Client Alerts

IRS Issues Rehabilitation Tax Credit Safe Harbor

By: Mary Forbes Lovett and John C. Goheen

About: Historic & New Markets Tax Credits

On December 30, 2013, the IRS issued Revenue Procedure 2014-12, setting forth a safe harbor for federal historic rehabilitation tax credit (HTC) transactions. In these transactions, investors are allocated HTCs through an ownership interest in either (i) a “developer partnership” which owns and develops a historic building, or (ii) a “master tenant partnership” which leases a historic building and receives a pass-through of the lessor’s HTCs. Investors have been skittish about HTC deals ever since the 2012 federal appellate court decision in the Historic Boardwalk Hall case, which disallowed the allocation of HTCs to an investor.

The IRS issued Revenue Procedure 2014-12 in order to provide more predictability regarding HTC transactions. The IRS will not challenge allocations of HTCs if the provisions of the safe harbor are satisfied. The safe harbor is generally effective for allocations of HTCs made on or after December 30, 2013. It is expected that HTC deals will now be structured to satisfy the provisions of the safe harbor.

Highlights of the safe harbor include the following:

  1. The developer must have a minimum 1% interest in items of partnership income, gain, loss, deduction and credit.
  2. The investor must have a minimum 5% interest in items of partnership income, gain, loss, deduction, and credit.
  3. The investor’s interest must constitute “a bona fide equity investment with a reasonably anticipated value” exclusive of tax benefits.
  4. The value of the investor’s interest must be contingent upon the partnership’s income and loss, must not be fixed in amount, and may not be reduced through fees, lease terms or other arrangements that are unreasonable compared to such items in real estate projects not involving HTCs.
  5. The investor cannot be protected from losses, and must participate in profits in a manner that is not limited to a preferred return.
  6. At least 20% of the investor’s capital contribution must be made before the project is placed in service, and at least 75% of the investor’s total expected contribution must be fixed in amount before the project is placed in service.
  7. Certain unfunded guaranties may be provided to the investor, including completion guaranties, operating deficient guaranties, environmental indemnities and financial covenants.
  8. Various types of tax credit guaranties are not permissible.
  9. Neither the partnership nor the developer may have a call right to purchase or redeem the investor’s interest.
  10. The investor may have a fair market value put right.
  11. An investor in the master tenant partnership generally cannot also invest in the lessor partnership.
  12. In master tenant structures: (a) any sublease of the project by the master tenant partnership back to the project developer must be mandated by a third party unrelated to the developer, (b) the term of the sublease by the master tenant partnership must be shorter than the term of the head lease from the lessor, and (c) the master tenant partnership may not terminate the head lease from the lessor during the period in which the investor remains a partner in the master tenant partnership.

For more information or customized counseling on this topic, please contact Mary Lovett, John Goheen or any member of the Tax or Real Estate Groups at Ulmer & Berne LLP.