‘Put’-ting Up With the NMTC Exit Process
Question: After the new markets tax credit (NMTC) compliance period has concluded and an investor exercises its put option, what next steps can the community development sponsoring/purchasing organization expect to follow for a successful unwind of the transaction structure?
Answer: There can certainly be variations to this answer, depending on the timeline of the parties involved and the details of who will ultimately hold the property and the loans. However, one of the most common approaches is outlined below:
- the sponsoring organization pays the agreed-upon put price to the investor owner and acquires sole ownership of the investment fund;
- the sub-community development entity (CDE) lender assigns the qualified low-income community investment (QLICI) loans, made to the qualified active low-income community business (QALICB) borrower, to its investment fund owner and distributes the loan assets accordingly;
- the sub-CDE lender liquidates all remaining assets and liabilities and dissolves;
- the investment fund essentially assigns the loans made to the QALICB borrower to its new sponsor owner; and
- the investment fund liquidates all remaining assets and liabilities (including any leverage loans that may have been made to the investment fund) and dissolves.
Depending on the details, the sponsoring organization would now have the following options relating to the loans encumbering a given project:
Maintain. The sponsor may be able to maintain the QLICI loans and the QALICB can operate the project as usual, making payments on the loans until maturity. If this is the desired path for the project sponsor, note that principal payments on the QLICI loans are likely to begin after the end of the NMTC compliance period. If the leverage lender is a third party, then QLICI loan payments made to the sponsor would likely turn around and be used to make the payments on the third party leverage loan. However, depending on the ownership structure and the extent of related party involvement between the leverage lender and the sponsor, debt forgiveness on the loans may be required and the option to maintain the loan structure may not be an option.
Refinance. The QALICB borrower can refinance the QLICI loans with conventional debt and payoff the loans now held by the sponsor. If a leverage loan exists, the QLICI payoff proceeds can then be used to satisfy the leverage loan; or
Forgive. The sponsor has the ability , and at times a requirement, to forgive the QLICI loans. In this situation, the sponsor should be prepared to recognize a significant amount of debt forgiveness expense and any other related income tax issues. For a nonprofit sponsor, this treatment may not be an issue, but for-profit sponsors should certainly have a plan in place to address any adverse tax issues. If the sponsor is also the leverage lender to the project, then there is a high likelihood that the leverage loan would also be forgiven and the resulting cancellation of debt income would provide an offset against any debt forgiveness expense.
These are just some of the possibilities available, but they are relatively common options when a put option is in play. Keep in mind that although there may be a put/call agreement in place, the put is not mandatory and the investor may not always exercise that option.
After unwinding the NMTC structure and the appropriate loan path has been determined, the sponsor can decide on one of the following options:
- continue owning and/or managing the QALICB borrower;
- acquire the project from the QALICB borrower via donation, distribution or purchase. This option typically depends on whether the sponsor is for-profit or nonprofit and will likely result in the liquidation and dissolution of the QALICB entity; or
- for real estate rental projects, sell the project to the tenant or another third party. This option will also generally involve the liquidation and dissolution of the QALICB.
In conjunction with the recommendations made in the February 2020 article in the Novogradac Journal of Tax Credits, “Considerations to Help Smooth NMTC Exits” by Novogradac partner Bryan Hung, CPA, when the time comes to unwind the transaction structure some of the most important items to consider are:
- paying attention to important dates and deadlines in the put/call agreement and other governing documents;
- ensuring that the appropriate entities are being assigned the various assets and liabilities that are changing hands;
- checking that the flow of any remaining cash funds factor in any final unwind and project costs, including costs incurred by attorneys and other service providers involved in the unwind process; and
- making certain that the book and tax accounting for any assigned assets and liabilities, and any resulting income or expense items, follows the correct course as indicated in the unwind agreements.
Consideration of many of these items ought to occur at the inception of any project. A certain level of tracking can also occur throughout the NMTC compliance period in order to experience the cleanest unwind and investor exit possible. Time, monetary costs and avoidance of any penalties are valuable items. Whether you are in the beginning stages of a project or nearing the end of your compliance period, proper planning for these outcomes can certainly prevent unexpected tax issues, delays and uncertainty.
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