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Washington Wire: Navigating Important Changes to the Tax Credit Terrain

Published by Michael J. Novogradac on Wednesday, January 1, 2014

Journal cover January 2014   Download PDF

As we look out on the horizon of the New Year, a number of recently enacted affordable housing and community development changes are expected to gradually reshape the tax credit landscape. And as 2014 progresses, several additional developments could create added obstacles or bridges to affordable housing, community development, historic preservation and renewable energy development.

Regulators Approve Final Volcker Rule
After more than two years of drafting and public comment, on Dec. 10 regulators released and approved final guidance interpreting section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act commonly referred to as the Volcker Rule. The so-called Volcker Rule places certain prohibitions and restrictions on the ability of a banking entity and non-bank financial company to make certain kinds of equity investments, and thus held significant implications for the tax credit equity market.

The final rule issued jointly by the Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board, the Office of the Comptroller of the Currency (OCC) and Securities and Exchange Commission (SEC) features an explicit exemption for investments in historic tax credits (HTCs) and contains a provision exempting public welfare investments that essentially provides a blanket exception for low-income housing tax credit (LIHTC) and new markets tax credit (NMTC) investments. Investments in renewable energy tax credits, however, are exempted only if they otherwise satisfy the public welfare investment test. Banking organizations covered by section 619 will be required to fully conform their activities and investments by July 21, 2015.

The exemptions and the 2015 deadline are both welcome news for the tax credit community. Because banks are such a sizeable portion of the tax credit equity market, their continued ability to invest in the LIHTC, NMTC and HTC averts what would have likely been a dramatic decrease in the amount of equity investment available for the congressionally mandated goals the tax credits were enacted to achieve.

It’s important to note that the rule distinguishes between banks’ roles as investors versus their roles as sponsors. The rule permits banking entities to acquire an ownership interest in, or act as sponsor to an investment that is designed primarily to promote the public welfare, or an investment in HTCs. As such, banks may, generally, act as a sponsor of funds comprised of LIHTC, NMTC or HTC investments, and renewable energy tax credit funds to the extent the investments are public welfare investments.

FASB Changes Tax Credit Accounting Rules
In another major development that has been years in the making, on Dec. 11 the Financial Accounting Standards Board (FASB) ratified the generally accepted accounting principles (GAAP) amendments for LIHTC investments that were approved by FASB’s Emerging Issues Task Force (EITF) at its Nov. 14 meeting. The EITF proposed, and FASB agreed, that amortization expense associated with LIHTCs should be recorded within the income tax provisions line of an investor’s income statement, and, furthermore, retain their classification as investments and not deferred tax assets. The Accounting Standards Update (ASU) implementing the changes for the LIHTC is expected to be issued by early this month.

Over time this change is expected to help with equity pricing for non-CRA investments as well tax credit investments with high tax loss to tax credit ratios, like many tax-exempt bond financed tax credit developments.

The guidance does not apply to other types of tax credit investments at this time, but there has been considerable interest from participants in other sectors. To read more about the possibility of extending the same principles to other tax credits such as the HTC, turn to John Leith-Tetrault’s column on page 62. Expanding the availability of the LIHTC accounting treatment to other tax credit investments is expected to be a top priority for the broader tax credit community in 2014.

OCC Releases Final CRA Rules
On Nov. 15 the OCC released the final revisions to "Interagency Questions and Answers Regarding Community Reinvestment," which it uses to provide additional guidance on Community Reinvestment Act (CRA) regulations. Five existing questions were updated and two were added. The questions address statewide and regional impact, nationwide investments, community development services, proportional investments and lending performance.

In the guidance, OCC clarifies how the agencies consider community development activities that benefit a broader statewide or regional area that includes an institution’s assessment area. The FAQs also provide guidance related to CRA consideration of, and documentation associated with, investments in nationwide funds.

While the revisions and new guidance are largely favorable to those interested in investing in tax credits, the guidance fell short of some stakeholders’ hopes by not addressing the definition of a CRA assessment area. Some bank investors have suggested that creating fewer, larger assessment areas would improve market conditions and increase the creation of affordable housing. Advocates of this type of change say it would allow banks to cast a wider net, which could increase diversity in their LIHTC portfolios and narrow the gap that exists between high credit prices in high-demand, major CRA assessment areas and prices in lower or no demand in non-CRA or minor CRA assessment areas.

Mel Watt Confirmed as FHA Director
On Dec. 10 the Senate voted to confirm Rep. Mel Watt, D-N.C., to serve as director of the Federal Housing Finance Agency (FHFA). Watt was elected to the House of Representatives in 1992. He was a member of the House Financial Services Committee and serves on the subcommittees on Capital Markets and Government Sponsored Enterprises and Financial Institutions and Consumer Credit. One of the most significant changes that may result from his taking the reins at FHFA is the possible funding of the National Housing Trust Fund (NHTF) and Capital Magnet Fund.

