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Tax Credit Projects in Distress

Mark BossiPatrick Clisham

Alan WeinerJon Krabbenschmidt

abiLIVE webinar seriesNovember 19, 2015

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• Historic Tax Credit (HTC)• Low Income Housing Tax Credits (LIHTC)• New Markets Tax Credits (NMTC)

Overview of Tax Credit Programs

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• Provides a tax credit to investors that offset their income taxes dollar-for-dollar

• Requires investors to be committed to the tax credit for extended period of time:

•HTC – 5 Years•NMTC – 7 Years•LIHTC – 15/30 Years

Overview of Tax Credit Programs

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• Similarities of Tax Credit Programs– Provide tax credits to investors/owners– Require investors to be owners of the property– Structured with LP or LLC to own the property– Utilize debt to provide sufficient capital to acquire

project

Overview of Tax Credit Programs

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• Differences in Tax Credit Programs• Types of Properties and Credit Periods

– HTC – Commercial or Residential – Credits taken first year and with 5 year of recapture

– LIHTC – Residential – Credits taken evenly over 10 years with 15 year recapture period

– NMTC – Commercial – Credits taken over 7 years with 7 year recapture period

Overview of Tax Credit Programs

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• Administration of Tax Credit ProgramsoLIHTC

State Housing Agency Administers and Monitors Program Delegated Authority Under Internal Revenue Code States are allocated credits that are reallocated to projects

o NMTC – US Treasury Department Administers and Monitors Program

o HTC 10% Credit – Monitored by IRS 20% Credit – Administered by US Parks Department and State

Housing Preservation Office Administer and Monitored by IRS

Overview of Tax Credit Programs

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• Bankruptcy Usually Triggered by Debtor Violation of Debt Provisions and Desire to Stay Foreclosure

Overview of Tax Credit Programs

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• NMTC program encourages investment in low-income communities (LICs)

• Provides federal income tax credits equal to 39% of Qualified Equity Investments (QEIs) in Community Development Entities (CDEs) that serve as intermediary vehicles for providing financing to LICs

• 7 years compliance period• Investors receive a tax credit of 5% of the QEI for the first

three years and 6% for the final four years

New Market Tax Credits (NMTCs)

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Community Development Entities must use...Substantially All of the proceeds from…Qualified Equity Investments to make…Qualified Low-Income Community Investments in…Qualified Active Low-Income Community Businesses located in…Low-Income Communities.

NMTC Program Definition

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Qualified Low-Income Community Investment

Qualified EquityInvestment

Treasury DepartmentCommunity

Development Entity

Investors

Qualified Active Low-Income Community Business

NMTCsApplication

NMTCs

Basic NMTC Transaction Structure

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$10MM QLICI

$10MM QEIs

$7,192,000

$2,808,000(.72)$3.9MM

NMTCs

Tax Credit Investor Leverage Lender

Investment Fund($10MM)

CDE (or Sub-CDE)

QALICB

Simple NMTC Leveraged Structure

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CDE investment/reinvestment requirements pose a challenges to the CDE’s options in dealing with distressed loans:- CDEs required to keep substantially all of their qualified

equity investments (QEIs) invested in qualified low-income community investments (QLICIs) for entire 7-year compliance period

- CDE must reinvest QEIs into a new QLICI within 12 months- Direct ownership of property by a CDE is not a QLICI- Complicated reinvestment tax issues involved

Restructuring/Workout Issues Involving NMTCs

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• Program requirements restrict/complicate:• Principal paydowns• Taking additional collateral• Taking title to collateral:–If CDE takes direct title, its 12-month reinvestment

period begins to run immediately, even though it does not yet have cash to reinvest–CDE must establish and qualify a new QALICB to take

title to delay the running of its reinvestment period

Workout/Restructuring Issues (cont.)

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• Recharacterization/breach of fiduciary duty challenges to “self-leveraged” NMTC financings–Great Northern Paper Company (Maine)–Agri-Best Holdings, LLC (S.D. Ill.)

