TN Economic Development Finance Course Feb. 20-21, 2014 UT Center for Industrial Services & Council of Development Finance Agencies

2. W h a t A r e To d a y ’s G o a l s ?
Number 1 is “not to overload
your brain with too much
information”

3. Background
• Part of 1986 Tax Reform to encourage the construction and rehabilitation of
low-income rental housing
• Contained in Section 42 of the Internal Revenue Code
• Emphasis on private sector involvement (i.e. developing and managing
properties)
• Objective: provide investor equity to lower debt service which decreases
rents to tenants

4. What is the LIHTC?
• Credit is a dollar-for-dollar Federal tax reduction
• Credit amount based on the cost of constructing or rehabilitating rental housing
developments
• Credits available over 10 year credit period
• Credits are the primary incentive/return for the equity investor

5. Ty p e s o f L I H T C s
9% Credit
• New construction or substantial rehabilitation – awarded through
competition
4% Credit
 New construction or substantial rehabilitation awarded in conjunction with
tax-exempt bonds

6. H o w D o Yo u G e t Ta x C r e d i t s ?
• Developer applies to housing credit agency (HCA) for reservation of credits
• 9% credits are awarded through competition
• 4% credits are awarded “as of right” in conjunction with tax exempt bonds

7. Role of Housing Credit Agency
“HCA”
HCAs are responsible for selecting developments to allocate the Credit,
“underwriting” the Credit (sizing it according to financial needs of the
project), reporting Credit activity to the IRS, and monitoring for
compliance with federal regulations.

8. Qualified Allocation Plan
“QAP”
HCA guidelines must be published in annual Qualified Allocation Plans
(“QAPs”), which detail selection criteria and compliance monitoring
rules. Most HCAs select projects through competitive cycles (at least
one per year), with various threshold and scoring criteria.
Selection criteria includes project characteristics, owner characteristics,
location, market feasibility, energy efficiency, income targeting, and
affordability periods.

9. Ta x E x e m p t B o n d s
Tax-Exempt Bond Financed Developments
• Developments with at least 50% of aggregate basis financed with tax-exempt
bonds are eligible.
• Credits are awarded “as of right.”
• Projects do not compete. Must meet QAP and underwriting criteria.
• Applicable Tax Credit Percentage is published monthly by U.S.Treasury, and is a
“floating” rate at or below 4%.
– August 2013 applicable tax credit percentage is 3.24%
• Frequently used to finance acquisition and rehabilitation of existing properties
(e.g., “Preservation” deals).
• Project size usually 100 units or more

10. Low Income Use Restriction
• Minimum Requirement: rent and income restrictions must remain in place
for a 15-year Compliance Period, plus an additional 15-year Extended Use
Period.
• Property owners may elect to “opt-out” of the Extended Use Period with
HCA approval under certain circumstances; Qualified Contract.
• Many QAP’s have longer use restrictions and prohibit opting out early.

11. Eligible Basis
• Eligible basis = adjusted basis of building at end of 1st year of credit period
• Includes common areas
• 30% boost in QCTs or DDAs
• Projects located in HUD-designated Qualified Census Tracts or difficult to develop
areas receive a 30% increase on eligible basis

12. Rent Rules
•
•
•
•
Rent + utility allowance (gross rent) cannot be >30% of household income
Qualifying income based on family size and # of bedrooms
Gross rent does not include Section 8 or other subsidies
Rent limits change annually when HUD publishes new Area Median Incomes
(AMIs)

13. Income Limits
 Minimum set aside: certain % of units restricted for % of AMI
• 20/50: 20% of units at 50% of AMI
• 40/60: 40% of units at 60% of AMI
 NYC only: 25/60: 25% of units at 60% of AMI

14. Recapture for Non-Compliance
•
•
•
•
•
•
Decrease in qualified basis
Not meeting minimum set-aside
Low-income occupancy decreases
Sale or foreclosure
Eminent domain
Damaged building out of service (e.g. Sandy casualty losses)

15. Ty p i c a l O w n e r s h i p S t r u c t u r e
G eneral Partner
N om ina l
E quity Investm e nt
T ax C redit Investor
1% C re dits,
P rofits & Losse s
99% C re dits,
P rofits & Losses
$$ E quity
O perating Partnership
D e ve lopm e nt
Fe e
D eveloper
R ent
M ortgage
T enant G roup

16. Project Summary & Assumptions






Construction start & placed in service dates
Occupancy (lease-up)
Debt & equity
Operating income & expenses
Development budget (sources & uses)
Tax credit assumptions (4%-9%, 30% basis boost, tax credit pricing)

