New Safe Harbor for Structuring Historic Tax Credit Partnerships

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Anthony P. Marshall, Esq.

Harris Beach PLLC, Syracuse, NY

Are you an investor or a developer with questions about historic
tax credits?

You should be aware that the IRS issued new safe-harbor rules in
Rev. Proc. 2014-12 on Dec. 30, 2013, in direct response to the
holding in Historic Boardwalk Hall, LLC v. Commissioner,
694 F.3d 425 (3d Cir. 2012).

In the Historic Boardwalk Hall (HBH) case, the
Third Circuit denied the taxpayer the right to claim historic tax
credits on the basis that it was not a true partner in the
partnership through which historic tax credits pass. The court
found that the investor partner lacked both a meaningful downside
risk and a meaningful upside potential.

The IRS, reacting to the impact of the HBH case on the historic
tax credit industry, issued Rev. Proc. 2014-12 to provide a safe
harbor to give investors and developers comfort in structuring
historic tax credit partnerships. The safe-harbor rules of Rev.
Proc. 2014-12 apply equally to project-level partnerships and
master-lease partnerships, in which the developer has elected to
pass the historic tax credits through to a master tenant.

Rev. Proc. 2014-12 is effective for allocations of historic tax
credits made on or after Dec. 30, 2013 - that is, with a
placed-in-service date of on or after Dec. 30, 2013.

The four key partnership structural provisions required to take
advantage of the safe harbor of Rev. Proc. 2014-12 are as

1. Partnership Interests: The minimum
requirements are a developer interest of 1% and an investor
interest of 5%. Most deals are structured with 1%/99% interests,
which may "flip" at the end of the five-year compliance period to
as low as 5% of the investor's initial 99% interest, or to

2. Guarantees: The developer may guarantee
the investor against recapture of historic tax credits for direct
acts or omissions to act that cause the partnership to fail to
qualify for historic tax credit. However, a guarantee against
recapture based on an IRS challenge of the transaction structure of
the partnership is impermissible.

A developer may provide completion, operating deficit, financial
covenant breach (but not minimum net worth covenant) and/or
environmental guarantees, as long as these guarantees are
unfunded.  However, cash reserves are allowed as long as they
total no more than reasonably projected 12-month operating

3. Exit Structure: At the end of the
five-year compliance period, the developer may not have a call
option (an option to buy at a specified price from the investor).
Rather, the investor may have a put option, as long as the sales
price is less than the fair market value of the investor's
partnership interest at the time of exercise.

4. Bona Fide Investment: This factor has
four separate terms:

    Equity timing: An investor must contribute at least
    20% of its total expected equity prior to the placed-in-service
    date, and at least 75% of the investor's equity must be fixed prior
    to the placed-in-service date. Note that typical equity adjusters
    based on milestones are allowed but cannot adjust the investor's
    commitment by more than 25%.
    Bona fide investment: The investor's interest must be
    a bona fide equity investment with a reasonable anticipated value
    that is commensurate with the investor's overall
    percentage interest in the partnership, separate from tax
    attributes (deductions, credits, allowances) allocated by the
    partnership to the investor, and that is not substantially fixed in
    Commensurate value: To have a commensurate value
    requires that the investor receive the cash and other economic
    benefits - other than historic tax credits - on a basis equal to
    its percentage interest.  This requirement continues to allow
    an investor's interest in the partnership to be determined
    principally by the amount of anticipated historic tax credits to be
    Value impacts: An investor's interest may not be
    depressed through the use of developer fees, disproportionate
    distributions, lease or other business terms that are not
    reasonable (and a sublease with a term not shorter than the master
    lease is deemed unreasonable) relative to arm's-length development
    transactions not using historic tax credits.  This is really
    the key requirement in Rev. Proc. 2014-12.

While preferred returns, developer, management and/or incentive
fees are allowed, they must be comparable to
non-historic-tax-credit development partnerships. This may likely
require third-party verification from accountants or appraisers as
a condition to a tax opinion from legal counsel.

Rev. Proc. 2014-12 establishes a number of safe-harbor
requirements that significantly differ in material ways from
customary terms in most historic tax credit transactions closed
over the years.  These requirements play out most
significantly in the value impact requirements, requiring
negotiation of business terms (fees, preferred returns and lease
arrangements) that previously were fairly well settled.

Because counsel will likely require independent verification of
the reasonableness of such business terms as a condition to
providing a tax opinion, you should seek the advice of your CPA,
who may enlist the expertise of an appraiser, in connection with
historic tax credit transactions.

For more information, in the Tax Management Portfolios, see
Milder and Borod, 584 T.M.
, Rehabilitation Tax Credit and
Low-Income Housing Tax Credit,  and in Tax Practice
Series, see ¶3140, Investment Tax Credit.

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