Twists and Turns of the Tax Code: What it Means for Housing Credit at the 2018 New Mexico Housing Summit September 12, 2018 www.novoco.com

Twists and Turns of the Tax Code: What it Means for Housing Credit at the 2018 New Mexico Housing Summit 3:30 PM - 5:00 PM SPEAKERS Jeff Nishita, CPA Melissa Chung, CPA Novogradac & Company LLP Novogradac & Company LLP jeff.nishita@novoco.com melissa.chung@novoco.com September 12, 2018 www.novoco.com

Agenda Tax Reform Income Averaging Opportunity Zones September 12, 2018 www.novoco.com

Low-Income Housing Tax Credit Effects of Tax Reform on Development and Credit Pricing Lower Corporate Rate Change in CPI Interest Expense Deductibility Limit 100 Percent Expensing Low-Income Housing Tax Credit September 12, 2018 www.novoco.com

Effects of Tax Reform on the Lower Corporate Tax Rate 9 Percent Property 35% 21% $0.95 $0.82 $1.00 $0.87 $1.05 $0.90 $1.10 Price per Credit 4 Percent Tax Exempt Bond Property 35% 21% $0.95 $0.81 $1.00 $0.86 $1.05 $0.89 $1.10 $0.93 Price per Credit MATCH the data from the blog post Assumes 4.5% – 5.0% investor level yield in all scenarios Results may differ based on a change in underlying assumptions. Property not eligible for 30% basis bonus September 12, 2018 www.novoco.com

Effects of Tax Reform on Development and Credit Pricing September 12, 2018 www.novoco.com

Effects of Tax Reform on the Change to CPI September 12, 2018 www.novoco.com

Effects of the Omnibus Bill on LIHTC September 12, 2018 www.novoco.com

Effects of Omnibus Spending Bill - 12.5% Increase in Volume Cap FY 18 Omnibus 12.5% allocation increase + 28,400 + 32,100 + $2,700,522,500 + $1,038,662,500 Percentage gained 2% 2% 2% 2% New Law 1,289,500 1,457,100 $122,617,032,400 $47,160,397,100 September 12, 2018 www.novoco.com

Effects of Tax Reform on Development and Credit Pricing 9 Percent LIHTC Allocations FY18 Omnibus 2028 $2.85 2018 $2.70 HERA 2022 $2.55 2009 $2.30 2008 $2.20 2017 $2.35 2007 $1.95 2002 $1.75 2010 $2.10 Per capita credit set at $1.25 ACTUAL PROJECTED September 12, 2018 www.novoco.com

Effects of Tax Reform Interest Expense Deductibility Limit 30% EXCLUDE Real Property Trade or Business Election 30 year for post 2017 PIS 40 year (?) for pre 2018 PIS of adjusted taxable income depreciation until 2022 September 12, 2018 www.novoco.com

Effects of Tax Reform Interest Expense Deductibility Limit Post-2017 PIS Properties, Pre-2018 PIS Properties PRE-2018 PIS POST-2017 PIS Need to analyze properties one-by-one 9% properties might defer election to 2022 (when depreciation & amortization are removed from the ATI) Tax-exempt bonds – recent transactions elect to deduct all interest => convert to 40 year life Generally elect to deduct all interest => 30 year life on building instead of 27.5 year life 2015 2016 2017 2018 2019 2020 September 12, 2018 www.novoco.com

Effects of Tax Reform Interest Expense Deductibility Limit Comparison Example: September 12, 2018 www.novoco.com

Effects of Tax Reform on Bonus Depreciation 100 Percent Expensing for personal property and land improvements SEPT. 27, 2017 Property PIS after this date is eligible, subject to binding contract limitation. DEC. 31, 2022 100 percent begins phase-down 100% 80% 60% 40% 20% 2018 2019 2020 2022 2023 2024 2025 2026 2017 2021 Used property eligible Cost segregation studies September 12, 2018 www.novoco.com

Agenda Tax Reform Income Averaging Opportunity Zones September 12, 2018 www.novoco.com

What is Income Averaging? Two main aspects to keep in mind 1. 2. Income averaging is a new minimum set-aside option, operates like the other two Applies to both rent and income At least 40% of units must be LIHTC with an average income/rent limit of 60% Bedroom mix and unit size are not considered Elected at 8609 Applies to how units are designated Not the households themselves No keeping track of a running average household incomes September 12, 2018 www.novoco.com

Reasons for Income Averaging AMI Reasons for Income Averaging ($50,000) AMI 80% 61% Income too high 60% 60% ($30,000) 50% 57% ($25,000) 20% 19% Can’t afford rent September 12, 2018 www.novoco.com

Effective Date Part of the Omnibus Spending Bill Effective for minimum set-aside elections made after enactment (March 23rd) Earlier elections are irrevocable States will have discretion on when and what projects are allowed to use income averaging September 12, 2018 www.novoco.com