17. Ta x C r e d i t E q u i t y
Eligible Costs
QCT/DDA Boost (130%)
14,405,812
x
Eligible Basis
Applicable Fraction
14,405,812
x
Qualified Basis
Applicable Percentage
x
x
Tax Credit Equity
10
12,965,231
x
Total Investor LIHTCs
Tax Credit Price
9.0%
1,296,523
Total LIHTCs Over Period
Investor Ownership %
100%
14,405,812
Annual LIHTC Eligible
10 years
100%
99.99%
12,963,934
x
.95
12,315,738

18. Investor Metrics
 Investor IRR
– Schedule of benefits
 Losses
» Depreciation
 Tax credits
– Distributions (cash flow)
– Capital contributions
 Quarterly compounding
 Capital Account
– Minimum gain

19. Developers’ Perspective
•
•
•
•
•
•
•
Developer Fee
Control property management and management fee
Control majority of any positive cash flow from operations and residuals
Highest equity price
Fastest equity pay-in
Retain control of property at end of 15 year compliance period
Least exposure under investor deal guarantees

20. Investor ’s Perspective
• Looking for reasonable certainty with respect to amount of losses and credits
- Investor Benefits
• Looking for reasonable certainty with respect to timing of Investor Benefits
• LP Agreements written attempting to “manage” the Investor Benefits Flow
• Rarely do LIHTC projects generate substantial positive NOI/cash flow
• If there is positive cash flow, GP/developer is generally entitled to as much as
90% as an Incentive Management Fee (tax deduction)
• If there is negative cash flow, GP/developer is generally obligated to fund
Operating Deficits (with a special allocation of non-depreciation operating
deductions equal to the amount funder)

21. Investor ’s Perspective
• If a project’s NOI/Cash Flow is close to zero, depreciation, amortization, and
accruing interest on soft debt will result in a net annual tax loss
• LIHTC follow the depreciation deductions
• Generally, LIHTCs, Depreciation & Amortization and Accruing Interest
deductions are reasonably quantifiable in the deal projection process
• Investors price deals based on projections and strength of GP/developer
guarantees

22. W h a t i s a 1 0 % Te s t ?
A 10% Test supports Accumulated Basis* in a project.
Accumulated Basis must be at least 10% of the Reasonably
Expected Basis* of the project on a specific date.
*Accumulated Basis: Total costs incurred to date which represent project’s
depreciable basis plus land.
*Reasonably Expected Basis: Project’s depreciable basis plus land costs. This
amount is generally stipulated by the Owner as part of the Carryover Allocation.
* Note: terminology varies by HCA

23. W h y C o n d u c t a 1 0 % Te s t ?
 If a project is not placed in service in the year of credit allocation, the project
must apply for a Carryover of the Allocation. This process is specific only to
competitive LIHTCs. LIHTCs in conjunction with tax exempt bonds are
exempt.
 The 10% Test is part of the Carryover Allocation Application to demonstrate
progress toward project completion.
 Typically, the HCA requires an Independent Accountant’s Report. The form
of report is dictated by the HCA and may vary from state to state.

24. Background on Bond Financing
• HCAs allocate competitive LIHTCs to projects based on their annual LIHTC
volume cap allocation received from the U.S. Treasury.
• An exception to this rule relates to projects financed with Tax-Exempt
Bonds. LIHTCs awarded as of right to projects financed with Tax-Exempt
Bonds do not count against the HCAs’ LIHTC volume cap allocation.
• As of right 4% LIHTCs are non-competitive. Projects must only meet
requirements under the State’s QAP and tax exempt bond rules.

25. W h a t i s t h e 5 0 % Te s t ?
The 50% test is calculated by dividing the Bond Proceeds by the
Aggregate Basis of the Project. For these purposes:
• Bond Proceeds: Include only the amount of bonds used to finance
the acquisition, hard construction and soft costs of the project.
Generally this will equal the mortgage amount. Bond Proceeds do
include interest earned on the bonds or bond reserve funds.
• Aggregate Basis: Includes the Project’s depreciable basis and land
costs.

26. What is a Cost Certification?
• CPA’s audit of project costs. Required by HCA’s to certify eligibility for
LIHTCs.
• Each HCA has specific information required to be included. Typically
required: schedules of total and eligible costs by project and building,
calculation of credits, sources and uses of funds, gap analysis and project
proformas.
• Upon final issuance of the cost certification, as a part of the final
application package, which usually includes additional materials, forms
8609 will be issued to the owner.

