Wednesday, January 1, 2014

Historic Rehab Industry Sails Into Tax Credit Safe Harbor

Written by Jason Yots: President, Preservation Studios LLC

In 2012, the federal version of the historic tax credit – an incentive offered for substantially rehabilitating historic commercial structures – generated over $5.3 billion in investment and created nearly 58,000 jobs.  For communities, like Buffalo, NY, that don’t see enough of either of those commodities, the historic tax credit (HTC) can be a welcome economic development engine, not just an historic preservation resource. 

So industries varying from preservation to construction to financial services were understandably dismayed when, in the August 2012 Historic Boardwalk Hall case, a federal appeals court invalidated long-settled HTC investment structures, while also failing to offer any advice for structuring future HTC syndications (Note #1).  In essence, Historic Boardwalk Hall scolded the HTC industry for doing things all wrong, but it didn’t tell us how to do them right. 

The ensuing uncertainty deeply chilled the HTC investment market, forcing some long-time institutional players to the sidelines while HTC advocates lobbied for clearer IRS guidance.  In New York, those troubles were compounded by programmatic restrictions that devalued our state’s fledgling HTC by bundling it with the federal credit.  In a word (or two), it’s been rough sailing for HTC projects and their proponents since the summer of 2012.

Thankfully, clearer skies await HTC industry members, home and abroad.  In New York, lawmakers hopefully have loosened one logjam by allowing for the “refundability” of the state’s HTC, beginning in 2015 (Note #2).   On the federal level, the IRS issued long-awaited HTC guidance, on December 30, 2013, in the form of Revenue Procedure 2014-12 (Note #3).

For the HTC industry, “Rev. Proc. 2014-12” is considerably more exciting than its name.  At 17-pages, it offers a thorough discussion of the issues raised by the Historic Boardwalk Hall case and, most importantly, it affords a “safe harbor” under which future (and past) compliant HTC projects may not be challenged by the IRS.  Key provisions of Rev. Proc. 2014-12 include:

  •   Partners Must Act Like “Partners”:  A major IRS criticism in Historic Boardwalk Hall focused on the HTC investor’s lack of meaningful investment risk or reward potential.  The IRS found such a “fixed” arrangement to be antithetical to the nature of a true partnership and, in Rev. Proc. 2014-12, it states fairly clearly that an investor’s economic risk and reward must be commensurate with its ownership interest and must remain unfixed.  This is a significant departure from the structures of many past HTC deals.
  •  Guaranties Are Nipped and Tucked: Along the same risk/reward continuum, the IRS previously attacked HTC project guaranties that were so expansive and/or financially-backed that they dissolved nearly all investor risk.  Rev. Proc. 2014-12 spells out the guaranties that will – and will not – be permitted in HTC deals.   Again, the industry is in for some changes.
  • Here’s Your Hat, What’s Your Hurry?  One of the many tricky aspects of HTC projects is the investor’s exit strategy.  Most investors would prefer to leave a partnership as soon as they claim the HTCs, but HTC program guidelines prohibit changing the ownership of an HTC project for the first 5 years after it’s placed in service.  In the past, HTC industry members attempted to preserve the sanctity of the partnership while affording some back-end certainty by allowing for a “put/call” process at the end of the 5-year regulatory period.  This process paid lip-service to the notion that the project sponsor and investor were partners, while giving both parties comfort that they, in a sense, could afford to divorce in the future.  In the Historic Boardwalk Hall case, the IRS argued that such prenuptial relationships don’t go far enough to preserve the partnership structure and, not surprisingly, Rev. Proc. 2014-12 flat-out prohibits the traditional put/call arrangements with which the HTC industry had grown so comfortable.  While prohibiting pre-determined, non-fair-market-value investor buy-outs, the IRS appears to have compromised a bit by allowing a partner-interest “flip” after the 5-year HTC recapture period expires  (for example, reducing the HTC investor’s interest from say 99% to 5%, and thereby devaluing it to a feasible fair-market buy-out level).
  • Threshold Ownership Levels Established:  The IRS provides precise minimum “partnership percentages” for the HTC project sponsor and investor of 1% and 5%, respectively.  Industry approaches to this have varied over the years.
  • Threshold Equity Investment Levels Established: To date, the level and timing of an investor’s HTC investment largely were established through arm’s-length negotiations between the HTC project sponsor and the HTC investor.  What resulted in some instances were HTC equity pay-in schedules that removed nearly all meaningful financial risk for the HTC investor (in some cases, investors could claim all of the HTCs before investing any funds whatsoever).  Rev. Proc. 2014-12 shifts that balance by requiring a minimum HTC investment of 20% prior to the date the project is “placed in service” (i.e., completed).  Furthermore, at least 75% of the HTC investor’s expected capital contributions must be fixed by that same date.  These provisions will help add some certainty to HTC project sponsors’ budgets.

While Rev. Proc. 2014-12 does not answer all of the industry’s questions, it certainly answers quite a few.  And while its implementation remains a major open question, it appears for now that HTC industry members will enjoy smoother sailing in HTC investment pools in years to come.


1.      See Historic Boardwalk Hall, LLC. v. Commissioner, 694 F.3d 425 (3d Cir. 2012), cert. denied, U.S., No. 12-901, May 28, 2013).

Photo credit: Jason A. Yots, 2013

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