Important LIHTC Partnership Agreement Features

In 2012, the U.S. Department of Housing and Urban Development (HUD) recognized that the Low-Income Housing Tax Credit industry had matured to the point where tax credit investors were contractually agreeing to receive “little or no residual value or return of capital” because, in part, competition for housing credits was significant, and investors in LIHTC partnerships look for tax benefits, not traditional real estate investment benefits. It is also well-documented that participation in the LIHTC program results in the formation of a unique business arrangement, one that is governed by carefully negotiated contracts that alter the typical bargained-for exchange in conventional real-estate business ventures. Accordingly, at the end of the statutorily prescribed 15-year compliance period (commonly referred to as Year-15), tax credit investors typically look to exit from a LIHTC partnership because they have realized their desired tax benefits, and those benefits are secured from recapture by the Internal Revenue Service.[1]  Because tax credit investors want the ability to reduce federal income tax liability, rather than generate traditional real estate benefits, it is commonly understood within the LIHTC industry that the super-majority of economic benefits (80 to 90 percent) from a LIHTC partnership (including residual value that may appreciate in the underlying real estate during the compliance period) is typically reserved by contract for participating real estate developers or sponsors as consideration for their 15-plus years of work, risk and stewardship prior to and throughout the compliance period when substantially all (99.99 percent) of the Housing Credits are being allocated to the tax credit investors.[2] 

With this backdrop and the continued rise of Year-15 disputes within the LIHTC industry, courts around the country have repeatedly recognized this unique business arrangement when resolving contract disputes produced by Aggregators and others who have emerged to adopt their strategies. Thus, it is important to understand key Year-15 features that can be contractually provided through LIHTC agreements, particularly because these carefully negotiated exits are “crucial to the efficacy of the LIHTC program” in that they allow developers or sponsors to utilize the appreciated equity for which they bargained to refinance affordable housing, make needed repairs and continue operating the housing in good condition after a tax credit investor exit, and invest thereafter in the creation of new affordable housing through continued participation in the LIHTC program.[3] Because of these circumstances, it is critically important that the carefully negotiated contracts that govern the relationship between tax credit investors and real estate developers or sponsors, including their agreed-upon contractual exit mechanisms, utilize plain and unambiguous language to memorialize their agreements to give full effect to the underlying business intent and arrangement. 

One key mechanism for exiting tax credit investors from a LIHTC partnership and compensating a sponsor or developer for its 15-plus years of stewardship and service is a contractual purchase option through which the investor members’ interests in the LIHTC partnership are acquired at the end of the compliance period and the LIHTC partnership survives under consolidated ownership.[4]  This can be accomplished, contractually, through an appraisal of the fair market value of the investor members’ interests in the LIHTC partnership. Fair market value may be determined using either: 1) a hypothetical distribution of sale proceeds, which assumes a sale of the affordable housing at fair market value and distribution of proceeds based on the parties’ agreed upon capital transaction waterfall that reserves the substantial majority of residual value from a sale for the developer or sponsor (typically 80 to 90 percent); or 2) a “going concern” valuation of the partnership, whereby benefits of ownership are projected out into the future and discounted back to present value, with consideration also given to the lack of marketability and control generally associated with limited partner ownership interests  (i.e., a discounted cash flow analysis). For maximum flexibility, it is recommended that both options be provided, and great care taken to use contract language that is plain, ordinary and simple. 

For instance, if a discounted cash flow analysis is the intended proxy for an investor member interest purchase price, then saying so directly rather than indirectly is recommended.  Similarly, when a hypothetical property sale and distribution of sale proceeds pursuant to the parties’ economic sharing agreement is the proxy, plainly say so and utilize references to specific sections within partnership agreements to avoid ambiguous arguments that may arise later. And, because neither proxy subsequently results in the dissolution of a LIHTC partnership or liquidation of assets, it is recommended that the parties’ contract directly express this agreement as well, which is also consistent with the growing body of case law on this topic that distinguishes between the distribution of proceeds from a property sale and the subsequent liquidation of a partnership’s remaining assets through dissolution or winding-up activities that occur post-sale.[5]  Indeed, while Courts have repeatedly rejected arguments designed to avoid these proxies and produce inflated exit prices based on positive capital account balances, the more clear, plain and direct parties are when memorializing their agreements the more likely they are to avoid future disputes. 