27. New Construction vs.
Acquisition Rehab
• New Construction: Involves construction of a project “from the ground
up.” In these circumstances, there was either vacant land with no existing
building, or all existing structures were demolished and a new structure
constructed.
• Acquisition / Rehabilitation: Involves acquiring an existing project and
rehabilitating the structure. This can involve rehabilitation around tenants,
tenants do not vacate units, or vacate units on a daily basis; or units can
be taken out of service, tenants are relocated during rehabilitation.
The nature of the construction/rehabilitation has direct effects on the ability
to capitalize costs as eligible as well as the method for determining credit
rates.

28. T h e R e h a b i l i t a t i o n Ta x C r e d i t s
Internal Revenue Code Section 47

29. Tw o Ty p e s o f
R e h a b i l i t a t i o n Ta x C r e d i t s
Older (pre-1936), non-historic and non-residential buildings: 10 percent
of qualified rehabilitated expenditures
• 10% credit buildings aren’t certified historic structures, just (pre-1936) old.
Don’t overlook these buildings, often the 10% credit can be combined with
other incentives like New Market Tax Credits
• Note the non-residential aspect of the 10% credit
Historic buildings: 20 percent of qualified rehabilitation expenditures

30. Important Dates in the History of
t h e R e h a b i l i t a t i o n Ta x C r e d i t s
• 1976: First federal tax incentives for historic preservation (accelerated
depreciation/ amortization).
• 1978: First federal tax credit for rehab of historic
buildings (10%).
• 1981: Three tiered tax credit (25%, 20% and 15%), including first credit for
rehab of older, non-historic buildings.
• 1986: Current two tiered structure; passive loss
limitations imposed.

31. T h e 2 0 % R e h a b i l i t a t i o n Ta x
Credit Fundamentals
• Preservation aspects jointly administered by NPS and State Historic Pres.
Offices (SHPOs).
• Tax Aspects Administered by the IRS.
• RTC is the most important (in dollar volume) federal preservation program.

32. T h e 2 0 % R e h a b i l i t a t i o n Ta x
Credit Statistics
• 1,020 proposed projects approved by NPS in 2012 *
• In 2012, 47% of HTC projects provided housing 1/3 of which were
affordable units; 21% office and 16% commercial uses*
• Of the 91% of Projects that used other incentives or publicly supported
financing, 43.5% used state historic tax credits *
• Top states ranked by Part 3 approvals: MO (89), VA (87), LA (72), PA (53)
OH and NY (36 each)*
• Average Cost of Projects Certified in 2012: $3.155 million, producing on
average about $631,000 in credits *
• More than $3.472 billion in private investment leveraged by up to $694
million in tax credits*
– Federal HTCs leverage $5 of private investment for every $1 of public expenditure
*Source: Annual Report for Fiscal Year 2012: Federal Tax Incentives for Rehabilitating Historic Buildings National Park Service

33. The NPS Rules: Parts 1, 2, and 3
Historic Preservation Certification Application
 Part 1 – Evaluation of Significance
 Part 2 -- Description of Rehabilitation
 Part 3 -- Request for Certification of Completed Work

34. W h a t Ty p e s o f B u i l d i n g s Q u a l i f y ?
The IRS Rules: Depreciable
Building Requirement
• Must be a “building”. Building is defined as a structure or edifice enclosing a
space within its wall and usually covered by a roof.
• Building must be depreciable. Depreciable buildings are generally those
used for nonresidential (i.e. commercial) or residential rental purposes. (See
Section 168(e))

35. B e S u r e Yo u P a s s “ T h e Te s t ”
Standard Rehabilitation Test
• Look back from placed in service
date to basis in building 24
months prior or beginning of
project, whichever is later
• QREs must exceed prior basis
or $5,000, whichever is greater
• Rolling 24-month window
Phased Rehabilitation Test
• Must be evidence that project
will take longer than 24 months
to complete prior to commencing
rehab
• 60-month window
• Otherwise similar rules

36. W h a t Ty p e s o f R e h a b i l i t a t i o n s
Qualify? Definition of QREs
• “Qualified Rehabilitation Expenditures” (QREs) is the tax term given to those
development costs on which rehabilitation tax credits can be claimed.
• QREs are any amounts chargeable to a capital account made in connection
with the renovation, restoration or reconstruction of a qualified rehabilitated
building (including its structural components), except as provided by law.

