IRS Releases Long Awaited Historic Tax Credit Safe Harbor
As many participants in the historic redevelopment industry know, the historic rehabilitation tax credit market has been at a near standstill since the Historic Boardwalk Hall case was issued in August, 2012. In Historic Boardwalk Hall, the Third Circuit held that “because [the investor] lacked a meaningful stake in either the success or failure of [the partnership], it was not a bona fide partner” and therefore could not claim the historic tax credit. As a result of Historic Boardwalk Hall’s potentially broad application, tax credit investors nationwide became reluctant to invest in new projects. On December 30, 2013, the IRS released Rev. Proc. 2014-12 to provide “more predictability” for historic tax credit investors.
There are a few ambiguities that will need to be addressed by the industry, but Rev. Proc. 2014-12 provides a reasonable safe harbor for new projects and projects that have closed but have not yet been placed in service. A summary of the highlights to the safe harbor include:
- Application. The safe harbor applies to allocations of federal historic rehabilitation tax credits from partnerships in both single tier and master lease structures. The safe harbor expressly states that it does not apply to other federal credits or state credit transactions.
- GP Interest. Principals must have a minimum 1% interest in all material partnership items. No more .01% general partner interests.
- Value Commensurate. “The Investor’s Partnership interest must constitute a bona fide equity investment with a reasonably anticipated value commensurate with the Investor’s overall percentage interest in the Partnership, separate from any federal, state, and local tax deductions, allowances, credits, and other tax attributes to be allocated by the Partnership to the Investor.” This requirement will need to be interpreted by participants in each development, but when read in conjunction with the rest of Rev. Proc. 2014-12 and Historic Boardwalk Hall, the intent is likely that an Investor with a 99% profit interest (a large capital account and possibly a lower percentage of sale proceeds) should receive cash flow distributions commensurate with its 99% profit interest (and overall percentage interest). The Investor must participate in the cash profit of the partnership and cannot be limited to a preferred return.
- Reducing Investor Return. As compared to non-tax credit projects, the value of the Investor’s partnership interest may not be reduced by unreasonable fees (including developer, management, and incentive fees), unreasonable structured lease terms or other arrangements.
- Master Subleases. Master Subleases are permissible to an affiliate of the Principal if “mandated by a third party unrelated to the Principal.” Subleases must be “shorter” than the master lease.
- Investor Capital Contribution:
- At least 20% before the building is placed in service, and
- At least 75% of the total expected capital contributions must be “fixed in amount” before the building is placed in service. Presumably, the fixed amount of capital contributions can still be conditioned upon benchmark achievements (e.g. Part 3, stabilization).
- Guarantees. The Investor cannot be substantially protected from losses from the Partnership’s activities.
- Unfunded permissible guarantees, include:
- Guarantees for the performance of any acts necessary to claim the HTC, such as completion guarantees, operating deficit guarantees, environmental indemnities and financial covenants;
- Guarantees for the avoidance of any act (or omissions) that would cause the Partnership to fail to qualify for the HTC or that would result in a recapture of the HTC; and
- Guarantee of Investor’s put price (described below).
- Impermissible Guarantees:
- Funded guarantees are not allowed. Funded for this purposes, includes reserves of cash or other property, and covenants for ongoing minimum net worth requirements. However, a twelve month projected reasonable operating expense reserve is not considered a funded guarantee;
- Guarantees of the Investor’s ability to claim the HTC;
- Guarantees of the cash equivalent of the credits;
- Guarantees for the repayment of any portion of the Investor’s contribution due to inability to claim the HTC in the event the Service challenges all or a portion of the transactional structure of the Partnership;
- Guarantees of distributions to the Investor (e.g. minimum priority return) other than the Investor’s put price (described below); and
- Indemnities for an Investor’s audit costs.
- Damages. Interestingly, Example 1 provides that in event a Principal violates its permissible guarantees, the Investor may receive a return of all or part of its contribution and any costs incurred with respect to the transaction.
- Unfunded permissible guarantees, include:
- No calls, at any price. Neither the Principal nor the Partnership may have a contractual right or agreement to redeem the Investor’s interest at a future date.
- The Investor may have a put right to sell its interest at a future date at a price that is not “more than its FMV” at the time of the sale. The safe harbor states its requirements do not prevent payment of unpaid fees, preferred returns or tax distributions owed to an exiting Investor, but it is unclear if such payments can exceed the FMV of the Investor’s interest at exit.
- Certain Partnership Interest flips are allowed. Example 1 of the safe harbor provides that after the 5 year HTC compliance period, an Investor’s initial 99% partnership interest may flip to 5% (or as low as 4.95%).
- Prior Projects. It is unlikely previously placed in service projects will be able to qualify for the safe harbor. Projects that were placed in service before December 30, 2013 can only satisfy the safe harbor if “all requirements” of the safe harbor were met at the time of placement in service and thereafter. Nevertheless, projects that do not met all of the safe harbor requirements should still benefit. Before the safe harbor was issued, IRS officials were looking solely at the “bad example” of Historic Boardwalk Hall in which the investor didn’t qualify as a partner. Rev. Proc. 2014-12 provides the IRS’s preferred “good example”, which is only a safe harbor (not absolute law). An investor can still qualify as a partner without meeting all requirements of the safe harbor. In audit situations, an investor should now be able to argue its investment is closer to the safe harbor than to Historic Boardwalk Hall, and thus it is a partner for tax purposes. IRS agents have indicated to RG they intend to use the comparative approach as well.