Tax Credits – Getting Past the Boardwalk
- Jun 19, 2013
Over the past 40-plus years, the U.S. government has enacted several discretionary benefit programs worth billions including 4 percent/9 percent Low Income Housing Tax Credits (LIHTC), New Market Tax Credits (NMTC), 10 percent/20 percent Historic Preservation Tax Credits (HTC), and specific deduction benefits for conservation easement donations. The benefits usually have no recapture requirement or discretionary component (meaning the tax code, not a government bureaucrat’s mood, decides how much benefit you get). Because of the complex structures, investors shy away from these investment alternatives. Don’t be too quick to judge the unknown. Not only do they help to create jobs and make an impact in communities that sorely need the investment, they are also an effective way to reduce one’s tax burden.
The project will normally have a general partner who might have a small percentage of the P&L allocation to start and operate the property. The limited partner has the remaining percentage of the P&L and gets some sort of preferred return in addition to the tax benefit. There will then be the project entity that owns the assets and actually does the work, like building or rehabbing a property. An exit strategy gives a specified rate of return for the limited partner who is bought out after a certain period, say five years. Typical tax equity IRRs for a solar project or low-income housing deal might be in the low teens. Historic conservation easement transactions might yield above 20 percent, some above 60 percent. In a high-tax state like California, the combined federal and state tax rate will be just above 50 percent. Based on syndication rates, it is possible to get one dollar’s worth of deduction benefit at a cost as low as 35 cents. For all the grousing about the current presidential administration’s vendetta to tax high income earners, this is certainly a strong strategy to offset one’s tax burden while making worthwhile investments.
Every industry has its bad boys. Historic Boardwalk Hall, L.L.C. v. Commissioner was denied certiorari (a petition to review a lower courts decision) by the Third Circuit U.S. Court of Appeals at the end of May 2013. It held that the investor was not a partner in the partnership and was denied the use of the tax credits. Before you decide all tax credit deals are risky and have audit issues, you must read past the first few paragraphs of the decision. The investors themselves had required audit indemnities and guarantees outside of the deal, which is unacceptable and why the deal fell apart. Most importantly, the judge clearly noted that the case was not intended to undermine tax equity itself, but to show that the investor had zero risk. You can’t have your pie and eat it too.
When investing in any transaction, it is important to understand the elements of economic substance. Like a traditional property acquisition, your money is at risk. Vacancies occur and a pipe might burst somewhere in the building requiring repair. The same occurs in a tax credit transaction. If you are a partner in the deal, you will need to be a bona fide participant in the risks and the benefits which can be lucrative in a high-tax rate market , as the one we are in currently.