Minimum Set-Asides Pre-March 23rd OR Set aside at least 20% of units in a project to be rent restricted for households with incomes at or below 50% of area median income Pre-March 23rd OR Set aside at least 40% of units in a project to be rent restricted for households with incomes at or below 60% of area median income September 12, 2018 www.novoco.com

Minimum Set-Asides Form 8609, Line 10c September 12, 2018 www.novoco.com

Minimum Set-Asides Pre-March 23rd NOW! OR OR Set aside at least 20% of units in a project to be rent restricted for households with incomes at or below 50% of area median income Pre-March 23rd OR Set aside at least 40% of units in a project to be rent restricted for households with incomes at or below 60% of area median income NOW! OR Set aside at least 40% of units in a project to be rent restricted and have household income limits (designated in 10% increments from 20% to 80%) that on average are at or below 60% of area median income September 12, 2018 www.novoco.com

Minimum Set-Asides IRC § 42(g) September 12, 2018 www.novoco.com

Designating Units Must be 20%, 30%, 40%, 50%, 60%, 70% or 80% (both rent and income) Can reach 60% average in a number of ways No federal requirement to designate a pro-rata share among bedroom sizes Agencies could adopt policies that are more restrictive September 12, 2018 www.novoco.com

Extended use agreement Designating Units Application Carryover allocation Extended use agreement Form 8609 When does it happen? Can units change designations and, if so, how? Definitely will need to shift some if not all units are LIHTC September 12, 2018 www.novoco.com

Failing the Minimum Set-Aside Scenario Single-building, 100% LIHTC project utilizing income averaging Nine equally sized units—3 units at 20% AMI and 6 units at 80% AMI One of the 20% AMI units becomes unqualified Question: What is the effect on the minimum set-aside? Answer: We don’t know yet! ! A few possible interpretations: The minimum set-aside is failed! Only the 20% unit is out of compliance Other units should be excluded to bring the average back to 60% 20% 80% 20% 20% 20% FAIL 80% 80% 80% 80% 80% 80% 62.86% AVG 60% 65%! 60% September 12, 2018 www.novoco.com

Multiple Buildings Project Form 8609 40% 80% September 12, 2018 www.novoco.com

Designating Larger Units to Support More Debt 2018 HUD MTSP Limits Hennepin County, MN Monthly Rent Revenue 80% MKT 20% 40% 50% 70% 80% 1 BDR $354 $708 $855 - 3 BDR - $1,716 $1,962 80% 50% 80% 40% 80% 40% 70% 20% 3BDR 1BDR AVG 60% $2,625 $9,564 $12,189 September 12, 2018 www.novoco.com

Designating Larger Units to Support More Debt 2018 HUD MTSP Limits Hennepin County, MN Monthly Rent Revenue 80% MKT 20% 40% 50% 70% 80% 1 BDR $354 $708 $855 - 3 BDR - $1,716 $1,962 80% 50% 80% 40% 80% 40% 70% 20% 3BDR 1BDR AVG 60% $2,625 $9,564 $12,189 September 12, 2018 www.novoco.com

Designating Larger Units to Support More Debt 2018 HUD MTSP Limits Hennepin County, MN Monthly Rent Revenue 70% MKT 20% 40% 50% 70% 80% 1 BDR - $1,416 3 BDR $490 $981 $1,226 $1,716 - Diff $136 $273 $371 - ($546) 50% 80% 40% 80% 40% 80% 20% 80% 3BDR 1BDR AVG 60% $5,664 $5,394 ($1,131) $11,058 September 12, 2018 www.novoco.com

Designating Larger Units to Support More Debt 2018 HUD MTSP Limits Hennepin County, MN $11,058 September 12, 2018 www.novoco.com

Designating Larger Units to Support More Debt 2018 HUD MTSP Limits Hennepin County, MN Income Averaging 9 x 60% 3BDR 1BDR 70% MKT 20% 40% 50% 80% 3BDR 1BDR 80% MKT 70% 20% 50% 40% 3BDR 1BDR 60% MKT With a DSCR of 1.15, at 5% interest, $7,032 more revenue could support $95K more debt. And if there were 10 buildings, that means nearly $1 million more debt! Monthly Revenue x 12 mo. x $12,189 12 x $11,058 12 x $11,603 12 Annual Revenue $146,268 $132,696 $139,236 $7,032 more with income averaging September 12, 2018 www.novoco.com

Tax-Exempt Bonds Law didn’t change minimum set-aside for bonds Income averaging still works with bonds, just have to meet both bond and LIHTC requirements September 12, 2018 www.novoco.com

