1. Legal Issues Impacting Nonprofit Properties Financed with LIHTCs
January 5, 2017
Jason Vargelis
Carle, Mackie, Power & Ross LLP
100 B Street, Suite 400
Santa Rosa, California 95401

2. Property Tax Abatement
In California, the low income portion of an apartment complex financed with low income housing tax credits (LIHTCs), can qualify for property tax abatement (and be exempt from ad valorem property taxes), if a nonprofit is one of the general partners of the owner
Property tax abatement requires that tenants have incomes that do not exceed 80% of area median income, and pay rents that are restricted based on their income
Property tax abatement is also available if a limited liability company wholly owned by a nonprofit is one of the general partners of owner

3. Depreciation- Accelerated or Standard
Most LIHTC projects are structured with all (or 99.99%) of the building depreciation on an accelerated 27.5 year schedule, instead of a standard 40 year schedule
27.5 year depreciation leads to more tax credit equity proceeds because the investor can take more depreciation deductions sooner than it could with 40 year depreciation

4. Depreciation – Special Rule for Nonprofits
A special depreciation rule applies to non profits:
if and to the extent that a nonprofit partner (including a partner owned by a nonprofit) receives tax allocations or distributions of cash flow or sale / refinance proceeds, then the building does not qualify for the 27.5 year schedule
Example: if the partnership agreement gives the nonprofit the right to receive 25% of sale / refinance proceeds, then at least 25% of the building depreciation needs to be on the 40 year schedule

5. Depreciation – Alternatives
a nonprofit is not subject to the special tax exempt depreciation rule if it forms a limited liability company that it owns and that acts as a partner and that elects to be taxed
funds the nonprofit receives for repayment of a loan to the nonprofit or for payment of fees to the nonprofit for services provided, are not treated as distributions or allocations, and therefore not subject to the special tax exempt depreciation rule

6. Anti-Churning – 50% Rule
Projects that receive acquisition tax credits must comply with anti- churning rules
Anti-churning prevents claiming acquisition credits when the buyer and seller are "related"
Buyer and seller may be "related" if a group of owners of a member of seller, have a sale and refinancing interest of 50% or more in BOTH the seller and buyer
Anti-churning applies to nonprofit and for-profit owners
A LIHTC right of first refusal (discussed later) does not itself cause the nonprofit to have a sale and refinancing interest of 50% or more

7. Anti-Churning Alternatives
Possible solutions (when general partner entities have interests that raise anti-churning issues):
reduce the back-end / sale and refinancing percentage of the general partners of buyer, to be less than 50%; this however can distort the business deal because it may unnecessarily increase the sale proceeds to be paid to tax credit limited partner (the typical formula of the tax credit limited partner being paid 10% of fair market value, in order to exit in year 15, would be changed to 50% if the general partner needs to have less than a 50% interest)
change the owners (or percentage interest of owners) of the general partners of buyer, so that the group of owners that had a 50% or more interest in the seller, will have less than a 50% interest in the general partners of buyer; this however can distort the business deal because (for sales other than through the right of first refusal discussed below) it may unnecessarily decrease sale proceeds to be paid to some of the owners of the general partners

8. Right of First Refusal – Possible Special Benefit
A Section 42(i)(7) right of first refusal was added to the Internal Revenue Code in 1990 to facilitate nonprofit ownership of tax credit properties
Nonprofits are included in a group of eligible holders that can purchase the property for a special minimum price at the end of the 15-year compliance period
Minimum price can be less than fair market value
No federal income tax benefit shall fail to be allowable as a result of the right of first refusal
Nonprofit acquisition in year 15 can benefit the nonprofit (the sale may be at a discount), but would not benefit any for-profit joint venture partners of the nonprofit (who would no longer have an interest in the year 15 sale)

9. Right of First Refusal – Minimum Price
Minimum purchase price is equal to the sum of:
the principal amount of the outstanding indebtedness secured by the buildings, plus
all Federal, state and local taxes attributable to the sale
Taxes are due based on whether a partner has a negative capital account
Right of First Refusal is not an option and is triggered only by a third party offer. Once triggered, the purchase price is the formula price and not the price offered by the third party