37. W h a t Ty p e s o f R e h a b i l i t a t i o n s
Qualify? Definition of QREs
• QREs include costs related to:
• walls, partitions, floors, ceilings;
• permanent coverings such as paneling or
tiling;
• windows and doors;
• air conditioning or heating systems,
plumbing and plumbing fixtures;
• chimneys, stairs, elevators, sprinkling
systems, fire escapes;

38. W h a t Ty p e s o f R e h a b i l i t a t i o n s
Qualify? Definition of QREs
• QREs include costs related to:
• construction period interest and
taxes;
• architect fees, engineering fees,
construction management costs;
• reasonable developer fees

39. W h a t Ty p e s o f R e h a b i l i t a t i o n s
Qualify? Definition of QREs
Costs EXCLUDED from QREs:
 Land and building acquisition;
 Enlargements that expand total volume (cf.
remodeling that increases FMR);
 Personal property (furniture
and appliances, cabinets and
movable partitions, tacked carpeting);
 New building construction;
 Sitework (demolition, fencing,
parking lots, sidewalks, landscaping)

40. Ta x - E x e m p t s a n d H i s t o r i c Ta x
Credits:
• Be aware of tax exempt use issues with Historic Tax Credits
• A tax exempt entity as an owner of or tenant in a historic building can cause
a loss of Historic Tax Credits—structure carefully.
• Grants/donations to the owner of a historic building can also cause tax issues
and potential reduction of Historic Tax Credits if not handled appropriately.

41. Ta x - E x e m p t s a n d H i s t o r i c Ta x
Credits:
Tax Exempt Ownership:
 Who is a Tax Exempt entity?*
–
–
–
–
Governmental/State entities
Any organization exempt from income taxes (such as a 501(c)(3))
Any foreign person or entity
Any Indian tribal government
 Can the Tax Exempt (or its sub-entity) make a 168(h) election to be taxed
as a for-profit entity?
 Will the same Tax Exempt be the end-user of the Building?
*IRC Section 168(h)(2)(A)

42. Ta x - E x e m p t s a n d H i s t o r i c Ta x
Credits:
Tax Exempt Use:
 Specific limitations on Tax Exempt Use by end-user tenants
 50% limitation (up from 35%)
What counts towards the limitation?
 Qualified vs. Disqualified Leases to Tax Exempt Entities
–
–
–
–
Did the tax exempt participate in the financing?
Is there a fixed purchase price/option to buy under the Lease?
Is the Lease term in excess of 20 years?
Has there been a “sale/leaseback” with the Tax Exempt

43. W h a t Tr i g g e r s t h e C r e d i t ?
Placement in Service (provided sub rehab test is met)
 CO or TCO is Evidence of Placement in Service
Is the building ready
for occupancy?

44. T h e 2 0 % R e h a b i l i t a t i o n Ta x C r e d i t
Recapture
• Credit previously allowed is recaptured if any portion of the project which
includes QREs is disposed of prior to the fifth anniversary of placement in
service.
• Amount subject to recapture decreases by 20% during each year of the five
year period.

45. T h e 2 0 % R e h a b i l i t a t i o n Ta x C r e d i t
Recapture
• Disposition includes any sale, exchange, transfer, gift or casualty.
Subsequent rehabs that do not comply with the Secretary’s Standards can
trigger recapture.
• Reduction of a partners interest can be deemed a disposition (33% rule).

46. Single Entity Structure
Tax Credit Investor
LLC
Managing Member
(Developer Affiliate)
.01% Credits, Profits &
Losses, Fees and
Cash Flow
Developer
Equity
Historic
Tax Credit
Equity
99.99% Credits,
Profits & Losses
and Cash Flow
Tax Credit, LLC
(Property Owner)
Loan
Proceeds
Debt
Service
Payments
Construction/
Perm Lender
Tax Credit Investor
Dev.
Fee
Rental
Payments
Tenants
Developer

47. H i s t o r i c Ta x C r e d i t S y n d i c a t i o n
The Credit Pass-Through
Structure
• Landlord LLC owns fee simple, undertakes rehab, enters into Dev.
Agreement, and earns the Historic Tax Credit.
• Master Tenant, LLC leases the entire project from the Landlord LLC for a
fixed annual rental payment.

48. H i s t o r i c Ta x C r e d i t S y n d i c a t i o n
The Credit Pass-Through
Structure
• Master Tenant, LLC operates the property, subleases to end users and
enters into the Property Management Contract.
• Landlord makes special tax election to pass the Historic Tax Credit through to
the Master Tenant LLC.

