The IRS has just released Rev. Proc. 2014-12 (Dec. 30, 2013), which outlines a safe harbor for partnerships involving syndications of federal historic rehabilitation tax credits. If a partnership and investment is structured to follow all of the requirements laid out in Rev. Proc. 2014-12, the IRS will not challenge the allocation of federal rehabilitation tax credits to the partners.
The safe harbor follows the IRS’ attack on credit syndications made in the Historic Boardwalk Hall LLC. v. Commissioner case, where based on the agreements and facts of that case the Third Circuit found that the investor was not a bona fide partner in a partnership because the investor lacked a meaningful stake in either the success or failure of the partnership.
Note that the revenue procedure applies only to the allocation of historic rehabilitation credits, it does not provide or affect existing rules regarding qualification for historic rehabilitation credits. In addition, the revenue procedure states that no inference should be drawn about the validity of credit allocations where the partnership fails to satisfy the requirements of the safe harbor. The IRS further notes that it will refuse to provide private letter rulings to individual taxpayers on the allocation of section 47 rehabilitation credits.
The revenue procedure is effective for credit allocations on and after December 30, 2013. If a building was placed in service before December 30, 2013, and if the partnership and its partners satisfied all of the requirements of the safe harbor when the building was placed in service and thereafter, the revenue procedure states that the IRS will not challenge the allocations of credits to eligible investors.
The revenue procedure further notes that a partnership allocating such credits can be structured as either a “Developer Partnership” or as a “Master Tenant Partnership”. A Developer Partnership is a partnership that owns and restores a certified historic structure. A Master Tenant Partnership is a partnership that leases such a building from a Developer Partnership and receives an allocation of federal credits.
Rev. Proc. 2014-12 lists several requirements for the safe harbor to apply:
- A principal partner must have at least a one percent (1%) interest in each material item of partnership income, gain, loss, deduction, and credits at all times.
- An investor partner must have at all times in interest in each material item of partnership income, gain, loss, deduction, and credit equal to at least a five percent (5%) of the investor's largest percentage interest in such items.
- An investor partner’s partnership interest must constitute a “bona fide equity investment” with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership, separate from any federal, state, and local tax deductions, allowances, credits, and other tax attributes to be allocated by the partnership to the investor. An investor’s partnership interest is a bona fide equity investment only if that reasonably anticipated value is contingent upon the partnership's net income, gain, and loss, and is not substantially fixed in amount. The investor must not be substantially protected from losses from the partnership's activities and must participate in the profits from partnership's activities in a manner that is not limited to a preferred return that is in the nature of a payment for capital.
- The value of the investor’s partnership interest may not be reduced through fees (including developer, management, and incentive fees), lease terms, or other arrangements that are unreasonable, by disproportionate rights to distributions or by issuances of interests in the partnership (or rights to acquire interests in the partnership) for less than fair market value consideration.
- An investor partner must contribute a minimum unconditional amount to the partnership before the building’s placed in service date of at least twenty percent (20%) of the investor’s total expected capital contribution in available funds (not notes).
- At least seventy-five percent (75%) of an investor’s total expected capital contributions must be fixed in amount before the date the building is placed in service, and an Investor must reasonably expect to meet its funding obligations as they arise.
- Certain unfunded guarantees may be provided to an investor, such as to guaranty performance of acts necessary to claim the rehabilitation credits and to avoid acts (or omissions) that would disqualify the partnership for rehabilitation credits or cause a capture of rehabilitation credits. Unfunded construction completion guarantees, operating deficit guarantees, environmental indemnities, and financial covenants also may be permissible.
- Credits guarantees are disallowed. No person involved in any part of the rehabilitation may directly or indirectly guarantee or otherwise insure an investor’s ability to claim rehabilitation credits or repayment of any portion of an investor’s contribution due to inability to claim rehabilitation credits, loss or recapture of rehabilitation credits. Further, no person involved in any part of the rehabilitation transaction may guarantee that an investor will receive partnership distributions or consideration in exchange for its partnership interest (other than a fair market value put right of an investor).
- No person involved in any part of the rehabilitation transaction may pay an investor’s costs or indemnify an investor for costs if the IRS challenges the allocation of credits.
- Neither a Developer Partnership, Master Tenant Partnership, or principal of either partnership may lend funds to any investor to acquire any part of the investor’s interest in the partnership, nor guarantee or insure any indebtedness incurred by an investor in connection with its acquisition of its partnership interest.
- Neither the principal partner nor the partnership may have a call option or other contractual right to purchase or redeem an investor’s partnership interest at a future date.
- An investor may not have a contractual option or right to sell or require any person involved in the rehabilitation transaction to purchase or liquidate the investor’s partnership interest at a future date at a put price that is more than its fair market value determined at the time of exercise of the contractual right to sell.
- The fair market value of an investor’s interest in the partnership may take into account only those contracts or other arrangements creating rights or obligations that are entered into in the ordinary course of the partnership’s business and negotiated at arm’s length with parties not related to the partnership or investor.
- Payment of accrued but unpaid fees, preferred returns, or tax distributions owed to an investor are permissible.
- An investor may not acquire its interest in the partnership with the intent of abandoning the interest after the partnership completes the qualified rehabilitation. If an investor abandons its interest in the partnership at any time, the investor will be presumed to have acquired its interest with the intent of later abandoning it unless the facts and circumstances clearly establish that the investor did not acquire its interest with the intent of later abandoning it.
- Allocations under the partnership agreement, including credit allocations, must otherwise satisfy the requirements of § 704(b) of the Code and the regulations thereunder.
Rev. Proc. 2014-12 is similar in several ways to Rev. Proc. 2007-65 (Oct. 19, 2007), in which the IRS provided a safe harbor to developers of wind energy projects and tax credit investors for allocations of renewable electricity production federal income tax credits by qualified wind energy partnerships. As a general matter it is unclear whether investors in wind energy partnerships have found the wind energy credit safe harbor to be realistic given the economic realities of such investments, and it remains to be seen whether investors in historic rehabilitation credit partnerships will find the requirements of Rev. Proc. 2014-12 to be realistic given the economic realities of those investments.
Any credit syndication must be carefully planned and reviewed by an experienced team. Hirschler Fleischer’s Tax Credit Group has experience with a wide variety of state and federal tax credit issues, including, historic, low-income, new market, energy production and investment tax credits, and land conservation projects and credits. The Tax Credit Group assists developers, real estate companies and landowners with projects intended to generate these credits, and structures, negotiates and prepares the partnership and/or other investment vehicles for syndicating such credits. In addition, the group counsels investment entities in structuring partnerships, private investment funds (including opportunity funds) and private development entities interested in investing in these credit projects, and also counsels brokers selling such credits. Hirschler Fleischer’s Tax Credit Group is ready to assist you with projects involving such credits.
Stephanie A. Hood