Following the reversal by the Third Circuit Court of Appeals of the Tax Court’s decision in the Historic Boardwalk case, the taxpayer has filed a petition for a rehearing or rehearing en banc of the Historic Boardwalk Hall case. The taxpayer’s brief in support of the petition asserts that the Third Circuit Court of Appeals misapplied the reasoning of the U. S Supreme Court case of Commissioner v. Culbertson. Under Culbertson, a partnership exists if, based on the totality of the facts and circumstances, it is determined that “the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.” The brief also contends that the Court of Appeals made a fundamental error in treating the historic tax credits as a return of capital. It is not common for cases to be reheard especially when there was no dissent on the panel. If the petition is denied the only appeal remaining is to the United States Supreme Court.
Creative Structuring Techniques in Real Estate Transactions – the Investor “Flip”
While interest rates for commercial real estate financing remain low, lender underwriting criteria remains very stringent. Lenders require substantial equity, guarantees, as well as strong tenants and general contractors when financing commercial real estate transactions. As a result, creative techniques are required when developing the capital stack of a commercial real estate transaction. One technique to attract equity to a project is to maximize the value of the federal tax benefits of the transaction. A partnership “flip” structure may be used to initially provide an equity investor 99.99% of the profits and losses from the development of the transaction. At a time when the equity investor receives a target yield the interests “flip” and the interests of the sponsor and investor are adjusted to reflect the intended “back end” equity ownership of the equity investor in the project. For the right investor this partnership “flip” structure can enhance the internal rate of return to the investor by combining cash flow with the cash value to the investor of the losses generated by the development of the project.
Developing Real Estate Projects – A New Look at Old Subsidies
The change in focus of the Federal New Markets Tax Credit Program to non-real estate businesses together with the high demand on the Program has deprived the real estate industry of a very valuable financing subsidy. Developers could use the New Markets Tax Credit Program to generate a subsidy of almost 20% of total project costs. The unavailabilty of the Program going forward will necessitate a new look at some old subsidies. For example, residential rental properties financed with volume cap tax-exempt bonds are eligible for the 4% Federal low-income housing tax credit without competition. The trade off for this subsidy is the restriction of the rental units to tax credit tenants for 30 years. However, this credit subsidy may be a very attractive where market and tax credit units are very similar or the project is focused on senior tenants. Similar traditional subsidies worth looking at in a new light include tax increment financing, financing through the EB-5 Program, and the variety of funding and subsidies available for green properties and properties using renewable energy. There may be some very creative uses for established subsidy programs in the development of new real estate projects.
Demand for NMTC Allocation Remains Strong
The Community Development Financial Institutions (CDFI) Fund announced that under the 2012 round of the New Markets Tax Credit (NMTC) program it had received 282 applications requesting an aggregate of $21.9 billion in NMTC authority. The CDFI Fund also described innovative uses of New Markets Tax Credit Authority which would be favored by the CDFI Fund. Innovative uses of NMTC Authority include the deployment of New Markets Tax Credit proceeds to underserved states, “qualified low-income community investments” (“QLICs”) of $2,000,000 or less, non-real estate QLICIs such as working capial and equipment loans, and revolving QLICs which would serve multiple “qualified active low-income community businesses”. In this vein, the emphasis on non-real estate QLICIs was recently supported by final NMTC Treasury Regulations which facilitate the redeployment of non-real estate QLICIs.
Treasury Issues Final NMTC Regulations
On September 28th the Department of Treasury issued final regulations modifying the New Markets Tax Credit Program to facilitate and encourage investments in non-real estate businesses in low-income communities. To address the concern that an investment in a non-real estate business would result in a liquidity event for the community development entity prior to the expiration of the 7 year compliance period, the final regulations provide that a CDE may reinvest a qualified low-income community investment during the compliance period in a “qualifying entity” provided that such reinvestment occurs within 30 days. A “qualifying entity” is defined as a certified CDFI or an entity designed by the Secretary of the Treasury. The regulations define a non-real estate qualified active low-income community business as any business whose predominant business activity (measured by more than 50% of the business’ gross income) does not include the development, management or leasing or real estate.
Duane Morris Forms Puerto Rico Renewable Energy Practice Group
Combining the capabilities of several strong practice areas of the firm, Duane Morris LLP has formed a Puerto Rico Renewable Energy Interdisciplinary Practice Group. This interdisciplinary practice group works with developers, lenders, investors, and private equtiy funds in the development of renewable energy projects in Puerto Rico. Dependent upon the importation of fossil fuels, Puerto Rico’s energy costs are very high making renewable energy a very cost effective alternative. In addition, the Puerto Rico Electric Power Authority has encouraged the development of renewable energy projects in the Island though the issuances of power purchase agreements with renewable energy developers. Members of the group consist of Larry Diamond and Marco Gonzalez of the firm’s Puerto Rico Practice Group, Jim McTarnaghan, and Phyllis Kessler of the firm’s Renewable Energy Practice Group, Nat Abramowitz ,who practices in the finance and bond field, and Art Momjian, who specializes in Federal tax credit programs including the federal renewable energy investment tax credit.
