Special Issues for Projects Involving Nonprofits
IPED Housing Tax Credits “101”
June 7-8, 2007
Molly R. Bryson
Thomas A. Giblin
Examples of Nonprofit Participation in
Tax Credit Projects
• 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)
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Obtaining and Maintaining 501(c)(3)
Status: Background
• Difference between nonprofit under state law and under federal law
• Tension between (i) the § 42 program which encourages nonprofit
involvement and partnership with for-profits; and (ii) the IRS concern that
nonprofits would be taken advantage of by for-profits
• Serving charitable purpose vs. benefiting a for-profit organization
– long history of what IRS and courts won’t allow
– obtaining Section 501(c)(3) status has been difficult and timeconsuming
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Obtaining and Maintaining 501(c)(3)
Status: IRS Memo Dated 4/25/06
• IRS memo outlines many factors, but failure to meet a factor is not fatal
• Resolving conflicts consistent with charitable purpose
• Providing low-income housing consistent with safe-harbor tests of Rev.
Proc. 96-32 (75% “low-income” and 20% or 40% at lower levels)
• Limiting amount and length of operating guarantee (6 months of expenses;
5 years from break-even)
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IRS Memo, Dated 4/25/06 (cont’d)
• Treating the payment of tax credit guarantee as a capital contribution or a
loan (rather than outside the partnership)
• Limiting amount of tax credit guarantee (to the extent of fees earned)
• Limiting repurchase price to 100% of capital contributions
• Removal only for cause after a reasonable cure period
• Right of first refusal
• Fixed price construction contract
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Tax-Exempt Use Property Issues
• 40-year depreciation of residential real estate (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 of the nonprofit serves as general partner
and makes a Section 168(h)(6) election, which results in taxable
income to the subsidiary but 27½-year depreciation
– election made on tax return
– also attached to exempt parent’s tax return
– must state it is a 168(h)(6) election
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Structuring Around Federal Grants
• Often awarded to exempt organizations
• Reduce qualified basis
• Result in taxable income to the partnership receiving the grant
• 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)
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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
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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 forprofit 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
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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 and minimum purchase price are specifically
set forth in IRC Section 42(i)(7)
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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
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Determining Minimum Purchase Price
Under IRC Section 42(i)(7)
•
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
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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
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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
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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
10603790
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