September 4, 2018 www.novoco.com

Benefits and Overview of Nonprofits

Participating in LIHTC Partnershipsfor the Florida Housing Coalition Conference

Christina ApostolidisPartner, Naples, FL

christina.apostolidis@novoco.comNovogradac & Company LLP

Agenda

Benefits of using LIHTCs and Overview

Safe Harbor Rules for Nonprofit Organizations in Affordable Housing

Structure and Partnership Agreements

Protecting the Credit

Life after LIHTC

Brief discussion on Tax Reform and the LIHTC Industry

September 4, 2018 www.novoco.com

Affordable Housing Overview

DEBT

InvestorTax Liability

Section 42

“Low-Income Housing Tax Credit”

Developer/Owner

x 10 years

• Income limits• Rent limits• Suitability for Occupancy

• Partnership• LLC• S-Corp

Tax Liability

DEBT

Total Project Costs

Equity

4mil130%

5.2mil100%

5.2mil

6mil130%

7.8mil75%

5.85mil

$x$x$

$x$

$x$x$

$x$

Ineligible costs:• Land• Marketing• P’ship org. costs• Commercial property• Off-site improvements*

Total Project Costs

$10.8mil $800k

Eligible basisDDA/QCT basis boostEligible basis (adjusted)Applicable fractionQualified basis

Annual tax creditsTen yearsTotal tax credits

Eligible Basis = $10mil

BA

468k10

4.68mil

527k10

5.27mil

See IRC § 42(b)

$8.46M

$10.8 Mil

Equity 78%

x

4mil130%

5.2mil100%

5.2mil

468k10

4.68mil

6mil130%

7.8mil75%

5.85mil

527k10

5.27mil

$x$x$

$x$

$x$x$

$x$

Eligible basisDDA/QCT basis boostEligible basis (adjusted)Applicable fractionQualified basis

Annual tax creditsTen yearsTotal tax credits

BA

Total Project Costs

Benefits of using LIHTCs

• How can LIHTCs help you further your mission?

• What assets do you have to make a deal work?

September 4, 2018 www.novoco.com

Safe Harbor Test for Low-Income Housing Organizations

• A low-income housing organization seeking 501(c)(3) charitable status, can either qualify using a facts and circumstances test or, more easily, by satisfying the following 4-part test (Rev. Proc. 96-32):– Minimum percentage tests;– Actual occupancy requirements;– Affordable to charitable beneficiaries; and– Special requirements for multiple building projects.

Minimum Set-Aside Test

• For each project, at least 75% of the units are occupied by residents that qualify as low-income (80% of the area’s median income (AMI) and either– 20% @ 50% - at least 20% of the units are occupied by

residents with incomes at or below 50% of AMI, or

– 40% @ 60% - 40% of the units are occupied by residents that do not exceed 60% of AMI (or 120% of Very Low Income).

• Similar to Section 42 – the 20% @50% and 40% @ 60% tests match the minimum set-aside requirements for LIHTC. However, the overall requirement that 75% of units must be rented to people at or below 80% of AMI is an additional requirement.

LIHTC Minimum Set-Aside = 40 at 60

Minimum Percentage Tests

Min. Set-Aside for 501(c)(3) status = 75 at 80

Safe Harbor*

*Rev. Proc. 96-32 identifies 10 factors to evaluate in determining whether a nonprofit entity is serving its charitable purpose even if safe harbor requirements are not met

LIHTC Minimum Set-Aside = 40 at 60

Minimum Percentage Tests

Min. Set-Aside for 501(c)(3) status = 75 at 80

Additional facts and circumstancesA substantially greater percentage than required by the safe harbor of residents with incomes up to 120 percent of the area’s very low-income limit

“ ”(60% of AMI)

Safe Harbor

Actual Occupancy Requirements• The project must actually be occupied by poor and distressed

residents.

• A reasonable Transition Period is permitted for the organization to place the project in service.– Reasonableness is determined by all facts and circumstances.

