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CRE Finance World Autumn 2015
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2. At Risk Rules
The IRS “at-risk” tax regulations provide that the amount of a
project’s non-recourse financing cannot exceed 80% of the credit
base of the qualified rehabilitation expenditures. If a proposed
non-recourse mortgage loan will push the project beyond the
80% threshold, are there steps the prospective lender can take to
avoid a potential loss of HTCs? One solution is to have the master
lessee, in its capacity as a partner of the property owner, assume
any deferred developer’s fee13, thereby removing non-recourse
financing in the amount of the fee from the property owner’s balance
sheet (the assumption of the fee would then be treated as a capital
contribution to the property owner by the master lessee). Alternatively,
the developer could guaranty a portion of the mortgage loan
(thereby making that portion recourse) in an amount sufficient
so that the “at-risk” rule is not violated. Before accepting such
a guaranty, however, the lender should assess the bankruptcy
consolidation risk created by obtaining a guaranty from an affiliate
of its borrower.
At first glance, the complexities created by master leases, SNDAs,
“at-risk” rules and other aspects of historic tax redevelopment
projects and the tax regulations that govern them may appear to
the lender more like a sentence to prison confinement than an
avenue for exploration. But, the lender willing to master the finer
points of historic tax credit transactions may very well find itself
at the forefront of an already established market now ready to
explode with new possibilities for fruitful exploitation.
1 According to the U.S. Department of the Interior, since its inception the
HTC program has been utilized in over 40,380 completed projects worth
approximately $73,000,000,000 (as of fiscal year end 2014).
2 Many states offer a similar historic tax credit program to the federal
program. Although, we limit our discussion to the federal program, many
of the issues and benefits are applicable to most or all of the state
programs as well.
3 A small cadre of large corporations, such as Chevron and Bank of
America, are the usual players in the HTC market.
4 For ease of drafting and readability, we refer throughout this article to
“partners” and “partnerships” but the HTC rules apply equally to limited
liability companies and their members.
5 The master lease must be for a term of at least 80% of the length of the
applicable recovery period, which means for commercial properties a
term of at least 32 years.
6 A transfer to a “disqualified transferee” could still result in a recapture
but the set of “disqualified transferees” is essentially limited to tax
exempt organizations such as governmental entities, foreign persons
and REITs.
7 According to the U.S. Department of the Interior, approved HTC applications
declined by nearly 25% over the three year period commencing in 2009.
By 2013, according to the NPS, the number of approved projects had
risen to 1,155 (representing approximately $6,730,000,000 in project
costs), a healthy but not spectacular 26% increase over 2012—the
enthusiasm for HTCs that arose with the return of a robust real estate
market having been dampened by concern over the implications of the
Historic Boardwalk decision.
8 According to the Journal of Tax Credits published by Novogradac &
Company LLP (February 2014 Volume V, Issue II, pg 3), “HTC investors
interviewed shortly after the issuance of the [Guidelines] were generally
positive [and]…believed they would come back into the market.” Developers
interviewed for the article also generally supported the notion that the
Guidelines would encourage developers to do HTC transactions.
9 According to the U.S. Department of the Interior, the number of approved
HTC projects in 2014 was almost exactly the same as 2013, as many of
the market players would not embark on new deals until the tax experts
had worked through the finer details of the Guidelines.
10 Rev Proc 2014-12. Section 4.02(2)(b).
11 The Guidelines prohibit the developer from obtaining a call option to
acquire the tax investor’s interest at the end of the recapture period, a
favored form of protection utilized by developers prior to the issuance of
the Guidelines. However, the significant reduction in ownership interest
at the end of the recapture period should be sufficient incentive for the
tax investor to exit the deal of its own volition.
12 The lender will typically receive a pledge of the developer’s interest in
the master lessee.
13 HTC deals typically contain large deferred developer’s fees since, in
addition to being income to the developer, these fees may be included
within the tax base and thereby increase the amount of the HTCs available
to the tax investor. Although the tax regulations are not clear on the
point, many experts believe that a deferred developer’s fee should be
included in the calculation of non-recourse debt.
“The tax investor’s very involvement in the transaction
can be a source of comfort to the lender in that the tax
investor will add its own underwriting and oversight
requirements to the transaction. The project will also
require certification by the NPS and SHPO, another
layer of oversight.. …..The capital structure will also
benefit from the tax investor’s involvement in the
transaction. The tax investor typically infuses large
amounts of funds prior to construction reducing the
potential for the project ending up ‘out of balance’.”
A Lender’s Guide To Funding Historic Tax Credit Projects