Tax Credit for Commercial Real Estate Investors
Commercial real estate investors take note—the ever-expanding tome known as the tax code has been updated with a new rule that could mean a credit for some developers. Revenue Procedure 2014-12, as it’s known, applies to allocations made on or after December 30, 2013. The IRS recently issued the rule to provide safe harbor for commercial real estate investors and developers in structuring historic tax credit partnerships. There are four key partnership structural provisions required:
The minimum requirements are a developer interest of 1 percent and an investor interest of 5 percent. Most deals are structured with 1 percent/99 percent interests, which may flip at the end of the five-year compliance period to as low as 5 percent of the investor’s initial 99 percent interest, or to 4.95 percent.
The developer may guarantee the investor against recapture of historic tax credits for direct acts or omissions to act that cause the partnership to fail to qualify for historic tax credit. However, a guarantee against recapture based on an IRS challenge of the transaction structure of the partnership is impermissible. A developer may provide completion, operating deficit, financial covenant breach (but not minimum net worth covenant) and/or environmental guarantees, as long as these guarantees are un-funded. However, cash reserves are allowed as long as they total no more than reasonably projected 12-month operating expenses.
At the end of the five-year compliance period, the developer may not have a call option. Instead, the investor may have a put option, as long as the sales price is less than the fair market value of the investor’s partnership interest at the time of exercise.
Bona Fide Investment
• Equity timing: An investor must contribute at least 20 percent of its total expected equity prior to the placed-in-service date, and at least 75 percent of the investor’s equity must be fixed prior to the placed-in-service date. Note that typical equity adjusters based on milestones are allowed but cannot adjust the investor’s commitment by more than 25 percent.
• Bona fide investment: The investor’s interest must be a bona fide equity investment with a reasonable anticipated value that is commensurate with the investor’s overall percentage interest in the partnership, separate from tax attributes (deductions, credits, allowances) allocated by the partnership to the investor, and that is not substantially fixed in amount.
• Commensurate value: To have a commensurate value requires that the investor receive the cash and other economic benefits—other than historic tax credits—on a basis equal to its percentage interest. This requirement continues to allow an investor’s interest in the partnership to be determined principally by the amount of anticipated historic tax credits to be allocated.
• Value impacts: An investor’s interest may not be depressed through the use of developer fees, disproportionate distributions, lease or other business terms that are not reasonable (and a sublease with a term not shorter than the master lease is deemed unreasonable) relative to arm’s-length development transactions not using historic tax credits. This is really the key requirement in Rev. Proc. 2014-12.
To fully understand how these laws may be relevant to your bottom line, please contact Larry Wood, CPA/CFP and Partner at DZH Phillips, one of the most competent and prestigious accounting firms on the west coast. Larry brings a wide breadth of experience to the table, with a particular emphasis on real estate and income tax planning. Click here to contact him to discuss your specific needs, or email him directly at LWood@Dzhphillips.com.