Bankruptcy Issues involving NMTCs

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Tax Credit Investor Leverage Lender(QALICB Sponsor or affiliate)

Investment Fund

CDE

QALICB

Simplified Self-Leveraged Structure

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• Established by Tax Reform Act of 1986• Continuation of Legislative Effort to Encourage

Private Sector Development, Acquisition and Operation of Affordable Multifamily Properties

• Section 42 of Internal Revenue Code

Low Income Housing Tax CreditsBackground

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• Credits available for new construction as well as for acquisition/rehabilitation

• Credits are awarded on a property-by-property basis• Generally administered by state housing agencies

Low Income Housing Tax Credits

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• Tax credits are awarded to a property/property developer

• Credits are to be taken over a 10 year period of time – assuming ongoing compliance with tax credit rules

• Compliance period, however, is 15 years• Significant “recapture” penalties for non-compliance• Some properties subject to extended compliance

periods

Low Income Housing Tax Credits

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• Compliance means units are rented to qualifying low income tenants at qualifying rents

• Properties must meet minimum set-asides• 40% of units rented to tenants earning no more than 60%

of area median income OR• 20% of units rented to tenants earning no more than 50%

of area median income• Notwithstanding, credits only received for qualifying units

within a property, thus tax credits must be “earned” each year

Low Income Housing Tax Credits

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Low Income Housing Tax Credits• Tax credits reduce tax on a dollar-for-dollar basis• Utilized by Individuals and Corporations• Corporations can also utilize passive losses (i.e.

commonly generated by leveraged real properties)• Corporations often investors in tax credit properties

either directly or through funds• General Partners (Developers) have obligations to

Investors

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Low Income Housing Tax CreditsTypical Structure

General Partner (1%)

Limited Partner (99%)

Grants/Subordinated Loans

Project Partnership

Senior Lender

Equity

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• General Partner is typically the developer – has minority (1% interest), but total operational control

• General Partner provides significant guaranties to entice LP investments

• Completion guaranty• Cash deficit guaranty• Tax credit guaranty• Recapture guaranty• Repurchase agreement

Low Income Housing Tax Credits

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• Limited Partners are passive investors• Either as direct investors or through tax credit

investment funds• Look for tax credits and passive losses for investment

return• View investment as low risk• Rely upon General Partners to deliver• Can withhold capital investments upon General

Partner breach of partnership agreement

Low Income Housing Tax Credits

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• Limited Partners do not guaranty debt• However, bear risk of “tax recapture”• During first 10 years, 1/3 of tax credits received plus

compounded interest to be repaid to IRS• Phases out during years 11-15• LPs look to General partner to indemnify• Also, no ongoing tax credits in case of non-compliance• Again, LPs look to GP for repayment

Low Income Tax Credits

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Tax Credit PropertiesUnique Issues Involving Workouts and Restructurings

• Valuation Issues in Bankruptcy• Lewis & Clark; Creekside; Sunnyslope• Tax Credit Impairments

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Tax Credit PropertiesUnique Issues Involving Workouts and Restructurings

• Unique Reorganization and Plan Provisions• Considerations for Filing

•Impact on participants •Authority to file

• Separate classification of Unsecured Junior Lenders • Interest rates and plan terms• Impact of Senior Lender Lien Positions vs. Tax

Restrictions

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Tax Credit PropertiesUnique Issues Involving Workouts and Restructurings

• Other Chapter 11 LIHTC Experiences• In re American Housing Foundation

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• HTC program encourages rehabilitation of historic and older buildings

• Two types of HTCs:–20% credit for the certified rehabilitation of certified

historic structures–10% credit for the rehabilitation of non-historic, no-

residential buildings built before 1936• Entire tax credit may be claimed for the tax year in which the

rehabilitated building is placed in service• Recapture exposure if the building is not held by the owner for

5 years

Historic Tax Credits (HTCs)

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QUESTIONS