Financial Projections Advanced Concepts Becca Hartstein Lisa Pekkala 2019 Applegate & Thorne-Thomsen, P.C. Investor & Syndicator Boot Camp, September 9, 2019

Eligible Basis General Rule – eligible basis equals adjusted basis (depreciable basis) of the residential rental space Eligible Basis is determined separately for new construction/rehabilitation and acquisition costs Tax Rules – all expenditures will have a specified tax treatment Capitalized into cost of building and recovered over a specified “class life” through annual depreciation deductions Costs that are incurred during the production period of property Also includes personal property and site work Once property is in service, costs may be expensed immediately in the year they are incurred (or accrued) Amortized over a specified period and deducted over that period (organizational costs, loan fees)

Eligible Basis Allocation between Land and Building Construction Loan Fees and Interest in Occupied Rehab Compare to Budget 266 Election Expense all interest and fees related to occupied rehab Relocation Costs Bond Issuance Fees Commercial Space Costs Amenities (parking, laundry, vending) Community Service Facility QCT Basis Limitation Rent charged to service provider tenant

Eligible Basis Reductions for Historic and Energy Credits Reduction for Federal Grants Exclusion of Ineligible Site Improvements Basis Boost QCT/DDA grandfathering Discretionary boosts (not available for tax-exempt bond deals)

Developer Fee Is Interest Necessary? Repayment Use of Alternate Trending Assumptions Acquisition/Rehab allocation 10% Test Considerations Percentage of Fee Deferred Accrual Schedule

Soft Funds Interest Rate Term Percentage of Cash Flow Seller Financing Is 0% OK? Maximum Rate? Simple or Compounding Term Percentage of Cash Flow Seller Financing Appraisal TDA Considerations Structuring TIF, CDBG, grants and other soft sources State Tax Credits

True Debt Analysis Purpose of Analysis – Need to establish that soft debt will be respected as debt and not a grant or an ownership interest (critical for every project) Must Use Reasonable Assumptions – common to use 3/3/5 rather than 2/3/7 Test Date – generally earliest maturity of soft debt Assume Market Rate Loan Refinancing for early maturing debt? Vacancy Rate – never lower than market study; 5% is commonly accepted Debt Term – Best to have soft debt mature no earlier than end of Extended Use Period; This allows Project to go market rate and refinance/sell Market Rents – look to market study and trend forward Cap Rate – Capped NOI is commonly used; Look to cap rate in appraisal No Forgivable Debt Diligence Items -– appraisal, market studies, all regulatory agreements

Capital Accounts - Generally Represents a partner’s investment in the Partnership Increases in capital account: Capital contributions Share of Partnership income allocated to partner Decreases in capital account: Partnership distributions Share of Partnership losses allocated to partner

Capital Accounts - Generally Treatment of Certain Items: Reasonable fees should not be treated as “distribution” that would reduce capital account LIHTCs do not reduce Capital Accounts State Credits do not reduce Capital Accounts Federal HTCs and Energy Credits do reduce Capital Accounts HTC – Reduce Capital Account and basis by amount of HTC Energy Credits - Reduce Capital Account and basis by 50% of Energy Credits

Capital Accounts – Problems Zero capital account – cannot be allocated further losses or LIHTC unless: Deficit Restoration Obligation (“DRO”) Minimum Gain Zero Capital Account After Credit Delivered- Yield issue, but can be lived with

Tax Reform’s Impact on Capital Accounts Lower tax rates mean tax losses are worth less and hurts equity pricing Less equity means lower capital accounts and capital will run out sooner 100% Bonus Depreciation Projects with lower proportions of equity (especially 4% bond deals) may have issues with negative capital accounts before all credits are delivered; also more exit taxes Can no longer elect 40-year depreciation for building (this slowed down losses so that Investor capital account remained positive during credit period) Can no longer “force” tax-exempt use for buildings

Capital Accounts – Projections Example LIHTC Delivered Capital Account is positive until after all LIHTC delivered in 2029 – Numbers Work!

Capital Accounts - Solutions What if capital account runs out before all LIHTC delivered? Slowing Depreciation Doesn’t Help Much Anymore- Prior 168(g) Alternative Depreciation election or forced tax-exempt use no longer effective! Bonus Depreciation – opt out (by asset class) Generally not recommended for personal property as it rarely helps Forced categorization as commercial property by failing 80% test? Reduce Interest Rate or Fees Reduce interest rate on loans (soft debt) Reduce or eliminate Fees Accruing Fees DRO “Bridge” capital contributions – DRO capped and extinguished once contributions are made

Capital Accounts – Solutions (continued) Loss Flips Don’t Solve Credit Reallocations Loss Flips Must occur after Credit Period so won’t help avoid Credit reallocation Special Allocation of Losses – specially allocate non-depreciation losses to the General Partner or State Credit Partner Allocation to State Credit Partner may be best solution General Partner may need a deficit restoration obligation Special Allocations to Nonprofit Tax-Exempt Entities can create Tax-Exempt Use Specific line items vs. Percentage of all deductions other than depreciation? Used to be touchy issue for Syndicators and used as last resort; industry generally seems to be accepting now Delay “electing real property trade or business” election Create “Good” Minimum Gain