Freshman Members of Congress Urge Extension of NMTC Program
On September 18, 2012 twelve freshman members of the House of Representatives signed a letter addressed to the leaders of Congress urging the extension of the Federal New Markets Tax Program which expired on Dec. 31, 2011. The authors of the letter urged that the New Markets Tax Credit Program is a critical tool for financing small businesses and creating jobs. Proposed Senate Bill 3531 provides for a two year extension of the New Markets Tax Credit Program at $3.5 billion of allocation per year. The President had requested an extension of the New Markets Tax Credit Progam at $5 billion a year wth a specific set aside for super markets in food deserts.
After Historic Boardwalk – A New Look at the Wind “Safe Harbor”
In the aftermath of the Historic Boardwalk case, the Historic tax credit investment community is struggling with a partnership investment structure which will not be challenged by the Service. Conceptually one may only need to look to Rev. Proc. 2007-65 in which the Service set forth a safe harbor for investors in partnerships owning qualified energy facilities. The positions advanced by the Service in its appeal of the Tax Court decision in the Historic Boardwalk case mirrored many of the safe harbor requirements of the Rev. Proc. 2007-65. As a result, to follow the safe harbor of Rev. Proc. 2007-65 one would conclude at a minimum future historic tax credit partnership agreements should: (1) provide both cash flow and tax credits to the investor; (2) no longer be structured as “pay as you go” transactions; (3) no longer have tax credit indemnities in favor of the investor; and (4) no longer have an investor “put” to the developer for nominal consideration. To sum up, developers and investors looking for guidance after the Historic Boardwalk Case may find comfort in the “safe harbor” of Rev. Proc. 2007-65
Life After the Historic Boardwalk Case
In the aftermath of the Third Circuit Court of Appeal’s decision in the Historic Boardwalk Case, investors, accountants, attorneys, and developers have been analyzing and discussing the ramifications of this case for the Historic Tax Credit industry. Several historic tax credit investors have indicated that they are on hold for future historic tax credit investments and many tax counsels to historic tax credit investors have indicated challenges to their ability to issue tax benefit legal opinions to their clients. Some of the preliminary pronouncements from the Historic Tax Credit industry are that future deals will need to generate real cash flow which will not be paid for by investors, non-profit deals will be challenging because of the real lack of upside potential, and for tax opinions to be issued deals may need to be structured to follow the safe harbor provided by the Internal Revenue Service in Revenue Procedure 2007-65 which addressed the partnership flip with the wind production tax credit. In a nutshell, it may be a period of time before the historic tax credit syndication market opens again and when it does it may look a lot different than before the Historic Boardwalk Case.
Court of Appeals Reverses Tax Court Decision in the Historic Boardwalk Case
Dealing a blow to the Historic Tax Credit syndication industry, the Third Circuit Court of Appeals on August 27th reversed the Tax Court decision in the Historic Boardwalk Case. In siding with the Internal Revenue Service, the Court of Appeals examined a partnership structure commonly used in the syndication of federal Historic Tax Credits and ruled that the tax credit investor was not partner in the entity generating the Historic Tax Credits. The Court of Appeals concluded that the tax credit investor “did not have any meaningful downside risk or any meaning upside potential in HBH [the entity generating the historic tax credits].” Citing a tax credit recapture guaranty in favor of the tax credit investor to protect its capital contributions and a guaranteed investment contract in favor of the tax credit investor to guaranty its 3% preferred return, the Court of Appeals determined there was no downside risk to the tax credit investor. In a similar vein, the Court of Appeals concluded that the consideration contained in the put and call agreements for the sale of the tax credit investor’s partnership interest had no bearing to the economic reality of the transaction. While the Internal Revenue Service appealed the Tax Court decision on several grounds, the Court of Appeals assumed for purposes of its opinion that the transaction had economic substance and based its decision on one issue – whether the tax credit investor was a partner. Although the Court of Appeals acknowledged sensitivity that “… we may jeopardize the viability of future historic rehabilitation projects,” the Court found that “[w]here we confront taxpayers who have taken a circuitous route to reach an end more easily accessible by a straightforward path we look to substance over form” and the Court concluded that the tax credit investor was not a bona fide partner.