On March 23, the President signed the Consolidated Appropriations Act, 2018 (H.R. 1625), a $1.3 trillion dollar spending bill that funds the federal government through September 30, 2018. In addition to preventing a government shutdown, this omnibus spending bill incorporated the following key provisions that help to strengthen and expand the Low Income Housing Tax Credit (LIHTC):
- A 12.5% increase in the annual per capita LIHTC allocation ceiling (after any increases due to the applicable cost of living adjustment) for calendar years 2018 to 2021.
- An expansion of the definition of the minimum set-aside test by incorporating a third optional test, the income-averaging test. Pursuant to the Code, a project meets the 40-60 minimum set aside test when 40% of the units in the project are both rent restricted and income restricted at 60% of the area median income. Under the new law, the income test is also met if the average of all the apartments within the property, rather than every individual tax credit unit, equals 60% of the area median income. Notwithstanding, the maximum income to qualify for any tax credit unit is limited to 80% of area median income.
This legislation is a great win for affordable housing advocates who have been pushing for LIHTC improvements through the Affordable Housing Credit Improvement Act, introduced in both the Senate (S. 548 sponsored by Senators Cantwell and Hatch) and the House (H.R. 1661 now sponsored by Congressmen Curbelo and Neal) in 2017, as discussed previously in a prior blog post.
We will continue to provide updates on legislation related to Tax Reform. Just in case you missed it, last month Ballard Spahr hosted a webinar on the impact of Tax Reform on the Low Income Housing Tax Credit with our colleagues from RubinBrown LLP, Enterprise Community Partners, Inc. and Red Stone Equity Partners. Presentation slides and a recording of the webinar are available on our event page.
As we know, the President has signed what was originally titled Tax Cuts and Jobs Act, the most significant overhaul to the U.S. Tax Code since 1986. The President signed the Act into law after the first of the year in order to avoid some automatic spending cuts.
In its final form, this Tax Code overhaul retains private activity bonds and the the low-income housing tax credit. However, according to A Call To Invest in Our Neighborhoods (ACTION) Campaign, the amendment of other critical provisions of the Tax Code, especially, the lowering of the corporate tax rate from 35 percent to 21 percent and the creation of a base erosion and anti-abuse tax, present concern for affordable housing, as these provisions can impact an investor’s tax credit appetite. In an analysis performed by Novogradac and Company, the final version of the bill “would reduce the future supply of affordable rental housing by nearly 235,000 homes over 10 years.” Further, it is anticipated that other changes to the Tax Code, such as those relating to bonus depreciation, depreciation, and interest expense limitations, will impact equity pricing.
The legislation also retains the new market tax credit, with no change to its expiration which is after the 2019 allocation. The 20% historic tax credit was also retained, but with significant modification, including claiming the credit ratably over 5 years.
Ballard Spahr’s Tax Group is also following the legislative developments of other provisions of the bill. Late yesterday, the Tax Group issued a thoughtful analysis of the final bill.
Please use our Tax Reform Alert Center as a resource to find more information on the bill and/or reach out to us directly.
Released in February, the 2016 budget set forth by the Obama administration takes a focused stance towards the country’s growing infrastructure requirements. The 2016 budget features tax-exempt bond proposals seen in the administration’s 2014 and 2015 budgets, and introduces four new bond proposals:
1) A New Category of Qualified Private Activity Bonds for Infrastructure Projects – Qualified Public Infrastructure Bonds
2) Modifications to Qualified Private Activity Bonds for Public Educational Facilities
3) Modified Treatment of Banks Investing in Tax-Exempt Bonds
4) Repealing Tax-Exempt Bond Financing of Professional Sports Facilities
The 2016 budget also encourages the financing of infrastructure by limiting tax rates for upper-income taxpayers who can use specific tax deductions, tax preferences, and interest on tax-exempt to reduce tax liability to a 28 percent maximum. The new 28 percent cap, though viewed by opponents as discouraging to the investment of tax-exempt bonds, reflects the administration’s position for broader reforms on tax expenditures.
A detailed look at the 2016 budget’s four new bond proposals and the 28 percent cap is available, along with insights into other pertinent bond proposals.
In previous Housing Plus blog posts we’ve discussed various tax credit proposals that have been released since the beginning of the year, which include the comprehensive tax reform proposal from House Ways and Means Committee Chairman Dave Camp (R-MI), the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act, which would temporarily extend more than 50 expired or expiring tax provisions, and the proposals included in the Obama administration’s fiscal year 2015 budget. Tax reform has been a popular topic of conversation in tax credit circles all year, and it was the subject of the Legislative Update panel at last week’s National Council of State Housing Agencies (NCSHA) Housing Credit Connect conference in Chicago. The panel was facilitated by Garth Rieman of the NCSHA and included members of the LIHTC industry.
