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CRITICAL TAX ISSUES IN TODAY’S HOUSING TAX CREDIT TRANSACTIONS: DEFERRED DEVELOPMENT FEES

CRITICAL TAX ISSUES IN TODAY’S HOUSING TAX CREDIT TRANSACTIONS: DEFERRED DEVELOPMENT FEES. San Francisco, California July 24-25, 2008 Molly R. Bryson. DEVELOPMENT FEES. A fee to the Developer for developing and constructing/rehabilitating the property

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CRITICAL TAX ISSUES IN TODAY’S HOUSING TAX CREDIT TRANSACTIONS: DEFERRED DEVELOPMENT FEES

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  1. CRITICAL TAX ISSUES IN TODAY’S HOUSING TAX CREDIT TRANSACTIONS: DEFERRED DEVELOPMENT FEES San Francisco, California July 24-25, 2008 Molly R. Bryson

  2. DEVELOPMENT FEES • A fee to the Developer for developing and constructing/rehabilitating the property • Fee earned for services rendered in connection with construction/rehabilitation • Earned in full by construction/rehabilitation completion • May be paid after completion • Development services described in a Development Agreement between the property owner and the Developer • Typically included in the property’s eligible basis (ie. Development Fee will generate tax credits) • Development Fee often paid to an affiliate of the general partner/sponsor

  3. DETERMINING THE APPROPRIATE DEVELOPMENT FEE FOR A PROPERTY • Total Development Fee must be reasonable for services being performed • Amount of fee often restricted by state qualified allocation plans • Development Fee is included in eligible basis to the extent the fee is earned in connection with tax credit eligible activities • Eligible activities include construction/rehabilitation activities (reviewing plans, applying for building permits, monitoring construction) • Ineligible activities include lease-up/marketing activities, obtaining permanent financing, acquiring land and obtaining tax credits • Investor/IRS scrutiny

  4. HOW IS A DEVELOPMENT FEE PAID? • From development sources (ie. equity and loan proceeds) • Timing of payment (benchmarks) • Lenders/investors will closely monitor any portion paid prior to completion/stabilization • From operations (cash flow available after payment of expenses) • When development cost uses exceed development sources, some or all of the Development Fee is deferred for later payment • Final amount of any Deferred Development Fee is subject to scrutiny • Generally, the Developer is a cash basis taxpayer, so it takes the Development Fee into income as it is paid

  5. WILL A DEFERRED DEVELOPMENT FEE REDUCE ELIGIBLE BASIS? • The entire Development Fee is generally included in eligible basis even if its payment is deferred • The Deferred Development Fee can bear interest • There must be an unconditional obligation to pay the Deferred Development Fee at some reasonable point • The financial projections should demonstrate that the Deferred Development Fee will be paid • 50% Bond Test caution

  6. TREATMENT OF UNPAID DEVELOPMENT FEE ON ITS REQUIRED PAYMENT DATE • Investors will require that any Deferred Development Fee be unconditionally due and payable at some specified date • Maturity date varies with facts/circumstances (usually 10-15 years) • Typical payment method: the general partner (typically an affiliate of the Developer) contributes capital to the Partnership and the Partnership applies the funds to pay the unpaid balance of the Deferred Development Fee • A paper transaction, but it generates taxable income to the Developer and is treated as a capital contribution by the general partner

  7. DEFERRED DEVELOPMENT FEE MAY CAUSE A REALLOCATION OF LOSSES/CREDITS • Once the capital account of the limited partner hits zero, losses and credits are allocated based on the lowest priority debt, which is usually the Deferred Development Fee • If the Development Fee obligation is recourse or the Developer is related to a general partner (80% test) losses and credits attributable to it will have to be allocated to the general partner

  8. STRUCTURING DEFERRED DEVELOPMENT FEES TO AVOID REALLOCATION OF LOSSES/CREDITS • Refinance the Development Fee obligation with third party non-recourse debt • If the Developer and the general partner are affiliates, the general partner can transfer 21% of its interest to a third party. In doing so, the Developer is no longer related to the general partner for purposes of this test • If the Development Fee obligation is non-recourse, the Developer can assign the right to receive any unpaid Development Fee to an unrelated person

  9. RESTRUCTURING DEFERRED DEVELOPMENT FEES PRIOR TO PAYMENT • If the Development Fee was reasonably likely to be paid at the end of the first year of the credit period, a renegotiation of the fee in a later year should not impact eligible basis • Restructuring the terms of a Deferred Development Fee may cause cancellation of indebtedness income if it impacts the interest rate, maturity date, collateral, or guarantee 11084960

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