• If a project does not require substantial construction or rehabilitation, 1 year is generally considered reasonable.

• If a project operates under a government program that permits a longer period, that longer period governs.

• Next Available Unit Rule – The safe harbor will continue to be met even if a resident’s income increases, but only if– the resident’s income does not exceed 140% applicable income limit or

– the next comparable non-qualifying unit is rented to someone under the qualifying income limits.

– Same as the LIHTC Next Available Unit Rule

LIHTC Available Unit Rule Search

Tax credits. Simplified.

Affordable to Charitable Beneficiaries

• The housing is affordable to charitable beneficiaries (low-income and very low-income individuals).

– This requirement is ordinarily satisfied by the adoption of a rental policy or mortgage policy that complies with government-imposed rental restrictions or mortgage limitations.

– In practice, renting to tenants at 30% of the applicable AMI percentage (30% of 50% or 30% of 60%) is deemed charitable.

Special Requirements for Multiple Buildings Projects

• Generally, if a project has multiple buildings and each building does not meet the first 3 prongs of the 4-part test, the buildings must share the same grounds.

• Exception: this prong is not required if the units are– individual homes or apartments located at scattered sites in a

community and

– provided exclusively to families with income at or below 80% of the area’s median income.

Other Charitable Purposes Can Qualify

• Renting to low-income persons is not the only qualifying charitable purpose. Other charitable purposes include

– Combating Community Deterioration

– Lessening the burdens of government

– Elimination of Discrimination and Prejudice

– Lessening Neighborhood Tensions

– Relief of the Distress of the Elderly or Physically Handicapped

Developer/Owner

GP

Fund LP

Non-Profit

GP

P’ship

Developer/Owner

GPNon-Profit

GP

Investor(s)

Fund LP

P’ship

Typical Ownership Structure

P’ship

Owner/Borrower Entity

Developer/Owner

GPFund LP

Typical Ownership Structure with Non-Profit MGP

P’ship

Owner/Borrower Entity

For-Profit

GPFund LPNon-Profit

GPManaging Administrative

Developer Fee

P’ship

Owner/Borrower Entity

For-Profit

GPFund LPNon-Profit

GP

Tax Credits, Profits, and Losses

99.99% 0.001% 0.009%

Managing Administrative

Allocation of Tax Benefits (including Tax Credits)

Residual Annual Cash

Flow10.00% Fixed Fee Prior to

Residual Allocation 90.00%

P’ship

Owner/Borrower Entity

For-Profit

GPFund LPNon-Profit

GP

Tax Credits, Profits, and Losses

99.99% 0.001% 0.009%

Managing Administrative

Allocation of Cash Flow

Residual Sale and Refinance

Proceeds10.00% 90.00%

Residual Annual Cash

Flow99.99% Fixed Fee Prior to

Residual Allocation 00.01%

P’ship

Owner/Borrower Entity

For-Profit

GPFund LPNon-Profit

GP

Tax Credits, Profits, and Losses

99.99% 0.001% 0.009%

Managing Administrative

Allocation of Sale and Refinance Proceeds

Note: Residual annual cash flow and sale proceeds are negotiable

• Operating Cash Flow = NOI less (Debt Service and Lender Reserves)

– Fixed Asset Management Fee to tax credit investor – Fixed MGP Fee if Nonprofit included in ownership structure– Investor Loan Recovery (if operating loans made)– Deferred Developer Fee– GP Loan Recovery (if operating loans made)– Incentive Management Fee to Sponsor/General Partner

• 90% – Balance according to ownership interests

• 99.99% to Investor• 00.01% to Sponsor/General Partner

Limited Partnership Provisions during Operations:Cash Flow Waterfall

JOINT VENTURING WITH FOR-PROFIT ORGANIZATIONS

• Factors to consider when partnering with a For-Profit

– Experience requirement

– Development activities and negotiating the developer fee

– Cash Flow splits

– Liability exposure

JOINT VENTURING WITH FOR-PROFIT ORGANIZATIONS

• Nonprofit assets – must be used EXCLUSIVELY for charitable purposes

• The IRS is very concerned when nonprofit organizations joint venture with for-profit organizations. – This creates the possibility that the charity’s assets will

benefit the for-profit.

