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AFFORDABLE HOUSING REVIEWThird Quarter 2016
CBRE AFFORDABLE HOUSING
CAN A 1031 EXCHANGE BE USED AS AN EXIT STRATEGY?As was the case when Part One of this article was written, real estate prices continue to rise. This is great news for low-income housing tax credit (LIHTC) developers reaching Year 15, who are looking to sell their property. As more fully discussed in Part One of this article, IRC § 1031 (1031) exchanges allow a taxpayer to exchange like kind property and defer recognition of the gain on sale. This article explores the possibility for an owner of a LIHTC project to use 1031 exchange to defer gain when selling their LIHTC property. For more information on using a 1031 exchange to buy a project for acquisition-rehab credits, please see Part One.
1031 Requirements Overview
Before we look at the issues unique to LIHTC transactions, we need to understand some of the general requirements for an exchange to qualify for defer-ral of gain under 1031. In order for a transaction to qualify for deferred gain, several require-ments must be met, including the following:
1. The exchange must be for property, real or personal. Interest in a partnership cannot be exchanged for partnership interest.
2. The property must be held for qualified use; meaning
that the property is held in a trade or business or for investment.
3. The property relinquished should be like kind with the property acquired.
4. An exchange must occur.
5. The same taxpayer that enters the transaction must complete the transaction.
LIHTC Year 15 Exit Strategy Considerations
As discussed in our last article, there are a few obstacles that make claiming acquisition cred-its on a property acquired in a 1031 exchange difficult, therefore
for purposes of this article we will assume that the acquired project will not be used in a future LIHTC transaction. Exit Timing of the Investor Limited Partner (ILP)
As stated above, one of the re-quirements of a 1031 exchange is that the same taxpayer that relinquishes the property must also acquire and hold the new property. Therefore, unless the ILP is removed prior to the 1031 exchange, the ILP will need to remain in the ownership entity of the acquired property. In ad-dition, the ILP’s gain will only be deferred as long as they remain in the ownership entity of the acquired property. Unless the
Thomas StaggThomas Stagg is a Partner in Novogradac & Company’s Seattle office. He specializes in LIHTC transactions.
Angie TaylorAngie Taylor is a Principal in Novogradac & Company’s San Francisco office. She specializes in partnership and individual taxation.
1031 AND LIHTC:
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ILP plans to remains in the own-ership of the acquired property, the 1031 exchange will have lim-ited benefit to them.
However, there are a few factors that will likely make an ILP less than enthusiastic to want to stay in ownership of the acquired property long term. First, the ILP will typically want to exit the LIHTC partnership at Year 15 to close out their investment, es-pecially if the ILP is a fund and not a direct investor. Second, as discussed in our previous article, there are certain obstacles that make acquiring a LIHTC project for acquisition-rehab credits as part of a 1031 exchange particu-larly difficult. This means that even if the ILP was interested in participating in the 1031 ex-change, the purchased proper-ty likely would not be a LIHTC project and may not fit within the ILP’s investment portfolio. Third, the ILP likely will not have as much gain to defer as the gen-eral partner. The ILP’s share of the gain from the transaction will typically only be 0 to 30 per-cent of the total gain, while the GP’s share of the gain will typi-cally be 70 to 100 percent. The fact that the ILP has less gain to defer means that they will have less motivation than the GP to take part in a 1031 exchange, which can make it difficult to negotiate a 1031 exchange with-in a typical LIHTC partnership.
Therefore, it is usually easier if the tax credit ILP is removed from the partnership prior to the 1031 exchange taking place. This is usually done by the general partner or some other interested party purchasing the ILP’s inter-est for its fair-market value. Care should be taken concerning the timing of removing the ILP so as to avoid issues relating to the same taxpayer rule.
