Transcript ACQUISITION/REHABILITATION: THE 10% ANTI-CHURNING RULE

ACQUISITION/REHABILITATION:
THE 10% ANTI-CHURNING RULE
James F. Duffy, Esquire
Nixon Peabody LLP
100 Summer Street
Boston, MA 02110-2131
(617) 345-1129
(866) 947-1697 (fax)
[email protected]
LEARNING THE BASICS:
HOUSING TAX CREDITS “101”
IPED, INC.
San Francisco, California
July 24-25, 2008
GP
Old
LP
GP
New
LP
Property
Selling
Partnership
Cash
Buying
Partnership
THE RULE
• Section 42(d)(2)(B)(iii) of the Code provides that in
order to receive acquisition credits, the building
cannot previously been placed in service by the
taxpayer or by a related person.
Note: This is a “cliff test” where if you fail the test,
you lose ALL of your acquisition tax credits.
RELATED PERSON TEST
Section 42(d)(2)(D)(iii)(II) tells you that a “related
person” to a taxpayer means 10% or greater
common ownership.
How do you determine your percentage
ownership in a LIHTC Partnership?
•
LIHTC Partnerships are structured with partners
receiving different percentage interests in different items:
- Tax Credits
- Cash Flow
- Sale/Refinancing Proceeds
- Maybe State Tax Credits
The LIHTC industry has prudently decided that if you
have a 10% or greater interest in any item in the
seller, you have to have less than a 10% interest in
all items in the buyer.
Since a General Partner tends to have more than a
10% interest in Cash Flow in the old Partnership (the
seller), the General Partner will be required to have
no more than a 9.9% interest in Cash Flow and in
Sale/Refinancing Proceeds in the new Partnership
(the buyer).
This is not your typical LIHTC business deal if the
syndicator/investor has 90.1% of Cash Flow and
Sale/Refinancing Proceeds.
So, what typically happens?
- Partnership Management Fee
- Incentive Management Fee
• The question is whether or not these fees exceed a
reasonable fee which would be paid to a third-party
service provider performing the same services.
• Anything paid (or payable if there were Cash Flow)
in excess of a reasonable fee could be reclassified
as additional Cash Flow to the General Partner.
•And, since we’re already at 9.9% of the Cash Flow
going to the General Partner, there’s no room for
error.
•The risk is the loss of all of the Acquisition Credits if
the General Partner is deemed to really have a
10.01% interest in Cash Flow.
• Look at these Cash Flow fees to see if they’re
“reasonable.”
• For instance, would a third-party service provider
agree to be paid only if there were sufficient Cash
Flow at that point in the Cash Flow waterfall?
• A Cash Flow fee looks more like a real fee, rather
than like a Cash Flow distribution, if it accrues, even
if there is no Cash Flow available to pay it currently.
Creative Techniques:
• Higher Property Management Fees
• A property management fee equal to, say, 14% of
gross rental income, with the argument that there
are very low rents (e.g., 30% of Area Median
Income).
• The property manager is affiliated with the General
Partner.
Purchase Money Notes
•
Payable by the buying partnership to the selling partnership
out of the buyer’s Cash Flow as payment of the purchase
price for the property
•
A good appraisal is important, as the purchase price for the
property must be properly supported so that a portion of the
purchase price is not re-characterized as a distribution of the
buyer’s cash flow.
New Co-GP to Receive Cash Flow
•General Partner has 9.9% of Cash Flow in the
buyer and a new Co-General Partner (which was
not a General Partner in the seller) has 70-80% of
Cash Flow in the buyer.
•Need to closely examine the full relationship
between the two General Partners.
Ground Lease
• The seller ground leases the property to a related
party of the General Partner, charging the “buyer”
(here, the ground lessee) an annual ground lease.
• The structure creates an appraisal issue as to the
proper value of the leasehold estate and the market
value of the annual leasehold rents (often difficult to
evaluate).
Development Fee for the Rehabilitation
•
If paid to an affiliate of the General Partner (the
usual arrangement), the fee must be tested for
reasonableness.
•
This can be especially problematic if there is a
minimal rehabilitation.
•
There is a similar issue (the reasonableness of
the fee) with a construction fee for the
rehabilitation work payable to a general
contractor affiliated with the General Partner.
• Some investors are more risk adverse than others,
so find out early on what is acceptable to your
investor.
The Investor as a “Related Party”
• Also, don’t forget the 10% test from the
investor side.
• It’s usually OK to use the same syndicator for
the buyer as was used for the seller, as long as
the ultimate investor(s) don’t cause a 10%
related party problem.
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