Industry Welcomes Guidance, Expects Renewed Equity Flow

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Historic tax credit industry participants have welcomed and praised the new IRS safe harbor guidance and are optimistic that it will eventually restore a healthy flow of equity investment capital for new projects. But they suggested it will be a number of weeks before the spigot turns on fully because of ambiguous or challenging parts of the guidance that need to be clarified or addressed and until investors, developers, and practitioners come to consensus on acceptable features of partnership structures for new deals.

One thing is certain: The structures of future historic tax credit transactions will be significantly different from those in the past, shifting greater risk to investors while also providing them greater potential upside.

The industry has experienced a fiscal “chill” since the Historic Boardwalk Hall decision in August 2012. The decision created uncertainty about whether typical federal historic rehabilitation tax credit deals would be respected by the IRS for federal tax law purposes, prompting a number of major traditional investors to stop or cut back on fresh equity investment commitments for new projects. Some historic credit deals have closed since the decision but with some revisions to partnership structures compared to pre-HBH deals.

New IRS Revenue Procedure 2014-12 is the end product of a lengthy dialogue between historic credit industry participants and IRS/Treasury officials that began April 2013 when the industry requested formal guidance on allowable historic tax credit partnership structures to provide certainty and comfort to investors and thereby enable new projects to move forward. (Revised Rev. Proc. 2014-12: http://tinyurl.com/kjf98uf)

New Guidance Lauded

“The overall reaction is relief, and a belief, based on conversations we’ve had over the last couple of weeks, that this is going to restore the flow of capital to the historic tax credit business,” said John Leith-Tetrault, chairman of the Historic Tax Credit Coalition and president of the National Trust Community Investment Corporation, a syndicator of historic and new markets tax credits. “We’re getting a lot of positive reaction from developers, investors, accountants, and lawyers and feel like the consultative process that we had with the IRS and Treasury really worked.”

“I think Treasury and IRS did a very good job in trying to create a safe harbor and a road map for the industry to move forward after Historic Boardwalk,” said Washington, D.C. tax attorney Jerry Breed, a partner at Bryan Cave LLP.

Several major corporate investors in historic tax credit transactions welcomed the new guidance.

“We have a pipeline of historic deals that we’re really excited to

move forward with now that we have a safe harbor,” said senior executive David Leopold of Bank of America Merrill Lynch, who said BofAML in 2013 closed six transactions utilizing historic tax credits, far fewer than the bank’s normal annual volume prior to HBH and the recession. “We intend to operate in line with the safe harbor guidance and execute on that pipeline and build it,” he said.

Executive Matt Philpott of U.S. Bancorp Community Development Corporation, in a statement, said: “Last year we experienced significant uncertainty in the industry, and we believe that this guidance will be useful in getting this important tax credit back into the service of helping fill financing gaps in historic property rehabilitation. The clarification to certain features under the safe harbor is helpful and appreciated. We expect to work with the

guidance immediately as applicable in our tax credit equity investments.”

Areas of Certainty, Uncertainty

Some sources believed that virtually all new historic tax credit partnerships and projects will be structured to meet all requirements to qualify for reliance on the safe harbor.

A partnership structured to satisfy the safe harbor requirements will be respected by the IRS for federal tax law purposes and not challenged. Still, the guidance provides that partnerships not fully meeting the safe harbor requirements won’t automatically be deemed as suspect.

Sources said some objective standards in the guidance should be easy to satisfy in structuring new deals. Examples include the requirements that the developer/ general partner have at least a 1% interest in the partnership and that the investor/limited partner contribute at least 20% of their anticipated total capital contribution before the project is placed in service, according to Boston tax attorney Forrest Milder, a partner at Nixon Peabody LLP.

Still, some areas of uncertainty need to be resolved.

“We’ve certainly taken a major step with the guidance,” said Boston attorney William Machen, a partner at Holland & Knight, “but there’s still some clarifications and stuff like that that we’re going to need to make this thing really work.”

Some of the biggest challenges, tax attorneys said, are getting clarification of some definitions and formulating acceptable procedures to verify that certain traits of proposed historic tax credit transactions are comparable to those in conventional, non-HTC real estate projects. For instance, the guidance provides that the value of an investor’s partnership interest “may not be reduced through fees (including developer, management, and incentive fees) that are unreasonable as compared to fees, lease terms, or other arrangements” for a non-HTC real estate project.

The guidance doesn’t define “unreasonable” nor conversely shed light on what would be considered reasonable. Accordingly, for example, practitioners will have to make judgments as to the allowable types and size of fees that reduce the amount of project cash flow available for distribution to the investor.

Machen felt it will probably be necessary to hire a third-party expert with good credentials, such as an appraiser or market analyst, “to come in and confirm that the terms of your deal are consistent with those of non-credit transactions.”

The attorneys also said some features of typical past historic tax credit projects differ from those of conventional commercial real estate projects, making comparisons difficult.

In addition, the guidance doesn’t allow for net worth and liquidity requirements to be imposed on providers of various permitted guarantees, such as on the general partner, even though these are common in conventional real estate transactions and in past historic tax credit deals. However, several attorneys suggested a possible workaround might be to “piggyback” on the net worth requirements imposed by lenders, which aren’t barred.

Current Projects, Pricing Impact

While the safe harbor guidance is intended to provide certainty for future historic tax credit deals, several sources anticipated reviewing the terms of existing historic tax credit deals in the pipeline and projects that have closed but not yet been placed in service to determine whether to make modifications to comply with the safe harbor.

The other big unknown is what impact if any the revised deal structures will have on the price investors are willing to pay developers for federal historic tax credits. While new deals structured under the safe harbor will require investors to bear greater risk than on typical historic deals of the past, their likely share of the partnership before any flip will be slightly smaller (99% vs. 99.99%) and any preferential return can’t be guaranteed. But they will have the opportunity for greater economic gain if a project is very successful.

Despite all the remaining certainties, sources are generally optimistic that the new guidance will put the historic tax credit industry back in a healthy place.

“I think people will figure out how to do it,” says Milder. “And that will improve the marketplace terrifically.”