Capital Accounts – Minimum Gain Minimum Gain Definition - the difference between the secured nonrecourse debt on the Project and the adjusted basis of the Project Explanation - To the extent that the debt exceeds the Project’s value, there is gain that must be eventually recognized. Even if the partnership gave the property to the lender for nothing, the partnership would be considered to have exchanged the property for the amount of the debt. Because the debt is higher than the property’s basis, there will be gain equal to the difference. Because this gain is unavoidable, the IRS will allow a partner to go negative to the extent that it has minimum gain Recourse Debt – does not make minimum gain if it is the most junior debt Stacked Debt Adds Complicates Tax Analysis – if recourse debt is stacked between other debt, needs to be reviewed with tax counsel – “Stacking Rules” Deferred Developer Fee Is Usually Not Nonrecourse – Most Deferred Developer Fee is structured as unsecured recourse debt. As such, typical Deferred Developer Fee would not create minimum gain. But see the discussions below for alternative approaches Minimum Gain Example – Unrelated Debt Unrelated Nonrecourse Debt $11,000,000 Net Assets (adjusted Basis) ($10,000,000) Partnership Minimum Gain $ 1,000,000 Investor Capital Account can go negative up to $1,000,000

Capital Accounts – Minimum Gain (cont’d) Allocation of Minimum Gain – The allocation of Minimum Gain is determined by the nature of the debt. (“Bad”) Partner Nonrecourse Debt – If a partner (or a party related to a partner) bears the risk of loss on the debt, then the debt is allocated to that partner. This is called “Partner Nonrecourse Debt” (“Good”) Partnership Nonrecourse Debt – If no partner bears the risk of loss, then the debt is considered “Partnership Nonrecourse Debt” and can be allocated among the partners through the partnership agreement. The partnership agreement will then allocate 99.99% to the limited partner Minimum Gain Example – Related Party Debt Nonrecourse Debt - Related $11,000,000 Loan from GP Net Assets (adjusted Basis) ($10,000,000) Partner Minimum Gain $ 1,000,000 All minimum gain allocated to GP. Investor cannot have a negative capital account

Capital Accounts – Minimum Gain (cont’d) Related Party Debt Example The below makes “Bad” Partner Minimum Gain 99.99% Interest 10% Cash Flow & Back-End 0.01% Interest 90% Cash Flow & Back-End   Syndication Partnership Apartment Building Investor Fund LLC Sponsor/ Lender Loan General Partner

Capital Accounts – Minimum Gain (cont’d) Minimum Gain Cure – 79/21 - If the Project lender owns less than 80% of a partner in the Partnership, then it will not be considered a related party. This will allow the debt to be treated as (“Good”) Partnership Nonrecourse Debt Must Be a Corporate Partner – The entity that is a partner in the Partnership must be a corporation or an LLC that elects to be taxed as a corporation on IRS Form 8832 Only 79% Ownership Must Be Real – Must have 79% of GP’s Vote and Value. Make everything pro rata Nonprofits and Relatedness – A nonprofit entity is deemed related to another entity if that entity controls it. This is usually measured based on a majority interest in the Board of Directors. If Developer controls 3 out of 5 Board members, then it would be deemed to control the nonprofit

Capital Accounts – Minimum Gain (cont’d) 79/21 Org Chart – Creating “Good” Partner Nonrecourse Debt 99.99% Interest 10% Cash Flow & Back-End 0.01% Interest 90% Cash Flow & Back-End 79% 21% Apartment Building Investor Fund LLC Sponsor/Lender Loan General Partner Corporation Unrelated Party Syndication Partnership

Capital Accounts – Minimum Gain (cont’d) Minimum Gain Cure – 10% De Minimis Rule -If the Project lender is a governmental entity (or an entity that regularly engages in the business of lending) and the lender’s direct or indirect interest in the partnership is less than 10%, the debt will be considered unrelated debt Must limit everything below 10% - Incentive management fees and residual interests must be capped at less than 10%. General partner fees or any other distributions to partners or related parties must be closely scrutinized Two General Partners – If there are 2 General Partners, but one is not related to the lender, then the other general partner can pick up the excess cash flow above 10% Cash Flow Strategies Loan Payments– Often cash flow will be absorbed for the 15-year period paying off the Deferred Developer Fee and applying 90% of cash flow to the related party debt. Section 42 Right of First Refusal (“ROFR”) – If the Sponsor is a Qualified Nonprofit, then it can control the back-end with the Right of First Refusal price of debt + taxes NFPs that are not governmental entities must also satisfy additional requirements!

Capital Accounts – Minimum Gain (cont’d) 10% De Minimis Org. Chart – Creating “Good” Partner Nonrecourse Debt 99.99% Interest > 90%10% Cash Flow & Back-End 0.01% Interest < 10% Cash Flow & Back-End Loan 100% Syndication Partnership Apartment Building Investor Fund LLC General Partner Corporation Sponsor /Lender

Minimum Gain – Stacking Rules Minimum gain is deemed to be generated in layers, beginning with the lowest priority debt Bottom layer is Partnership Nonrecourse Debt, it will generate “good” minimum gain Once the minimum gain exceeds that layer of debt, additional minimum gain is deemed to be generated by the next layer of debt Must analyze each layer of debt to determine whether it generates “good” or “bad” Partner Nonrecourse Debt minimum gain Partner Nonrecourse Debt will generate “bad” minimum gain

Capital Accounts – Minimizing Exit Taxes Exit Taxes – Using the above techniques, an Investor can often be allocated minimum gain and would be allowed to go negative in its capital account and be able to receive 99.99% of LIHTC Downside is creation of exit taxes for the Investor when it gets out of the Partnership sometime after Year 15 Because a General Partner’s right to buy out an Investor is at a price that is no less than the amount of exit taxes, this often becomes an issue for the General Partner Loss Flip – A not uncommon tactic to avoid or reduce exit taxes is to provide that after all LIHTC have been delivered, as much as 80%-90% of losses (including depreciation) can be allocated to the General Partner. This will reduce the later- year losses to the Investor and avoid negative capital accounts or at least slow down how far its capital account goes negative Special allocation of losses to GP from the outset