Implications of the Extended-Use Period
LIHTC projects funded after 1990 are required to have a minimum extended-use period of 30 years. In addition, many states layer on a longer compliance period. This means that a LIHTC project will typically be required to follow the LIHTC rules for another 15-plus years after the initial 15-year com-pliance period ends. Due to this extended-use period, state agen-cies often have the right to ap-prove transfers of ownership of a LIHTC project. Typically this sets limits on who can purchase the LIHTC project and often causes delays in the transaction. There-fore, even if the other issues dis-cussed can be overcome, it is im-portant to allow yourself plenty of time for the LIHTC sale to take place. This timing must be con-sidered within the constraints of the exchange. In a typical ex-change, you have 45 days after the transfer of the relinquished prop-erty to identify the property to be
acquired and 180 days to actually receive the property.
In addition, many LIHTC projects have other public funds, such as tax-exempt bonds, HOME funds, etc., that may require approval before a transfer can take place. It is important to understand these transfer requirements and plan the timing of the 1031 exchange accordingly.
Relinquishing to a Related Party
In an effort to maximize bene-fits, a partnership may wish to sell (relinquish) the property to a related party so that the prop-erty can be resyndicated. To complete the 1031 exchange, the relinquishing partnership would still need to acquire a separate replacement property. Relin-quishing to a related party has many special rules and would require several articles to fully cover the intricacies. However, LITHC partnerships who may want to proceed with resyndi-cations need to be aware of the holding rules that are applicable to transactions involving related parties under IRC 1031(f). These rules may apply on both the re-linquishing and acquiring sides of the transactions.
The best strategy is to get your tax professionals involved at the beginning of the exchange trans-action to ensure success.
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Congress has turned its attention to the affordable housing crisis this year with several legislative initiatives at various stages of the review and approval process. Unlike previous years, there seems to be greater bipartisan cooperation in recognizing the severity of the crisis and in improving federal affordable housing programs. Highlights of three of these measures follow.
The Affordable Housing Credit Improvement Act
This bill was originally intro-duced in May by Senators Ma-ria Cantwell (D-WA) and Orrin Hatch (R-UT). In its original form, the bill proposed to ex-pand the number of LIHTC cred-its by 50% over a five-year peri-od, create an income-averaging option at LIHTC properties, and establish a permanent 4% cred-it rate floor for acquisition and bond-financed projects. In July, Cantwell and Hatch, along with five other co-sponsors, intro-duced new legislation that adds to the provisions of the May bill. In its current form, the Act pro-vides:
1. LIHTC Authority Increase: LI-HTC authority would increase by 10% each year for five years until it reaches $3.53 per cap-ita in 2021. The small state minimum amount would also increase 10% each year before reaching $4,035,000 in 2021. Beginning in 2022, increases to the per capita amount and small state minimum would
again be subject to inflation. Estimates of the number of additional affordable rental units that could be funded by the 50% increase over the 10-year period range between 200,000 and 400,000.
2. Income-Averaging: This would allow a certain number of apartments in a LIHTC prop-erty to be available to resi-dents making up to 80% of the area median income (AMI), so long as the average across the entire property is 60% or less.
3. Preservation of Affordable Hous-ing: Creates a purchase option that will allow nonprofit and government sponsors to acquire housing credit properties when the current 15-year compliance period expires, in order to keep properties affordable well-past the compliance period.
4. 4% Minimum Rate: Creates a permanent 4% minimum credit rate for the acquisition of prop-erty and for multifamily housing bond-financed developments,
consistent with the passage of the permanent 9% minimum credit rate at the end of last year.
5. Homelessness and Extremely Low Income Families: Provides a 50% credit boost incentive for projects that target home-less or extremely low-income individuals and families, al-lowing them to remain finan-cially feasible while targeting the neediest populations.
The bill contains additional provisions addressing Native American housing needs, ener-gy efficiency credits, and rural housing tenant income rules. It was referred to the Senate Fi-nance Committee on July 14 for further action.