(Assume single-building project) Bonds LIHTC Tax-Exempt Bonds (Assume single-building project) MKT 80% 70% 30% Only 3 of the 10 units are below 60% AMI limits! 8 units w/ avg 60% AMI limits However, 3 of the 10 units are below 50% AMI limits. 8 3 30% = 80% = 10 10 September 12, 2018 www.novoco.com IRC §142(d)(1) IRC §42(g)(1)

Resyndication Give tenants the right to enforce What about post Y15 properties? Even more unknown than setting and shifting designations Existing extended use agreements Have 60% rent maximums, and Give tenants the right to enforce State laws limit owners’ and agencies’ ability to remove or make changes September 12, 2018 www.novoco.com

Agenda Tax Reform Income Averaging Opportunity Zones September 12, 2018 www.novoco.com

Qualified Opportunity Funds (QOFs) Taxpayers can get capital gains tax deferral (& more) for making timely investments in Qualified Opportunity Funds (QOFs) which invest in Qualified Opportunity Zone Property September 12, 2018 www.novoco.com

Three Tax Incentive Benefits 1. 2. 3. Gain Deferral Partial forgiveness Forgiveness of additional gains September 12, 2018 www.novoco.com

Effects of Tax Reform on Opportunity Zone Funds Investing in Opportunity Act Allows investors with capital gains from sale of assets to defer those gains Similar in concept to Section 1031 “Like-Kind” exchanges Creates new incentive to invest capital gains in low-income communities Authorizes the designation of “opportunity zones” Governors (and DC Mayor) responsible for designating these zones Encourages investors to pool resources and risks in “Opportunity Funds” (O Zone Funds). Investors can temporarily defer capital gains recognition if they reinvest in these zones Incentivizes long-term investment by stepping up basis 10 percent step-up after 5-year hold, 15 percent step-up after 7-year hold Provides shallower subsidies per investment than the NMTC, but can be used on a greater scale September 12, 2018 www.novoco.com

September 12, 2018 www.novoco.com

Effects of Tax Reform on Opportunity Zone Funds Sample Investment Jan. 2, 2018 Taxpayer enters into a sale that generates $1M of capital gain Taxpayer is deemed to have a $0 basis in its QOF investment QOF Invests the $1MM in Qualified Opportunity Zone Property June 30, 2018 (Within 180 days), Taxpayer contributes entire $1M of capital gain to a Qualified Opportunity Fund 2018 2019 2020 2021 2022 2023 2024 2026 2027 2028 2029 September 12, 2018 www.novoco.com

Effects of Tax Reform on Opportunity Zone Funds Sample Investment June 30, 2023 (After 5 years), Taxpayer’s basis in investment in QOF increases from $0 to $100k June 30, 2025 (After 7 years), Taxpayer’s basis in investment in QOF increases from $100k to $150k 2018 2019 2020 2021 2022 2023 2024 2025 2026 2028 Jan. 1, 2018 Taxpayer enters into a sale that generates $1M of capital gain June 30, 2018 (Within 180 days), Taxpayer contributes entire $1M of capital gain to a Qualified Opportunity Fund Taxpayer is deemed to have a $0 basis in its QOF investment QOF Invests the $1MM in Qualified Opportunity Zone Property Dec. 31, 2026 $850K of the 1MM of deferred capital gains are taxed and the basis in QOF investment increases to $1MM. September 12, 2018 www.novoco.com

Effects of Tax Reform on Opportunity Zone Funds Sample Investment June 30, 2028 (after 10 years) , Taxpayer sells its investment for $2.0MM. Basis in the investment is deemed to be FMV. The effect is no tax on appreciation in investment. 2018 2019 2020 2021 2022 2023 2024 2025 2027 2028 Jan. 1, 2018 Taxpayer enters into a sale that generates $1M of capital gain June 30, 2018 (Within 180 days), Taxpayer contributes entire $1M of capital gain to a Qualified Opportunity Fund Taxpayer is deemed to have a $0 basis in its QOF investment QOF Invests the $1MM in Qualified Opportunity Zone Property September 12, 2018 www.novoco.com

Opportunity Zone Incremental Benefit 23.8% Tax Rate 5 Year 7 Year 12/31/2026 10 Year Standard After Tax IRR 6.00% Incremental OZ Benefit 2.08% 1.95% 1.71% 3.08% OZ Investment IRR 8.08% 7.95% 7.71% 9.08% Percentage Increase 35% 32% 29% 51% September 12, 2018 www.novoco.com

September 12, 2018 www.novoco.com

Who are the Likely Investors? September 12, 2018 www.novoco.com

Individuals Banks “C” Corporations September 12, 2018 www.novoco.com

Where will “Ozone” capital come from? For individuals, investing in an “Ozone” fund is a superior strategy to Sec. 1031 since it affords a wider range of eligible investments, potential forgiveness of 15% of the original gain and the potential for tax free appreciation in their Ozone fund investment. The only negative is that the Ozone investment benefits will be limited to the gain being deferred versus 100% of the proceeds from an asset sale Any losses from the Ozone fund will shelter income being taxed up to the 37% statutory max rate. However, most individuals are likely to be passive investors meaning that any tax losses or credits generated by their investment will be suspended until their investment is disposed of due to the passive activity limitations September 12, 2018 www.novoco.com

