Special Issues for Projects Involving
Nonprofits
IPED Housing Tax Credits “101”
February 22-23, 2007
Molly R. Bryson
Thomas A. Giblin
Examples of Nonprofit Participation in
Tax Credit Projects
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General partner, or co-GP with a for-profit
Developer or property management agent
Lender
Social service provider
Lessor under ground lease (or Managing GP) to
qualify for property tax exemption/abatement
• Holder of right of first refusal under § 42(i)(7)
Obtaining and Maintaining 501(c)(3)
Status: IRS Memo Dated 4/25/06
• Resolution of conflicts consistent with charitable
purpose
• Providing of low-income housing consistent with
safe-harbor tests of Rev. Proc. 96-32 (75% “lowincome” and 20% or 40% at lower levels)
• Limit on amount and length of operating guarantee
(6 months of expenses; 5 years from break-even)
IRS Memo, Dated 4/25/06 (cont’d)
• Payment of tax credit guarantee treated as a capital
contribution or a loan
• Limit on amount of tax credit guarantee (to the extent
of fees earned)
• Limit on repurchase price to 100% of capital
contributions
• Removal only for cause after a reasonable cure
period
• Right of first refusal
• Fixed price construction contract
Tax-Exempt Use Property Issues
• 40-year depreciation (may be ok with investor)
• Qualified allocation (0.01% interest in all tax items,
including cash flow and sale/refinance proceeds)
– be alert to incentive fees
• For-profit subsidiary as general partner making a
Section 168(h)(6) election
– election made on tax return
– also attached to exempt parent’s tax return
– must state it is a 168(h)(6) election
Structuring Around Federal Grants
• Often awarded to exempt organizations
• Reduce qualified basis
• Instead structure grant award to exempt organization
followed by a loan to the partnership at AFR
– partner non-recourse debt: potential issue if investor’s
capital account goes negative
– 79/21 solution (use of a second exempt organization
as minority stockholder of the general partner)
Nonprofit Set-Aside
• Each state tax credit agency must set aside at least
10% of its annual credit ceiling each year for projects
involving qualified nonprofit organizations
• Many states provide preferences for nonprofit
sponsored projects by assigning “points” to projects
with nonprofit involvement
• Whenever there is nonprofit involvement, need to
determine whether the tax credit agency actually
awarded credits from the nonprofit set-aside
Nonprofit Set-Aside (Cont’d)
• Nonprofit organization must be exempt from federal
income tax under Section 501(c)(3) or 501(c)(4) of
the IRC
• One of the organization’s exempt purposes must
include the fostering of low-income housing
• Nonprofit cannot be “affiliated with or controlled by” a
for-profit organization
• Nonprofit must own an interest in the project (directly
or indirectly)
• Nonprofit must materially participate in the
development and operation of the project throughout
the compliance period
Right of First Refusal Under
IRC Section 42(i)(7)
• Added to IRC Section 42 in 1990 to facilitate
nonprofit ownership of tax credit properties at the
end of the 15-year compliance period
• Eligible holders/minimum purchase price is
specifically set forth in IRC Section 42(i)(7)
Eligible Holders of a Right of First Refusal
Under IRC Section 42(i)(7)
• Tenants of the project (in cooperative form or
otherwise)
• Resident management corporation of such building
• Qualified nonprofit organization
• Government agency
Determining Minimum Purchase Price
Under IRC Section 42(i)(7)
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Minimum purchase price is equal to the sum of:
(1) the principal amount of the outstanding
indebtedness secured by the buildings (other than
indebtedness incurred during previous 5 years),
plus
(2) all Federal, state and local taxes attributable to
such sale
Right of First Refusal:
General Observations
• A right of first refusal is not an option. Needs to be
triggered by a bona fide third party offer
• A right of first refusal can be granted at any time
during a project’s lifecycle
• Parties may come together in year 15 to negotiate
fair price
• Congress expected minimum purchase price to be
favorable to nonprofits
Business Considerations When Granting a
Right of First Refusal
• The statutory purchase price is a minimum price.
• Statutory purchase price does not include:
– accrued but unpaid fees to limited partners
– unpaid limited partner loans
– unpaid tax credit adjusters
Business Considerations When Granting
a Right of First Refusal (cont’d)
• Need to understand how sales proceeds are
distributed under the partnership agreement
• Right of first refusal should terminate if an affiliate
general partner withdraws or is removed
• Need to determine a specific term for the right of first
refusal
• Loan documents should contemplate a sale in year
15
IRC Section 4965
• New Section 4965 (2005 Tax Act) and new Notice
2006-65 (7-11-06) provide: If an exempt
organization is involved in a deal with “contractual
protections,” then (i) possible 100% tax on
organization’s income or cash from deal, and (ii)
$20,000 fine on the “entity manager”
• IRS has provided recent guidance
10311776