History and the Hill: Multiple Challenges Call for Industry Resilience

Published by John Leith-Tetrault on Wednesday, May 1, 2013
Journal thumb May 2013

It’s hard to believe that a tax credit that has done so much to revitalize towns and cities across America could be under such attack. You would think that a Reagan Administration financing incentive that had enabled the rehabilitation of over 38,000 buildings, generated 2.3 million jobs and leveraged $106 billion in rehabilitation expenditures compared to just $20.5 billion in credit allocations, would enjoy natural bipartisan support on the Hill. You would also think that the Internal Revenue Service (IRS) would not compare a congressionally mandated credit like the federal historic tax credit (HTC) to abusive tax shelters, and that the HTC would enjoy the same favorable financial accounting treatment as other 1980s -vintage tax credits such as the low-income housing tax credit (LIHTC).

But alas, none of these presumptions is true. If there are existential moments for federal tax credits, that moment is now for the HTC. It will take commitment and resilience on the part of the HTC industry to successfully meet these three challenges facing the HTC.

Market Demand Drops in the Wake of IRS Chief Counsel Memo and Increased Audit Activity
It was just last fall that the HTC market froze based on initial reactions to the 3rd Circuit Court’s decision in the Historic Boardwalk Hall (HBH) case. By early December, deals were closing again based on an HTC industry consensus on how to differentiate new transactions from the facts in HBH. Investors resisted early calls for an IRS revenue ruling that would end uncertainty and it was back to business as usual. Then in March, the release of an IRS Chief Counsel Memorandum (CCM) that revealed the facts in a Detroit HTC transaction cast doubt on where the IRS would draw the line on the issue of how much risk investors were expected to bear in HTC deals to be respected as partners. The Detroit project’s facts were somewhat obscured by heavy redactions, adding to investor concerns about the memo. News of the CCM was followed by reports to the Historic Tax Credit Coalition (HTCC) of aggressive IRS audit activity based on HBH compliance reviews on closed transactions. (Read more about the CCM on page 65.)

Investor response to these events was swift and severe. Chevron, by far the largest dollar volume HTC investor, “paused” its investment activity with no clear date for a re-entry into the market. U.S. Bank stated that it would suspend HTC investments pending the issuance of clear guidance from the IRS. Sherwin Williams and PNC Bank, however, have stayed in the market. Syndicators report that discussions with potential new HTC investors have become stalled over HBH fears. There is general concern among law firms active with the HTC that there is now no certainty about what investor risk factors are needed to withstand IRS scrutiny.

Prompted by this market disruption, the HTCC has submitted draft guidance to the IRS that it would like the IRS to use to shape a revenue ruling. While the detailed content of this draft guidance is confidential, it focuses on defining the amount of upside and downside risk an investor must have to pass the HBH test. Factors to consider are the nature of guarantees, the amount of construction period capital that is at risk, and the potential for upside cash from operations and investment exit. A meeting with the Treasury and IRS officials was held on April 9 and there has been discussion of placing an HTC revenue procedure on the IRS Priority Guidance List for fiscal year (FY) 2014, which begins July 1, 2013. The best news coming out of the IRS meeting has been the IRS’ sincere statements of support for the federal HTC’s mission and its commitment to help calm the markets. Further discussions between the IRS and the HTCC will likely occur in the near future.

It’s Crunch Time on Tax Reform
April 15 was the deadline for submitting comments to the House Ways and Means Committee tax reform working groups on behalf of the HTC. The HTCC submitted comments to three of the groups: Debt, Equity and Capital, Real Estate and Financial Services. The submissions include the latest report on the HTC’s economic impact (conducted for the National Park Service by Rutgers University), the HTC recapture survey (completed for the National Trust for Historic Preservation by Novogradac & Company) and a letter signed by more than 100 organizations that support the HTC. To view a copy of the HTCC’s submissions to these tax reform working groups, go to http://historiccredit.com. The HTCC also defended the retention of the HTC in a post-reform tax code on an April 17 panel convened by the Ways and Means Committee’s Financial Services Tax Reform Working Group.

These working group interactions were preceded by a well-attended industry lobby day on February 25 that brought more than 230 HTC advocates to Washington, D.C. to urge retention of the HTC as the tax code is reformed, and to seek co-sponsors for reintroduction of the Creating American Prosperity through Preservation (CAPP) Act, which serves as the HTCC’s list of “bright ideas” to improve the HTC as part of a tax reform bill. Introduction of H.R. 1, the House’s tax reform bill, is expected by the middle of May so now is the time to keep up the contacts and communication with Members of Congress. To take action on behalf of the HTC, go to www.preservationnation.org/take-action/advocacy-center/policy-resources/historic-tax-credits.html.

Broadening Application of Effective Yield Accounting
The March 14 decision by the Financial Accounting Standards Board (FASB) Emerging Issues Task Force (EITF) to ask staff to prepare a rule change to allow for the application of effective yield accounting treatment to non-guaranteed LIHTC transactions was a move in the right direction. However, the proposed expansion of EITF 94.1 will not, at least initially, include the HTC.

The currently used equity method of accounting requires both an above the line and below the line booking of a tax credit investment. The above the line entry (for generally accepted accounting principles) to the profit and loss (P&L) statement is an impairment calculation that anticipates the possible partial write-off of an investor’s equity investment when it exits the transaction. For the HTC, that impairment could be as much as 50 percent of the full investment in the first year. The below the line balance sheet entry is for the amount of the credit. The effective yield accounting method would net the two financial statement effects and show a net positive impact. Publicly traded companies are sensitive to the above the line P&L impact of tax credit investments because their financial health is measured on Wall Street against pre-tax earnings.

The effective yield accounting white paper submitted by the Financial Services Task Force did call for the inclusion of other credits including the HTC, new markets (NMTC) and renewable energy credits in the new rule, but the staff recommended a narrower approach to the EITF. This is an unfortunate development for the HTC in particular because the HTC’s negative P&L impact under the current equity method of accounting is more severe than it is for credits like the NMTC and LIHTC that vest over seven and 10 years, respectively.

The HTCC has submitted a comment letter to FASB’s Emerging Issues Task Force asking that the rule change apply to all credits equally and simultaneously as long as they meet the four criteria established to qualify transactions for effective yield accounting treatment. To read more about these criteria, go to novogradac.wordpress.com. To read the HTCC’s comment letter, go to http://historiccredit.com. The HTCC’s concern is that in today’s competitive market for tax credit investments, those credits that can offer investors effective yield accounting treatment will have a strong market advantage. In its letter the HTCC urges the EITF to level the playing field.

Each of these three challenges to the future of HTC is formidable on its own. All three together amount to a daunting near-term advocacy burden that would be difficult for any industry coalition to bear. But with success, a stronger and more influential industry will emerge.

John Leith-Tetrault has more than 30 years of experience in community development financing, banking, community organizing, historic preservation, training and organizational development. He has held senior management positions with Neighborworks, Enterprise Community Partners, Bank of America and the National Trust for Historic Preservation. Mr. Leith-Tetrault is the founding president of the National Trust Community Investment Corporation and serves as the Chairman of the Historic Tax Credit Coalition. He can be reached at (202) 588-6064 or [email protected].