The Housing Opportunity Through Modernization Act
This bill focuses on expanding the project-basing capabilities of state housing agencies adminis-tering housing choice vouchers. Under this law, an agency will be able to project-base up to 20% of its authorized number of vouch-
LEGISLATIVE UPDATE
AFFORDABLE HOUSING
John FioramontiSenior Research Analyst
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ers, plus an additional 10%, to assist households in areas where vouchers are difficult to use or to assist people with disabilities, formerly homeless individuals, veterans, or seniors. The maxi-mum term of an initial contract or extension is also increased from 15 to 20 years. The goal of this provision is to expand access to higher opportunity areas for low-income families, allowing them to move to saf-er, low-poverty neighborhoods. It is believed that this greater flexibility will give more options to housing authorities to bet-ter utilize aging housing stock, create more housing options in high-opportunity neighbor-hoods, and to better serve their homeless and special-needs pop-ulations. Other key provisions of this Act are:
1. Amends the Family Unifica-tion Program (FUP) to expand access for youth aging out of foster care to avoid home-lessness by extending the el-igibility age up to 24; and to otherwise eligible youth who will leave foster care within 90 days and are homeless or at risk of homelessness. In addi-tion, the bill extends the peri-od for which youth who have left foster care may receive as-sistance to 36 months.
2. Provides employment-related protections by requiring de-lays in rent increases for ten-ants who start employment or who get an increase in their earnings by getting a better paying job or by increasing their work hours. This will al-low tenants to retain 100% of
their increased earnings for a longer period of time.
3. Allows housing agencies more flexibility in using funds for needed renovations in public housing.
Additional provisions of the law streamline certain administra-tive requirements for both the housing agencies and the prop-erty owners, and bolster rural housing programs. In an un-characteristic display of biparti-sanship, the Housing Opportu-nity Through Modernization Act received unanimous approval in both the House and the Senate and was signed into law by the President on July 29, 2016.
The Housing for Homeless Students Act
This legislative proposal seeks to amend the Internal Revenue Code to qualify homeless youth and veterans who are full-time students for rental housing in properties financed through the LIHTC program. To qualify for the credit, the student must have been a homeless child or youth during any portion of the seven-year period prior to occu-pying the housing unit and the veteran must have been home-less for a similar five-year period. These proposals are two excep-tions to the so-called “student rule” that prohibits full-time students from living in tax cred-it-funded housing. This provi-sion in the Code was originally intended to prevent LIHTC cred-its from being used to construct student housing and to prevent college students from accessing LIHTC housing intended for
individuals and families with long-term affordable housing needs. Similar to many well-in-tentioned rules, the strict appli-cation of the “student rule” has operated to prevent truly home-less and/or formerly homeless youth and veterans from pursu-ing a full-time education unless they are willing to lose access to LIHTC-funded housing.
This is not the first effort at amending the “student rule” to allow homeless students to qual-ify for a LIHTC-funded apart-ment. In 2012, we wrote about H.R. 3076, sponsored by Con-gressman Jim McDermott (WA-7), that was virtually identical to this proposal but never made it out of the House Ways and Means Committee. At that writ-ing we opined, “Young, homeless people should not be penalized under Section 42 for pursuing an education and improving their lives … [C]ommon sense dictates that affordable housing built with tax credits should be avail-able to the full-time student that is homeless due to real poverty.”
The “student rule” already recog-nizes exceptions for former foster children, single parents, and par-ents receiving public assistance that are pursuing full-time educa-tions. There is no justification for not also exempting low-income children and veterans who have a recent history of homelessness and want to improve their lives through education.
This Act was referred to the House Ways and Means Committee on May 19, 2016. We hope it does not suffer the same fate as its predecessor.
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CBRE Affordable Housing’s Debt and Structured Finance team continues to grow and expand its base of expertise with the addition of James (Jim) Flinn as a Senior Vice President. A seasoned industry veteran, Jim has more than 15 years of experience in the affordable housing finance space. Jim joins CBRE from JLL’s Affordable Housing group as managing director where he established their tax-exempt bond platform. Prior to JLL, he was a managing director at Red Capital. Jim has extensive knowledge of and experience with Section 8 housing, LIHTC and tax exempt bond transactions, debt structuring and cash flow analysis, making him a valuable addition to the CBRE Affordable Housing team.
