Year 15 Issues for a Low-Income Housing Tax Credit Partnership
Year 15 planning for a low-income housing tax credit (LIHTC) partnership starts even before the project is first placed in service. The major year 15 issues that an LIHTC partnership should consider during its initial project structuring are the agreements that are put in place that will affect year 15 negotiations and outcomes, the exit strategies that are available for investors and general partners in year 15 and their tax consequences, and plans for how an LIHTC partnership can be better prepared for year 15.
Agreements Affecting Year 15
LIHTC partnerships should check the exact terms of the agreement and whether a right of first refusal agreement is in place. Internal Revenue Code (IRC) §42(i)(7)(A) provides that a project after the close of the compliance period will not lose its federal tax benefit with respect to any qualified low-income building merely by reason of a right of first refusal held by the tenants or resident management corporation of the building or by a qualified not-for-profit organization or government agency that purchases the property for a defined minimum purchase price. IRC §42(i)(7)(B) defines the minimum purchase price as the sum of the principal amount of outstanding indebtedness secured by building, other than any indebtedness incurred within the five-year period ending on the date of the sale to the tenants, plus all federal, state and local taxes attributable to the sale.
An LIHTC partnership should also check if there is any buy-sell agreement or any provisions in partnership agreements, lender agreements or regulatory agreements that may contain requirements and restrictions on the disposition transactions after year 15. For example, an option agreement may define the way to calculate the purchase price to buy out the investor after year 15. Another example might be a loan agreement that puts restrictions on the withdrawal of the reserves after year 15.
Exit Strategies and Tax Consequences
Several exit strategies are available to LIHTC partnerships, including the sale of property, sale of a partnership interest, bargain sale of the property or a partnership interest, re-syndication, or a qualified contract. Different disposition plans have different tax consequences.
Sale of Property
At the end of the compliance period, an LIHTC partnership may sell the property to the general partner, a related party, residents or other third-party buyer. Special care should be given to the cash distribution waterfall of the sale proceeds and the gain and loss calculation on the sale on tax basis. If there is a gain at the end, some portion of it will be treated as unrecaptured IRC §1250 gain. The LIHTC partnership will also need to determine if any portion of the gain is attributable to depreciation recapture of IRC §1245 property, which is treated as ordinary income.
Sale of Partnership Interest
When the compliance period ends, in general, the investor might choose to sell its partnership interest to the general partner. Alternatively, the general partner may exercise a call option to buy the investor’s partnership interest pursuant to certain agreements or provisions within the original partnership agreement. The amount realized by the seller includes the amount paid by the buyer and the amount of debt associated with the interest being sold that the seller is relieved of. At the same time, the seller’s tax basis immediately before the sale includes its tax capital balance and its share of liability. If the LIHTC partnership still exists after the sale of partnership interest (for example, there are still two partners in the deal), whether the sale will result in a technical termination under the provisions of IRC §708(b) needs to be evaluated.
Bargain Sale of Property or Partnership Interest
Upon reaching year 15, the LIHTC partnership might donate the property to a charitable organization or the investor may donate its partnership interest to a charity through a bargain sale transaction. Regulation §1.170A-4(c)(2)(ii) provides that a bargain sale is a transfer of property that is in part a sale or exchange of property and in part a charitable contribution of property. Regulation §1.170A-1(c)(1) states that if a charitable contribution other than money is made in property, the amount of the contribution is the fair market value of the property donated at the time of the contribution as adjusted by the amounts as applicable by IRC §170(e)(1) and IRC §170(e)(3. In addition, the LIHTC partnership would recognize gain on the sale of the portion of the property sold.
At the end of the 15-year compliance period, an owner of an LIHTC property might also consider rehabilitating the property through re-syndication. However, re-syndication would only work if the deal incurs at least $6,000 per unit of rehabilitation costs within a 24-month period, as described in IRC §42(e)(3)(A)(ii). In addition, the deal needs to meet the 10-year rule, as described in IRC §42(d)(6), to be able to claim acquisition credits. The owner would also need to check the qualified allocation plan in a specific state for any specific requirements for re-syndication and compliance.
According to IRC §42(h)(6)(F), an LIHTC project could become a market-rate project if upon the owner’s written request and within a one-year period beginning on the date after the 14th year of the compliance period, the housing credit agency is unable to find a qualified contract for the acquisition of the low-income portion of the building. The section further provides that the qualified contract price for the low-income portion of the building may not be less than the applicable fraction of the sum of the outstanding indebtedness secured by the building, the adjusted investor equity in the building, and other capital contributions not already reflected, reduced by cash distribution from the project. However, the LIHTC partnership should check to see if more stringent requirements are provided in any agreement or in the laws of the state where the project is located.
Getting Prepared for Year 15
Investors and general partners should consider the following in preparing for year 15:
- Become familiar with the executed agreements in place that might affect year 15. Keep a good record of all prior year tax returns.
- Understand the estimated disposition plan as indicated in the original underwriting financial projection.
- Run a cost benefit analysis of the available exit strategies in early years.
- Keep careful records of the investor’s tax capital, estimate the possible exit taxes, and prior to year 15 consider corrective actions to mitigate the exit taxes.
- Initiate an early talk with investors regarding the exit options – it’s not too early to begin having those conversations in year 11 or year 12.
In summary, year 15 planning for LIHTC partnerships should be started as early as during the underwriting process and should be an ongoing process throughout the compliance period.
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