49. Master Lease/Credit PassThrough Structure
Managing Member
(Developer Affiliate)
Developer
Equity
90% Profits &
Losses, Fees and
Cash Flow
Landlord, LLC
(Property Owner/Lessor)
Loan
Proceeds
Debt
Service
Payments
Construction/
Perm Lender
.01% Credits, Profits
& Losses, Fees and
Cash Flow
Pass-through of Historic
Tax Credits & Share of
Residual
Lease Payment &
Equity Investment
10% Profits, Losses,
and Cash Flow
Tax Credit Investor
LLC
Historic
Tax Credit
Equity
99.99% Credits,
Profits & Losses,
and Cash Flow
Master Tenant, LLC
(Master Tenant)
Rental
Payments
Sub-Tenants/
End Users

50. What is a NMTC Under Section
45D
•
•
•
•
•
•
General Business Credit Under Section 38
Amount of Credit = to 39% of Qualified Equity Invest. (QEI)
Claimed over 7 year compliance period (5% 3yrs and 6% 4yrs)
Who can and cannot use the credit?
Difference between credits and credit allocation
Reported on Form 8874

51. Industry Acronyms
CDFI
Community Development Financial Institutions Fund (arm of
US Treasury that administers program)
CDE
Community Development Entity
QEI
Qualified Equity Investment (investment made in a CDE that
triggers the credit)
QALICB Qualified Active Low-Income Community Business (recipient
of NMTC capital)
QLICI
Qualified Low Income Community Investment (loan/equity
investment from CDE to business/real estate)
LIC
Low-Income Community
ATS
CDFI Fund’s Automated Tracking System (QEI registration
system)
CIIS
Community Impact Information System (system CDFI uses to
recapture community impact information)

52. What is a CDE
• Community Development Entity (for-profit/non-profit)
• What is required to be and maintains status of a CDE?
– Mission Test
– LIC Accountability Test
• What is a Subsidiary CDE?
• Why would someone want to be a CDE?

53. What is an Allocation Agreement
Contract between CDFI Fund and Allocatee CDE
Spells out what they can do with award
•
•
•
•
•
•
•
•
Spells out amount awarded
Service Area
Types of Investments
% targeted at high distress tracts
% targeted at non-metro tracts
Flexible product terms
Amount you must invest and dates to invest
Live within the Spirit of Application

54. Who are The Players
• Whose on first
• Whose on second
• Whose on shortstop
• Whose on third
• Who is catching
CDE
Investment Fund
Tax credit Investor
Leveraged Lender(s)
QALICB/Borrower/End User

55. Who Benefits and How?
• Everyone at the party recognizes benefits
• Investor thru IRR on credit
• Leveraged Lender thru debt service payments/CRA
• CDE-Fees and further its business/mission
• QALICB/Borrower – Very cost effective capital!

56. To d a y ’s N M T C S t r u c t u r e
Leveraged Lender
Investors
loan
Investment Fund
QEI
CDE
loan
loan
QALICB
Equity
Investment

57. What Does The CDE Do?
• For transaction purposes all CDE’s use “sub-CDE’s” (single purpose entity)
• Receives QEI (triggers credit and locks allowance dates)
• Pays CDE fees
• Originates and makes loans/investments (85%/sub all test)
• Collects debt service
• Pays Expenses
• Distributes cash to Investment Fund
• MM/GP responsible for operations (usually Allocattee)

58. Q u a l i f i e d C e n s u s Tr a c t
• Currently under 2010 Census
• < 80% Median Family Income (distressed 60%)
• > 20% Poverty Rate
• Other high distress indicators (Enterprises zones, Empowerment zones,
Non-Metro tracts, Brownfield, Medically underserved, etc.)

59. What Constitutes a QLICI?
• Loan/Investments “active” “qualified” “low income” community business
(loan purchases or other CDE invest.)
• CDE must loan/invest 85% of QEI within 12-mos in business (for 6 yrs and
drops to 75% year 7) - “Sub-All-Test”
• Redeployment Rules

60. What/Who is a QALICB
• Any business in qualified tract other than:
– Residential Rental Property (80/20 rule)
– Business developing, holding, selling or licensing intangibles
• Must meet Activity Tests
• Must be “active” (3 year rule)
• If Real Estate must have substantial improvements

61. Recapture
• Regulatory vs. Program Compliance
• 4 events can trigger recapture
• 6-Month cure period

62. Why Program Works
Leveraged
Lender
Debt Service
Payments
$3 million Equity
Investment
(owns 100%)
Investment
Fund
$7 mill. Loan @
5%
Investor
Tax Credits
CDE
$200,000 Fees
To MM/GP
A-Loan $7 mill
7 yr. put option
$10 million QEI
(owns 99.99%)
Distribute cash
Debt
serv
pymnt
QALICB
B-Loan $2.8
million
MM/
GP