$2

Mill

ions

$10

Construction

Lease up

Perm Loan Closing

Compliance PeriodTax Credit Period

CreditsRemaining

Potential Recapture + Interest

Debt Balance

NOI

Risk

$10 Mil LIHTCs

$8 Mil Equity

$2 Mil Perm Loan• 30 yr amort

• 7.0% int rate

0 17

Casualty(Fire/Hurricane/Flood)

3

1 Cost overruns,Slow lease-up,Perm loan shortage

2 Rise in operating costs,Drop in rental revenue

Fund LP

Noncompliance with tax credit rules

4

Lease up

Compliance PeriodTax Credit Period

0 17

1 Cost overruns,Slow lease-up,Perm loan shortage

Construction Fund LP

DevelopmentCompletionGuaranty

Construction

Perm Loan Closing

Compliance PeriodTax Credit Period

0 17

Lease up NOI

Fund LP

2 Rise in operating costs,Drop in rental revenue

Operating Deficit Guaranty

Construction

Lease up

Perm Loan Closing

Compliance PeriodTax Credit Period

0 17

CreditsRemaining

Potential Recapture + Interest

Risk

Fund LP

Tax Credit Guaranty(nonrecourse to Guarantor)

Possible reasons for reduction of tax credit amount:1. Reduction in eligible basis2. Rental to non-qualified occupants3. Rental rates exceeding LIHTC limits4. Noncompliance due to property condition

Noncompliance with tax credit rules

4

IRS Guidance - The Choi Memo

• Specific guidance has been issued for processing tax-exemption applications for nonprofit organizations that want to be the general partner in a partnership with a for-profit, such as an LIHTC investor.

• See Memorandum for Manager, EO Determinations from Robert S. Choi, Director EO Rulings and Agreements, Re: Low Income Housing Tax Credit Limited Partnerships (July 30, 2007)

http://www.novoco.com/low_income_housing/resource_files/irs_rulings/memorandums/choi_memo_073007.pdf

IRS Requirements to Process Application

• Limited Partnership Agreement or LLC Operating Agreement must specify that the LP or LLC will operate

– housing that it owns in a manner that furthers charitable purposes by

– providing decent, safe, sanitary and affordable housing for low income

– persons and families (including the elderly or physically handicapped, where appropriate).

Choi Memo

Charitable Purpose Prevails

• Partnership/Operating Agreement must provide that in the event of a conflict between

– the obligations of the nonprofit (in its capacity as general partner or managing member) to operate the LP or LLC in a manner consistent with such charitable purpose, and

– any duty to maximize profits for the limited partners or other members,

the charitable purposes contained in the LP agreement or the LLC governing documents will prevail.

Choi Memo

Must have a Conflict of Interest Policy

• Nonprofit must adopt a conflict of interest policy to protect the Nonprofit ’s interest when it is contemplating entering into a transaction or arrangement that might result in an excess benefit transaction or might benefit the private interests of the applicant’s officers, directors, trustees or its partners.

• The sample conflict of interest contained in the Instructions for Form 1023, or a similar conflict of interest policy, may be adopted.

Choi Memo

Protecting the Nonprofit

• Must limit the Nonprofit’s financial exposure as General Partner in case the Project doesn’t go forward as planned. A number of protections are listed, but alternative protections can be used if shown to protect the Nonprofit– Must have an independent Phase I environmental

report on the proposed project and exercise due diligence to minimize any risk before entering into any agreements for any environmental indemnification.

