The House of Representatives’ tax reform proposal was released on November 2, 2017, and the Senate’s tax reform proposal was released on November 9, 2017. Numerous amendments were made to each bill before they were approved by the full House and Senate, respectively. On Dec. 2, the Senate passed the Tax Cuts and Jobs Act by a party line 51-49 vote. Substantial differences between the bills are expected to be reconciled in a Conference Committee over the next several weeks. Both bills include several provisions that directly impact real estate development incentives that many organizations rely on to support their business activities and goals. Here’s what we know—and how you may be affected.
Low-income housing tax credits
Proposed changes: The low-income housing tax credit (LIHTC) would stay in effect under both bills, but the House bill calls for the repeal of the tax-exempt status for qualified private activity bonds. Certain changes discussed between the Affordable Housing Tax Credit Coalition (taxcreditcoalition.org) and the Housing Ways and Means Committee (the “Committee”) that would have helped to compensate for the impact of the lower corporate tax rate were not made. Changes proposed to the LIHTC program in a bi-partisan bill called the Affordable Housing Credit Improvement Act back in March 2017 were not included.
The Senate bill expands the basis "boost" to apply to certain buildings in rural areas. However, it then reduces the basis "boost" from 130 percent to 125 percent for buildings that qualify for the boost. In addition, the bill contains a provision that would allow developers to specifically give preference to veterans housing without violating the general public use requirements.
Impact: According to the National Low Income Housing Coalition (nlihc.org), about 40 percent of all annual LIHTC rental housing production is financed using qualified private activity bonds. Consequently, repeal of tax-exempt status for qualified private activity bonds would result in a reduced production of affordable rental housing by an estimated 45,000 -55,000 units per year. Also, the proposed lower corporate tax rates would reduce the value of LIHTCs by approximately 15 percent, given the value of the deductions investors currently receive for depreciation and other items associated with their investment. As a result, lower corporate tax rates would reduce the efficiency of the existing tax incentive and likely lead to an even larger decrease in production of affordable rental housing. However, such impact could be mitigated to the extent that tax reform results in shorter depreciable lives for residential rental property as proposed in the Senate bill (from 27.5 years to 25 years) and/or accelerated cost recovery as proposed in both bills.
Planning opportunity: Sponsors with projects expected to be financed with tax-exempt bond proceeds and 4% LIHTC should carefully evaluate spending additional pre-development dollars until this is resolved. If the bonds aren’t issued prior to the end of 2017, the project will not qualify for the 4% LIHTC. Additionally, projects that haven’t yet closed on their LIHTC financing should stay in close contact with their investor and carefully review their letters of intent to understand whether some of the proposed changes to the tax code could negatively impact the equity pricing for the transaction. Finally, sponsors of projects that have not yet been placed in service that are counting on the 130 percent basis "boost" should be prepared to fill a funding gap that will be created if the basis "boost" is reduced to 125 percent.
The proposed lower corporate tax rates would reduce the value of LIHTCs by approximately 15 percent.
New markets tax credits
Proposed changes: The new markets tax credits (NMTC) program would be terminated under the House bill, and the last two years of funding, previously approved by Congress, would be eliminated. The Senate bill does not propose any direct changes to the NMTC program. However, the NMTC program will be negatively impacted by a last minute amendment to the Senate bill that retains the Alternative Minimum Tax (AMT), even though the Senate Finance Committee approved version of that bill proposed to eliminate corporate AMT after 2017. The House bill also proposes to eliminate corporate AMT after 2017.
Impact: Even though the Senate bill does not make any direct changes to the NMTC program, the threat of its enactment could bring the NMTC program to an immediate halt. Since NMTCs cannot be used to reduce AMT, it would be very difficult for corporate taxpayers to utilize NMTCs if the highest corporate tax rate is reduced to 20 percent and AMT is retained at a 20 percent tax rate.
If the House bill provision is enacted, the 2017 NMTC award round, which is expected to be announced in the first quarter of 2018, would likely be the final awards made under the NMTC program. That is, unless Congress subsequently passes a bill to extend it. Termination would not negatively impact an Investor’s ability to claim a full seven years of credits for investments made related to NMTC awards granted through the 2017 round. However, the reduction of the highest corporate tax rate, paired with retention of corporate AMT at a 20 percent rate, could make it difficult for investors to claim NMTCs in any tax year after the highest corporate tax rate is reduced to 20 percent, regardless of when the Qualified Equity Investment (QEI) was made.
Loss or impairment of the NMTC would mean numerous community development projects would not occur. According to the NMTC Coalition, between 2003 and 2015, $16 billion in NMTCs leveraged over $80 billion in total project investments, creating nearly 750,000 jobs.
Planning opportunity: Sponsors of projects with strong community impact that need NMTC subsidy to move forward should attempt to be “shovel ready” before the next round of NMTC awards is announced in the first quarter of 2018 in case there are no additional rounds of NMTC awards. Project sponsors should also be aware that the last minute amendment to the Senate bill to retain AMT could bring the NMTC program to an immediate halt.
