Maximizing NMTC Benefit by Using HTC Subsidy as a Source Leverage Stack
Question: When twinning new markets tax credits (NMTCs) and historic tax credits (HTCs), can HTC subsidy be used as a source of the leverage stack to maximize the NMTC benefit for a transaction?
Answer: Yes, with strategic structuring, HTC subsidy can be used as a source of leverage to maximize the NMTC benefit.
When considering the different aspects of an NMTC transaction, one major item that the project sponsor team must resolve is what the different source(s) will be for the leverage loan. The leverage loan is the funding needed by an investment fund, in addition to NMTC investor equity, to make the qualified equity investment (QEI) for the transaction. The project sponsor team is tasked with pooling sufficient sources for leverage while working to maximize the NMTC benefit. When twinning NMTCs and HTCs, strategic planning can be done to use the HTC subsidy as part or all of the leverage stack. There are different ways that a project can be structured to get the proceeds from the HTC subsidy to the entity that will serve as the leverage lender. Some of these approaches use federal HTCs, state HTCs or both, dependent on the structure.
In an NMTC transaction, the leverage loan and NMTC equity proceeds flow through the NMTC structure to the qualified active low-income community business (QALICB). The development’s HTCs are generated based on qualified rehabilitation expenditures (QREs) incurred at the QALICB. The amount of HTC equity that will be funded into the project is then based on the amount of those HTCs.
A common structure that is used when twinning NMTCs and HTCs is referred to as a lease passthrough structure. In this structure, the HTCs are passed through a lease from the QALICB, serving as the landlord, to a master tenant entity. HTC equity is contributed from an HTC investor into the master tenant for a 99% ownership interest. The master tenant then either contributes, loans or pre-pays rent with the proceeds from the HTC equity into the QALICB. This structure, however, also provides the opportunity for the HTC proceeds to be used for the leverage stack. Instead of the master tenant using the HTC equity proceeds for one of the aforementioned vehicles to the landlord, all or a portion of the equity proceeds can be loaned from the master tenant to the leverage lender as a source of leverage, which could potentially provide a boost to the overall net NMTC benefit. This boost to the net NMTC benefit is potentially achieved because passing the HTCs through the lease so that the equity at the master tenant entity can be used for leverage instead of fully contributed to the QALICB, provides the opportunity for the development to use a larger amount of NMTC allocation as a source for construction costs at the QALICB in lieu of direct HTC equity at the QALICB by the HTC investor.
With this potential boost comes further complexities for the transaction. As it is common in the HTC industry for the investor’s equity to come into the project in installments as certain benchmarks are achieved, the entirety of the HTC equity proceeds will not be on hand at the transaction’s closing. With that said, there still must be sufficient sources available at closing to make the leverage loan into the NMTC structure. Therefore, in this scenario, the leverage lender will need to receive funds at closing to bridge the future HTC equity installments, typically in the form of a bridge loan. As the future equity installments are made and the leverage lender receives the additional draws on the loan from the master tenant, the proceeds are used to repay this bridge funding that was received at the closing. Also note, some developments qualify for not only federal HTCs, but state HTCs as well. When a property is eligible for state HTCs, this could provide even further HTC subsidy available to serve as leverage in an NMTC transaction, further helping a project to maximize its NMTC benefit.
There are various approaches that can be used when using HTC subsidy as a source of leverage and it is important for the project team to work through this while planning the transaction to ensure that the proceeds are moving through the structure and ultimately to the leverage lender entity appropriately.
When twinning NMTCs and HTCs, using HTC subsidy as a source of the leverage stack is an excellent way to maximize the NMTC benefit for a transaction and free up additional sources to be used on other project costs. Doing so requires strategic structuring and planning, and there can be potential complexities that arise during the process. Please consult your Novogradac tax expert if you have any questions.
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