rehab around tenants: monthly periodic costs will not be eligible.
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Periodic Costs
Costs which attach to specific periods of time such as insurance, real estate
taxes, etc. These costs are allocated across the relevant period and are
eligible in the percentage that the related month is out of service – see
monthly capitalization.
Construction loan costs and costs of issuance including title & recording on loans
are periodic costs. This is an often confused concept.
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Interest Capitalization
Interest is also a periodic cost, but varies from the previous costs in that
capitalization is typically done on a quarterly basis on the first day of each
quarter.
Monthly capitalization is an option for acquisition rehab projects with a irregular
pattern for quarterly capitalization.
Interest capitalization can be a complex calculation.
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Interest Cap Example –
Traditional Financing
January
February
March
Interest
Charges
$
8,000
$
9,000
$ 10,000
$ 27,000
Out of
Service
100%
75%
50%
Capitalized
$
8,000
$
6,750
$
5,000
$ 19,750
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I n t e r e s t C a p E x a m p l e – Ta x Exempt Bond Financing
Total Bond Issue
$ 3,000,000 A
B
Quarter 1
Quarter 2
Quarter 3
$
$
$
$
Interest
Charges
10,000
10,000
10,000
30,000
C
Bonds Drawn
for
Construction
$ 1,000,000
$ 1,750,000
$ 2,250,000
D = (C / A)
Construction
Fraction
33%
58%
75%
E = (B x (1 - D))
Investment
Interest
Expense
$
6,667
$
4,167
$
2,500
$
13,334
F = (B - E)
G
Construction
Interest
Expense
Out of Service
$
3,333
100%
$
5,833
75%
$
7,500
50%
$
16,666
FxG
Capitalized
$
3,333
$
4,375
$
3,750
$
11,458
* Note = 266ii election can be made to capitalize investment interest expense
rather than deducting the amounts. This results in no offset to any income
earned on bond reserves, which will be recognized as revenue.
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Avoided Interest
Avoided interest relates to the cost of interest which has been avoided through
the use of equity for financing the Project.
Avoided interest is calculated on non-traced debt as the weighted average
interest rate for the period.
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Determining the Applicable
Percentage – New Construction
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Determining the Applicable
Percentage - Acquisition
64
Determining the Applicable
Percentage - Rehabilitation
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Definitions
“30% Boost”: Properties located in a federally-designated Qualified
Census Tract, or Difficult Development Area, are eligible for 30% increase
in eligible basis in calculating the credit for new construction and
rehabilitation costs (acquisition portion not eligible).
Aggregate Basis: Land + depreciable basis; relevant for calculating tax
exempt bond 50% test.
Annual Credit Amount: Product of Qualified Basis and Applicable Credit
Percentage Fraction.
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Definitions (cont.)
Applicable Fraction: The lesser of the unit fraction or floor space fraction.
Must meet for each BIN in project.
Applicable Tax Credit Percentage: Rate published monthly by Treasury to
determine credit amount based on Qualified Basis. Fixed at 9% for most
new construction and rehabilitation expenses for projects receiving
allocations until December 31, 2014. Floating rate at or below 4% for
acquisition and construction/rehab costs financed with tax-exempt
bonds.
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Definitions (cont.)
Eligible Basis: Development costs related to acquisition, rehabilitation, or
construction of a new building that are depreciable to that building.
Floor Space Fraction: S. F. low income units
S.F. total units
Qualified Basis: Product of Eligible Basis and Applicable Fraction.
Unit fraction: low income units
total units
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QUESTIONS?
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Presenter
Marshall Phillips
Principal
CohnReznick, LLP
525 North Tryon Street, Suite 1000
Charlotte, NC 28202
[email protected]
704-332-9100
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Presenters
Nic Mathias, CPA
Senior Manager
525 N. Tryon Street, Suite 1000
Charlotte, NC 28202
704-900-2013
[email protected]
Garrick Gibson, CPA
Senior Manager
816 Congress Avenue, Suite 200
Austin, TX 78701
512-499-1448
[email protected]
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