One of the interesting parts of the panel discussion was an attempt to quantify the potential impact of some of the proposals. The panel estimated that the loss of the temporary 9% minimum credit rate alone (the July 2014 rate is 7.56%) would reduce a typical project’s sources and uses budget by about 10-20%. Further, the aggregate effect of the proposals set forth in Chairman Camp’s discussion draft (which, among other reforms, extends depreciation periods and repeals the 130% eligible basis boost) could result in a loss of up to $1 billion dollars in annual investor equity to finance affordable rental housing, and about 33,000-50,000 affordable housing units a year. Broadly, these numbers suggest: (1) a decrease in the overall number of LIHTC projects (particularly if the ability to finance such projects with private activity bonds is repealed), and (2) a deterioration in the quality of LIHTC units due to reduced project budgets.
The panel suggested that the best way to avoid reforms that would be adverse to the affordable housing community is to start educating members of Congress about the importance of affordable rental housing and the viability of the LIHTC program as a means to attract private investment. An effective way to do that may be to invite members of Congress and their staff to ribbon-cutting ceremonies, so that they can talk to residents and observe the impact of the LIHTC program first-hand.
The panel concluded that comprehensive tax reform was unlikely this year, but noted that we may see some legislation after the midterm election, most likely in the form of an extenders package. We’ll be sure to update our readers in future blog posts as reform packages advance through Congress. In the meantime, it may be worthwhile reaching out to your Congressional delegation to highlight LIHTC projects that make a difference in the community.
In a previous post earlier this week, I described the proposed regulations under Section 752 of the Internal Revenue Code (the “Proposed Regulations”), and in particular, the proposed changes to the rules regarding the characterization of recourse and nonrecourse debt.
If enacted, the Proposed Regulations would have a significant impact on Low-Income Housing Tax Credit (“LIHTC”) transactions. LIHTCs are allocated to partners in the same manner in which they share the losses and depreciation deductions allocable to a partnership’s ownership of a qualified low-income building. The typical allocation scheme in which an investor partner is allocated 99.99% of each of these items will act to quickly reduce the investor’s capital account balance. Once the investor’s capital account balance is reduced to zero, it would only be able to continue to be allocated LIHTCs to the extent of its share of the partnership’s minimum gain attributable to nonrecourse liabilities, which is typically generated from depreciation deductions. Accordingly, LIHTC transactions are generally structured using nonrecourse debt to the greatest extent possible.
Given the relatively large appetite for nonrecourse debt in LIHTC deals, the Proposed Regulations would be positive to the extent that the complexity and subjective nature of the proposed recourse debt characterization rules makes it easier to classify debt as nonrecourse. However, there are certain circumstances in which it is preferable to characterize debt as recourse versus nonrecourse. For example, if a nonrecourse loan is made by a partner or a related person to a partner, only that partner (and not the investor partner) would be entitled to take into account the minimum gain generated by such loan. Because LIHTCs follow the allocation of losses and depreciation deductions among partners, minimum gain generated by a partner nonrecourse loan can result in a reallocation of LIHTCs away from the investor partner. In such a situation, it might be advisable to restructure the loan as recourse instead. Under the existing rules, this is relatively easy (e.g. by having the partner guarantee the repayment of the debt). However, re-characterizing the debt as a recourse obligation would be more difficult under the Proposed Regulations, as it would have be structured to meet the “seven commandments” and net worth tests described in my previous post.
The Proposed Regulations would certainly present new challenges for LIHTC deal structuring, but the strong preference for nonrecourse debt in LIHTC deals may help tax attorneys manage the impact of the Proposed Regulations better in LIHTC deals than in some other real estate investments.
One of the hot topics at the recent ABA Taxation Section meetings in Washington, D.C. was the IRS’s proposed regulations regarding the allocation of partnership recourse and nonrecourse liabilities under section 752 of the Internal Revenue Code (the “Proposed Regulations”). The Proposed Regulations have been the subject of heavy criticism since they were released in January, in part because of the fact that the existing regulations are relatively well-understood, and there is no obvious need for change. Part I of this post will examine the Proposed Regulations at a general level, and Part II will discuss them in the context of a Low-Income Housing Tax Credit (“LIHTC”) transaction.
It is relatively easy to distinguish recourse versus nonrecourse debt under the existing Section 752 regulations. Generally, nonrecourse debt is a liability of a partnership for which no partner (or related person) bears the economic risk of loss, and recourse debt is a liability for which a partner (or a related person) would be obligated to make a payment if the partnership were to constructively liquidate.
Under the Proposed Regulations, the analysis is more complicated. A partner’s payment obligation would only be recognized as recourse if it meets seven new requirements related to the payment obligation and a new minimum net value requirement that takes into account the fair market value of the partner’s assets. Due to the added complexity and the subjective nature of several of the “seven commandments,” the ABA panel appropriately noted that the characterization of debt as nonrecourse is “virtually a matter of election” under the Proposed Regulations.
In my next post, I’ll examine the potential impact of the proposed changes to the debt characterization rules in LIHTC deals.