Similarly, when a nonprofit sponsor or developer is participating, a Section 42(i)(7 ) Right of First Refusal (ROFR) can and should be included among the Year-15 contractual exit mechanisms.  Under the Code, and as courts have confirmed, this ROFR is a special right, reserved only for qualifying organizations like tenant groups or 501(c)(3 ) nonprofits, and is intended to be an efficient and orderly process whereby a qualifying organization can harness access to capital by acquiring affordable housing at the end of the compliance period for the debt secured by the housing and the taxes attributable to the sale of the housing under the ROFR.[6] This statutory “Minimum Purchase Price” is commonly referred to in the LIHTC industry as a “debt-plus-taxes” purchase price and is intended by statute to be less than fair market value. The Code does not require, nor provide specific mechanisms by which to trigger an ROFR, instead leaving it up to the participating parties to supply such terms through their contractual agreements if they so desire, with the understanding that Congress designed the ROFR to be a simple and orderly process that follows a desire or intent to sell the affordable housing at the end of the compliance period.[7] Accordingly, because the Code does not mandate the provision of a ROFR, parties should ensure that a ROFR is provided by contract when a qualifying organization is involved in a LIHTC partnership, and all conditions to exercise and close on it should be plain and simple without unnecessary hurdles.[8] However, where contractual requirements have been supplied by contract, they can be satisfied and courts have enforced ROFRs, but given the key features of a Section 42(i)(7 ) ROFR and minimal requirements attendant thereto parties should avoid complication and keep these ROFRs plain, efficient and unambiguous.[9]

In sum, the LIHTC program produces unique business arrangements that require carefully constructed contracts to ensure that the parties’ business agreements are accomplished at the end of the compliance period. Thus, partners must pay close attention to their Year-15 exit mechanisms to ensure that they will receive their bargained-for benefits when the time comes for them to receive them.

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[1] Year 15 HUD Report at 25, 29, 32; Comptroller Report at 3-4; SunAmerica Hous. Fund 1050 v. Pathway of Pontiac, Inc., 33 F.4th 872, 874-75 (6th Cir. 2022); AMTAX Holdings 227, LLC v. Tenants’ Dev. II Corp., 15 F.4th 551, 553-54 (1st Cir. 2021); JER Hudson GP XXI LLC v. DLE Invs., 275 A.3d 755, 764-66, 771 (Del. Ch. May 2, 2022).

[2] See Year 15 HUD Report, at 11, 30, 41, 44-5, 76, 86, n.25; CRS Report RS22389, at 1, 4-6; see also, e.g., AMTAX Holdings 436 LLC v. Full Circle Villagebrook GP, Ca. No. 23-CV-14409, 2024 WL 3043171, at *4-6 (N.D. Ill. June 18, 2024); Saugatuck, LLC v. St. Mary’s Commons Assocs., L.L.C., Ca. No. 2:19-CV-00217, 2022 WL 3699484, at *7-8 (E.D.N.Y. Aug. 26, 2022); Centerline/Fleet Housing Partnership, L.P. – Series B v. Hopkins Court Apartments, L.L.C., 195 A.D.3d 1375 (N.Y. 4th Dept. 2021).

[3] Pathway of Pontiac, 33 F.4th at 875.

[4] See supra, n.5; see also Year 15 HUD Report, at 29.

[5] Full Circle Villagebrook GP, 2024 WL 3043171, at *4-6; St. Mary’s Commons, 2022 WL 3699484, at *7-8; Hopkins Court Apartments, 195 A.D.3d at 1377-78.

[6] Pathway of Pontiac, 33 F.4th at 874-75, 880-81; Tenants’ Dev. II Corp., 15 F.4th at 554-55; Homeowner’s Rehab, Inc. v. Related Corp. V SLP, L.P., 479 Mass. 741, 744-45, 753-57 (2018).

[7] Id.

[8] Id.

[9] Id.