The COVID-19 pandemic has disrupted all aspects of life — real estate projects are no exception. The CARES Act will impact most businesses. As summarized below, developers should consult their tax advisor to understand the various complexities of applying the qualified improvement property (QIP) change retroactively so that they can chose the optimal path.
If your projects involve historic tax credits (HTC), the other major factors include timing adjustments, transition rules, loan modifications, and bridge loans. The sooner you begin to address these potential impacts, the better. Here’s how to start.
HTC timing adjuster provisions
If your project is subject to work restrictions in response to shelter-in-place guidelines, it will likely suffer a significant delay. This could impact the project’s ability to meet the HTC delivery timing requirements imposed by the tax credit investor, which could trigger a timing adjuster to reduce the HTC pricing factor.
Don’t wait until after you’ve missed deadlines to talk to your investor.
To mitigate any adjustments, review the operating and partnership agreements to determine the deadline applicable to the HTC timing adjuster. If you expect the delay could trigger the HTC timing adjuster, you should inform your tax credit investor of the delay and ask if they’re willing to reduce or eliminate the adjuster. Some may even be willing to push back the deadline for completion, given the circumstances.
The key here is timely communication — don’t wait until after you’ve missed deadlines to talk to your investor. Being clear and candid won’t guarantee you’ll receive relief but can definitely improve your chances.
HTC transition rules
The timing for claiming HTCs changed in 2017 as a result of the Tax Cuts and Jobs Act (TCJA). Previously, HTCs were claimed in the taxable year in which the related qualified rehabilitation expenditures (QREs) were placed in service. Now, HTCs are claimed ratably over five years, beginning with the tax year that the QREs are placed in service.
A transition rule allows “grandfathered” projects to claim HTCs under pre-TCJA tax law in the tax year when the project is placed in service. To qualify for grandfathered treatment:
- The building must be owned or leased by the taxpayer, at all times, on or after Dec. 31, 2017.
- The 24- or 60-month substantial rehabilitation period must begin no later than June 20, 2018. Consequently:
- A nonphased project with a 24-month measurement period must satisfy the substantial rehabilitation test by June 20, 2020.
- A phased project with a 60-month measurement period must satisfy the substantial rehabilitation test by June 20, 2023.
If your project is expected to qualify under the transition rule but hasn’t yet been completed, consider if the delay could impact your ability to satisfy the timing requirement. A significant downward adjuster in tax credit pricing will likely apply to any QREs that don’t satisfy the transition rule.
Qualified improvement property
The CARES Act corrected a glitch in the tax depreciation provisions of the TCJA, by reducing the depreciable life of QIP from 39 years to 15 years, which makes QIP eligible for 100% bonus depreciation. Such a change was retroactive to property acquired and placed in service after Sept. 27, 2017.
There are many complexities associated with applying this change retroactively, particularly for HTC projects, so it’s important for developers to consult with their tax advisor to choose the optimal path.
Potential tax implications of loan modifications
The economic pressure of COVID-19 shutdowns are forcing many real estate owners to request a deferral of payments on their loans. Deferrals may alleviate the stress on project cash flows, but there are often tax implications when restructuring loan payment terms. Modifying any loan terms could trigger cancelation of indebtedness income. Treasury regulations for modifications of a debt instrument are complicated, so always consult your tax advisor prior to modifying the terms of any loan so you understand the potential tax implications.
HTC bridge loans
It’s common for developers to obtain HTC equity bridge financing, and project delays like the ones we’re seeing now may delay the receipt of the HTC equity from your tax credit investor. In addition, timing adjusters and adjusters for failing to satisfy the TCJA transition rule could reduce the amount of HTC equity.
Deferrals may alleviate the stress on project cash flows, but there are often tax implications when restructuring loan payment terms.
It’s important to monitor the impact of any project delays upon the timing and amount of HTC equity and determine how they might impact the project’s ability to repay the bridge loan. Inform your bridge lenders about any delays and the expected impact of such delays upon the amount and timing of HTC equity contributions and ask them to request an extension of the bridge loan term if it’s necessary to align with the project’s updated timeline. Any extension of the bridge loan term will result in additional interest carry, which will need to be funded via contingency or an increase in other project funding sources.
The impact of the COVID-19 pandemic on developers will be significant, but remember that knowledge is power and communication is key. Negative effects can be mitigated through proactive planning with your tax advisor and consistent communication with your tax credit investor and lenders. Questions? Give us a call. We can help.