Where will Ozone capital come from? We expect that Ozone Funds will be offered to individual investors attracted to the idea of investing in low-income areas and building long-term appreciation on a tax-free basis. Individual investors will need to consider that the state tax treatment of their investment may be different Developers that own appreciated assets have a significant opportunity to sell such assets to third parties and invest the gains in self-directed opportunity funds that invest in a business or real estate project that constitutes qualified Ozone property. September 12, 2018 www.novoco.com

Where will Ozone capital come from? A number of developers are considering sponsoring their own opportunity funds and raising capital from various sources. Developers should consider Ozone projects that also qualify for new markets and/or historic rehabilitation tax credits We expect a variety of managed Ozone funds organized for individual investors will be offered by registered investment advisors September 12, 2018 www.novoco.com

Where will Ozone capital come from? 85 - 90% of the equity capital invested in LIHTC projects comes from banks subject to the CRA and it is likely that Ozone fund investments that finance affordable housing will earn “positive consideration” towards their investment test goals However, it appears that most banks do not have capital gains as they are generally not permitted to own equities Two important exceptions may be banks with investment banking affiliates and banks that own older LIHTC investments with large negative capital accounts. Triggering “phantom” capital gains for banks that are already planning to make LIHTC investments may be a good strategy September 12, 2018 www.novoco.com

Where will Ozone capital come from? Publicly traded companies own lots of appreciated assets and they can be expected to be drawn to Ozone projects. However, most “C” corps will likely be attracted to commercial real estate projects, plant expansion, infrastructure and other investments with higher rates of return than will be available from LIHTC investments Life insurance companies may be a viable alternative capital source as a number of them were LIHTC investors in 2010 & 2011. As a result, these firms are familiar with the asset class, they like to make large investments and properly structured projects located in opportunity zones should, in theory, offer them premium yields September 12, 2018 www.novoco.com

How LIHTC Properties Qualify September 12, 2018 www.novoco.com

www.novoco.com/blog “All rental real estate, including residential real estate, located in OZs appears to be eligible to be a Qualified Opportunity Zone (QOZ) property as long as the real estate is newly constructed, or acquired after Dec. 31, 2017 and substantially improved, and meets the active conduct standard provided in the statute.” September 12, 2018 www.novoco.com

Qualified Opportunity Fund Purpose: An investment vehicle organized as a corporation or a partnership for the purpose of investing in Qualified Opportunity Zone Property (QOZP). Self Certify September 12, 2018 www.novoco.com

Qualified Opportunity Fund Qualified Opportunity Zone Property (QOZP) Qualified Opportunity Zone Stock Qualified Opportunity Zone Partnership Interest Qualified Opportunity Zone Business Property September 12, 2018 www.novoco.com

Qualified Opportunity Zone Stock and Partnership Interests The investment must be acquired after December 31, 2017 in exchange for cash; Must be a qualified opportunity zone business, or is being organized for the purpose of being a qualified opportunity zone business; Must remain a qualified opportunity zone business for substantially all of the qualified opportunity fund’s holding period September 12, 2018 www.novoco.com

Qualified Opportunity Zone Businesses (QOZB) A trade or business in which substantially all of the tangible property owned or leased by the taxpayer is qualified opportunity zone business property (QOZBP) and: Percent -> % At least 50% of income derived from Active Conduct Substantial portion of intangible property used in active conduct of business < 5 percent unadjusted basis of property is nonqualified financial property September 12, 2018 www.novoco.com

Qualified Opportunity Zone Business Property (QOZBP) Tangible property used in a trade or business Acquired by purchase from an unrelated party (20% standard) after December 31, 2017 During substantially all of holding period, substantially all the use is in a QOZ Original use in the QOZ commences with the taxpayer OR Taxpayer substantially improves the property during any 30-month period after acquisition, additions to basis exceed an amount equal to the adjusted basis of such property at the beginning of such period September 12, 2018 www.novoco.com

Business/Tax Issues September 12, 2018 www.novoco.com

Timing Investor gain realization vs. staged capital contributions Six month testing dates for Opportunity Fund Cash needs of LIHTC partnerships September 12, 2018 www.novoco.com

Practical Issues How will the “Ozone benefit” be split? Timing issues Unable to sell the asset versus selling the partnership interest Typical structures Issues with land Guidance??? September 12, 2018 www.novoco.com

QUESTIONS? September 12, 2018 www.novoco.com