Choi Memo

Protecting the NonprofitMore financial protections

• Must have a fixed price construction contract with a bonded contractor or one that has a letter of credit

• Operating Deficit Guarantees must be limited either to:– Not more than 5 years from break-even operations, or– 6 months of operating expenses (including debt service)

Choi Memo

Protecting the NonprofitMore financial protections

• Must have a fixed price construction contract with a bonded contractor or one that has a letter of credit

• Operating Deficit Guarantees must be limited either to:– Not more than 5 years from break-even operations, or– 6 months of operating expenses (including debt service)

Choi Memo

Protecting the NonprofitLimits on Credit Adjusters

• If the Nonprofit is obligated to make adjuster payments to the LIHTC investor, such payments must be limited:– Not exceed the amount of developer fee and other fees

that the Nonprofit is entitled to, or

– Provide that payments of adjusters will be treated as capital contributions or a loan which takes priority over any other distribution of residual assets upon sale or refinancing

Choi Memo

Protecting the NonprofitNonprofit Right of First Refusal

• The Nonprofit must get the Section 42 Right of First Refusal (ROFR)

– ROFR purchase price cannot be less than debt plus exit taxes

Choi Memo

Protecting the NonprofitRepurchase Price Limitations

• LIHTC Partnership agreements frequently provide that the Investor can require that its interest be repurchased by the General Partner for failure to meet certain critical items, such as failure to qualify for LIHTC.

• Limitation – the LIHTC investor cannot receive more than its capital account from the Nonprofit.

Choi Memo

Protecting the NonprofitConsent Limitations

• LIHTC Investors can have consent rights• Examples of consent right matters:

– sale or refinancing of the LIHTC project; – admission of a new partner or member;– acquisition of additional property; – transfer of the applicant’s interest in the limited partnership or limited

liability company; (v) borrowing substantial additional funds; – entering into contracts with affiliated entities; – amendment of the limited partnership agreement or

operating agreement; – change of accountant or property manager; and/or – approval of annual budget

Choi Memo

Protecting the NonprofitLimitations on GP Removal

• The LIHTC Investor’s right to remove the Nonprofit General Partner should only be for cause.

• Partnership Agreement must provide the Nonprofit General Partner with

– Written Notice of the proposed removal

– Reasonable Cure Period

Choi Memo

Limitations on Choi Memo

• The Memo does not attempt to apply itself to already existing nonprofits. On its face the Memo is limited to situations where tax-exempt applications will be processed.

– Some large pre-existing nonprofits feel comfortable operating outside the Choi memo.

• The Memo does not attempt to list the full extent of what Nonprofits, only gives a safe harbor, that if complied with, will get an application for tax-exemption processed

• However, the Choi Memo has been added to the Internal Revenue Manual which is generally used by the IRS.

– It has also been cited in one audit which was settled.

Choi Memo

Protecting the Credit: Tax Credit & Compliance Period

x %

x %

6,250,00080

5,000,0009

450,000

Eligible Basisx Applicable FractionQualified Basisx Tax Credit PercentageAnnual LIHTCs

Protecting the Credit: What is Recapture?

• Casualty loss• Reconfiguring space• Disrepair• Building disposition

• Over-income tenants• Bad files• Rent too high• Violate Available Unit Rule, Full-Time Student Rule, Vacant Unit Rule

Protecting the Credit: What is Recapture?

• Casualty loss• Reconfiguring space• Disrepair• Building disposition

• Over-income tenants• Bad files• Rent too high• Violate Available Unit Rule, Full-Time Student Rule, Vacant Unit Rule

Protecting the Credit: What is Recapture?

• Option to buyout LP in Year 15 – non-profits (as GP)

– Nonprofits can have option price of:

• Partnership debt +

• Taxes (i.e. exit taxes)

(Great Deal! If taxes don’t exist, then just assume debt!)

– Technically supposed to be right of refusal; often worded as an option though

– Very important to monitor, manage, and babysit the LP’s capital account, to make sure it doesn’t head negative

Life after LIHTC period:Option to Buyout LP In Year 15

Tax Reform and LIHTC Industry

• Reduction in corporate tax rate makes the LIHTC less valuable to investors

• Business Interest Limitations & Depreciable Lives• Bonus Depreciation• Opportunity Zones

September 4, 2018 www.novoco.com