What brought you to CBRE Affordable Housing?
JF: The opportunity to help build a comprehensive affordable housing platform at CBRE was appeal-ing to me primarily because of the reputation of the people already within the group and the abil-ity to leverage off of that reputation to expand its affordable debt business. CBRE is also one of the largest Fannie Mae and Freddie Mac lenders in the country so it clearly has the ability to provide out-standing service to its clients, which is very attrac-tive from an originations standpoint. What makes CBRE Affordable Housing so unique in your opinion?
JF: A lot of shops talk about being able to provide an array of affordable housing services but CBRE is unique in that it is the only group that is able to offer investment sales, advisory, investment bank-ing, and debt and structured finance under one roof. As a Freddie Mac Multifamily Approved TAH Seller/Servicer, CBRE Affordable Housing also pro-vides its clients with a powerful tool in financing their affordable housing properties.
What is the benefit to the client or borrower of an integrated platform?
JF: It makes life much easier for the client because there is a level of continuity and service that CBRE is able to provide that others cannot. We are able
to manage every aspect of a transaction for a seam-less execution. This includes access to and execu-tion of Freddie Mac, Fannie Mae, and FHA financ-ing programs – all of which are the major source of affordable housing financing.
What is the current state of the affordable housing nationwide and what trends are you seeing?
JF: There is a lack of available affordable housing across the country and the agencies and HUD have made a real commitment to help preserve the existing stock and increase the number of new affordable units. We continue to see a number of projects being re-syndicated that are coming out of the 15 year tax-credit compliance periods. Owners are also taking advantage of these historically low interest rates to refinance existing loans to a lower mortgage rate and provide some additional capital for repairs and improvements. The good news for the client is that there are a number of agency and FHA loan programs that can be used to acquire, refinance and recapitalize affordable housing projects.
Jim’s primary responsibility will be growing direct, in-house loan originations for CBRE’s GSE’s debt platform. Jim can be reached at (614) 519-0299 or email at [email protected].
CBRE AFFORDABLE HOUSING TARGETS GSE DEBT PLATFORM WITH ADDITION OF JAMES FLINN
Jim FlinnSenior Vice President
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KEYCONTACTS
Leadership
ROBERT SHEPPARDManaging DirectorE [email protected]
JEFF ARROWSMITHSenior DirectorE [email protected]
ARMAND TIBERIOVice ChairmanE [email protected]
SPENCER HURSTVice ChairmanE [email protected]
Research
JOHN FIORAMONTISenior Research AnalystE [email protected]
Investment Sales
JEFF KUNITZExecutive Vice PresidentE [email protected] TIM FLINTSenior Vice PresidentE [email protected]
DMITRY GOURKINEFirst Vice PresidentE [email protected]
BRANDON GRISHAMFirst Vice PresidentE [email protected]
JOHNATHAN SMITHVice PresidentE [email protected]
BEN BARKERSenior AssociateE [email protected]
ALEX MEDEIROSAssociateE [email protected]
JOSH RUSSELLAssociateE [email protected]
MICHAEL TERRYAssociateE [email protected]
Debt & Structured Finance
JIM FLINNSenior Vice President, OriginationsE [email protected]
KARU ARULANANDAMChief UnderwriterE [email protected]
ALEX PEDERSENDeputy Chief UnderwriterE [email protected]
KIMBERLY BORJACapital Markets Operations ManagerE [email protected]
STEPHEN LANGLead Production AnalystE [email protected]
ANTJE WOLFSenior Production AnalystE [email protected]
CBRE Disclaimer 2016 To learn more about CBRE Affordable Housing, please visit www.cbre.com/affordablehousing. Disclaimer: Information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt its accuracy, we have not verified it and make no guarantee, warranty or representation about it. It is your responsibility to confirm independently its accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of CBRE.
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