The FHFA oversees government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which were statutorily obligated to contribute to the NHTF by the Housing and Economic Recovery Act of 2008 (HERA). However, the obligation to contribute was suspended later that year, before any contributions were made, when the GSEs were put into conservatorship. Now that the GSEs are reporting net income, many affordable housing stakeholders have called on FHFA to allow the GSEs to contribute to the trust fund. With the possibility of a near term lifting of the suspension, housing advocates are encouraging the U.S. Department of Housing and Urban Development (HUD) to issue final regulations for the NHTF. HUD published a proposed rule on Dec. 4, 2009 regarding the formula to be used to allocate HTF funds and proposed NHTF program rule on Oct. 29, 2010.

The Capital Magnet Fund was also created by HERA and is administered by the Community Development Financial Institutions (CDFI) Fund. The Capital Magnet Fund provides competitively awarded grants to certified CDFIs and nonprofit organizations having as one of their principal purposes the management or development of affordable housing. The CDFI Fund published a notice of funds availability in the Federal Register on March 4, 2010, announcing $80 million for the fiscal year 2010 funding round. The CDFI Fund received 230 applications requesting more than $1 billion in grants that would leverage an estimated $23.38 billion in eligible projects.

It is worth noting that during his time in Congress, Watt introduced and cosponsored a number of bills related to the LIHTC and NMTC. For example, in the 112th session of Congress Watt cosponsored H.R. 3661, a bill that would have made permanent and expanded the temporary minimum credit rate for the LIHTC.

Key Tax Credit Provisions Expire
With the expiration on Dec. 31 of the 9 percent LIHTC percentage floor many affordable rental housing properties under development were left with a large equity gap. The additional equity provided by the floor for the past few years has allowed LIHTC developments to serve lower-income populations, provide more services and offer more amenities. The additional equity also made many projects feasible at a time when other federal, state and local gap financing sources were being reduced.

The NMTC was also allowed to expire on Dec. 31. However, in contrast, the program still has one allocation round pending, which means community development activity can continue, at least in the near term. The most recent application round combined the calendar year (CY) 2013 and CY 2014 rounds, making $8.5 billion ($3.5 billion authorized by Congress for CY 2013 and $5 billion requested in the President’s 2014 Budget) in tax credit authority available, pending congressional authorization. The CDFI Fund has said that if congressional authority for the CY 2014 NMTC allocations was not enacted by early fiscal year 2014, it would proceed with making $3.5 billion in awards only for CY 2013. At this time, that prospect appears likely. If this turns out to the be the case, the CDFI Fund has also indicated it would consider combining CY 2014 and CY 2015 NMTC authority, again pending congressional authorization.

Many reports suggest an extension effort won’t occur until late summer or early fall. In remarks on Dec. 11, Sen. Chuck Grassley, R-Iowa, the ranking Republican on the Senate Finance Committee, said the set of tax provisions commonly known as “tax extenders” would likely be extended sometime this year. Grassley indicated the delay in passing tax extenders was most directly attributable to the ongoing discussions regarding comprehensive tax reform. The Eastern Iowa newspaper The Gazette, quotes Grassley as saying, “They don’t want to poison tax reform next year.” As we went to press, there were suggestions the Senate would mark up an extenders bill in February.

Tax Reform Slows but Continues to Loom
In 2013 the march toward tax reform was slow, but steady. Completion of comprehensive tax reform is not expected to happen in 2014, but the prospect of the changes that will be proposed and debated could concern investors a bit. For example, Senate Finance Committee Chairman Max Baucus, D-Mont., released the third in a series of tax reform proposals late last year focused on reforming cost recovery and tax accounting rules. Under the plan, Sen. Baucus proposes extending depreciation periods for taxable years beginning after Dec. 31, 2014. The depreciable life for residential rental property would be extended from 27.5 years to 43 years and the depreciation methodology for personal property and land improvements would also be altered. The proposal poses adverse outcomes for the LIHTC market as well as negative retroactive effects on existing LIHTC investments.

This example illustrates how even proposed tax reform can affect the market for tax credit investments, as these proposed retroactive changes could affect investor attitudes and underwriting of current LIHTC investment opportunities. As such, the Novogradac LIHTC Working Group is drafting a comment letter warning Sen. Baucus about the adverse effect the proposal would have on the creation and preservation of affordable rental housing. As we went to press, many were predicting that Chairman Camp would be releasing a draft tax reform bill by Jan. 15. Others were predicting a release months later, and that no committee mark-up of the bill would occur.

IRS to Issue Historic Tax Credit Partnership Guidance
Another highly anticipated development on the horizon is guidance from the Internal Revenue Service (IRS) regarding a safe harbor for HTC partnerships. Following the Third Circuit Appeals Court Historic Boardwalk Hall decision and the issuance of IRS Office of Chief Counsel Memorandum (CCM) 20124002F, HTC activity slowed considerably and the preservation community appealed to the IRS for guidance delineating acceptable alternative investment structures for the HTC. The tax credit community is hopeful that HTC redevelopment would pick up following the release of this guidance if investors are given some degree of comfort regarding the IRS’ view of their investments.

Despite – and in some cases because of – the legislative gridlock that prevented Congress from considering several tax credit priorities, last year saw several important changes that the tax credit community will need to understand to successfully navigate the altered terrain. Looking ahead, the pending developments should also be watched carefully if we are to make the most of 2014.

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