The last minute amendment of the Senate bill to retain corporate AMT could bring the NMTC program to an immediate halt.
Historic tax credits
Proposed changes: Under the House bill both the 20 percent historic tax credit (HTC) and the 10 percent rehabilitation tax credit would be repealed for qualified rehabilitation expenditures (QREs) paid or incurred after December 31, 2017. Under the Senate bill the 20 percent HTC would remain in effect, but the credit would be claimed annually over 5 years beginning with the date the QREs are placed in service. Like the House bill, the Senate bill eliminates the 10 percent rehabilitation tax credit for QREs paid or incurred after December 31, 2017.
Impact: Both proposed bills include an identical transition rule that would allow a taxpayer to claim rehabilitation tax credits under the existing rules, as long as the taxpayer owns or leases the building continuously after December 31, 2017, and the 24-month substantial rehabilitation period begins within 180 days of enactment of the repeal or modification. Although neither bill’s transition rule mentions a 60-month measurement period, which is generally available for phased projects, an argument can be made that phased projects will be able to claim credits under the existing rules for a longer period under the transition rule in the bills. The ownership test in the transition rule appears to apply at the property owner (i.e., partnership) level and not the partner level.
Planning opportunity: Developers that are planning a rehabilitation of a historic or old building but have not yet closed on the acquisition of the property, should consider forming a partnership with the current owner before December 31, 2017 to meet the property ownership requirements of the transition language in the bills. Developers that are planning a rehabilitation of a historic or old building that they already own can maximize flexibility in qualifying for and/or syndicating rehabilitation tax credits by making sure that such building is owned in a regarded partnership by December 31, 2017 to meet the property ownership requirements of the transition language in the bills.
Developers planning a historic rehab should consider taking steps before December 31, 2017 to meet the property ownership requirements of the transition rules in the bills.
If the ownership test is applied only at the partnership level, the transition language in both bills appears to allow changes in the ownership of such partnership after December 31, 2017. Consequently, even if the rehabilitation credit is eliminated as proposed in the House bill, developers should be able to continue to close on historic tax credit syndications through 2019 – potentially into 2020 – as long as a partnership owns or leases the building by December 31, 2017, and is expected to complete the rehabilitation by mid-to-late 2020 (and maybe mid-to-late 2023 for phased projects).
Section 118 – Grant structuring changes
Proposed changes: Under the House bill, Section 118 would be repealed, effective upon enactment, which would make grant proceeds taxable upon receipt. The Senate bill does not propose any modifications to Section 118.
Impact: Section 118 has often been used by real estate developers to defer the tax impact of grant proceeds by structuring the grant to be made to a corporation. Repealing Section 118 would make it very difficult, if not impossible, for a for-profit developer to receive a grant to help fund a real estate development project without paying federal and state income taxes on the grant proceeds upon receipt.
Planning opportunity: Since repeal would be effective upon enactment, developers with existing Section 118 structures should attempt to accelerate the receipt of grant proceeds, if possible, to precede enactment.
Otherwise, if grant proceeds cannot be accelerated to precede enactment of the repeal of Section 118, for-profit developers funding projects with grant proceeds should consider the tax impact of the grant proceeds as they create or revise their capital stack.
Since repeal would be effective upon enactment, developers with existing Section 118 structures should attempt to accelerate the receipt of grant proceeds, if possible, to precede enactment.
Taxation of capital contributions
Proposed changes: The House bill would introduce a new concept that would require partnerships and corporations to recognize taxable income upon receipt of capital contributions, to the extent that the amount of the capital contribution exceeds the fair market value of the stock or partnership interest that is issued in exchange for such capital contribution.
Impact: Depending upon how taxpayers are allowed to determine the fair market value of the stock or partnership interest that is issued in exchange for a capital contribution, this provision could be problematic in structuring several common real estate development financing transactions. For example, in most transactions that involve the syndication of federal and/or state tax credits, the value of the partnership interest that tax credit investor receives is often lower than their capital contribution, because the project’s cost typically exceeds the value of the completed project. In such situations, if this provision in the House bill is enacted, partnerships could be required to recognize taxable income in connection with the receipt of capital contributions from the tax credit investor.
Planning opportunity: This provision could impact transactions that have previously closed or are currently in the process of closing, to the extent that the investor has not made all of its capital contributions as of the date the tax reform bill is enacted. Developers should monitor the status of the tax reform legislation to determine if such provision could create a funding gap equal to the amount of tax required to be paid on the capital contributions from the tax credit investor.
We recommend organizations conduct a careful analysis of the impact of these and other potential changes on their specific business activities and plans. Check back to this article regularly for updates as the tax reform bills make their way through the Legislature.
As always, if you have questions, feel free to give us a call.