Monday, July 9, 2012
On this blog we have discussed at length the various ways tax credits can benefit a state. They circulate money back into an economy to increase spending, provide incentives to clean up dilapidated sections of town raising property values, and provide an engine for job creation. While we focus mostly on tax credits in the Southeast, particularly South Carolina, there are plenty of other parts of the country that have seen the benefits of such credits. Below are just three examples of many:
In order to boost a still recession injured economy, the Rhode Island Public Expenditure Council voted to temporarily reauthorize the already effective Historic Preservation Income Tax Credit. The credit is similar to South Carolina's recently stalled Abandoned Buildings Revitalization Act. The credit itself allows a developer to recoup 30% of the costs of approved rehabilitation work, providing an incentive to undertake potentially expensive projects that may not visit direct benefits on the developer.
Both the economic and non-economic benefits of the tax credit are touted. In general, preserving buildings is not only cheaper than replacing buildings in many cases, but the process of declaring buildings historic (and therefore eligible for a tax credit) increases property values. Non-economic benefits include the “preservation of a culture and community” according to RIPEC, as well as aesthetically improving a neighborhood.
The authorization of this tax credit is only temporary - full reauthorization will only come as part of a full evaluation of the state’s tax policy. While RIPEC agrees with the need to perform due diligence, it strongly advocates the long-term economic benefits of such credits.
In a case of absence making the heart grow fonder, the Oklahoma state legislature ended a two-year suspension of an energy efficiency tax credit on July 1. Now, builders once again have the incentives to increase energy efficiency in newly built homes. Hopefully this will reduce the drop off in quality noted by the head of an Oklahoma City based green construction inspection company Guaranteed Watt Saver.
Some expenditures eligible for as much as a one-to-one tax credit include energy-efficient heating and cooling systems, roofs coated with materials to reduce heat gain, and improved insulation. The credit can range from $2,000 to $4,000. However, Todd Booze, vice president-secretary of the Oklahoma State Home Builders Association sees this as a valuable long-term investment. The long term housing stock will be improved and those who buy the energy efficient homes can save up to $2,000 a year.
If you are one of the millions of people who saw The Avengers this summer, not only did you see The Incredible Hulk put Loki in his proper place, but you also got a glimpse of metropolitan Cleveland, Ohio. This is largely due to the efforts of Ivan Schwarz and the Greater Cleveland Film Commission, who were largely responsible for encouraging the Ohio legislature to create a $20 million tax incentive for Hollywood movie makers to film in the city. By all accounts, the tax credit has been a resounding success.
The credit reimburses producers up to 25% of dollars spent in Ohio and up to 35% of money spent paying wages to Ohio employees. The credit has proved so popular that Governor John Kasich signed a bipartisan bill to double the available money for the tax credit to $40 million in both 2012 and 2013. However, it’s not just big budget Hollywood films that are eligible for this credit—documentaries, commercials, and even video games are eligible for the $40 million tax credit pool.
According to a study by Cleveland University, Ohio has reaped a return of $1.20 for every $1.00 spent on tax credits, including ones for the movie industry. Ohio’s filmmaker’s tax credit, Rhode Island’s historic preservation credit, and Oklahoma’s energy efficiency credits are three of many examples of how such credits can create jobs, improve neighborhoods, create disposable income, and generally improve quality of life. Hopefully for the next legislative session South Carolina will follow the lead from other states and pass the Abandoned Building tax credit and other potential economy improving tax credits.
at 10:30 AM
Friday, June 8, 2012
As the official term of the South Carolina Legislative Session ended yesterday, so did the chances for the Abandoned Buildings Revitalization Act to become law this year. Supporters of the bill, including me, will try to revitalize the bill next year. The bill would have provided a 25% tax credit on investments in abandoned buildings for income producing purposes. In order to qualify, the building would have to be 66% vacant for a period of at least 5 years prior to the investment.
at 2:39 PM
Wednesday, May 9, 2012
One of the many casualties of the recession was the real estate market, and South Carolina is no exception. It is not uncommon to drive down the street and see derelict structures that once housed families or businesses. Abandoned buildings can wreak havoc on an area, lowering property values and becoming a magnet for unsavory activities and other forms of decay. The city of Florence alone has about 2,500 abandoned or dilapidated structures. It is in the best interest of the state to prevent these buildings from falling into disrepair. South Carolina state legislators agree, which is why they are proposing a new law that would help rescue these abandoned buildings. The law, entitled the “Abandoned Buildings Revitalization Act,” seeks to save these buildings through the strategic use of a tax credit.
There are several requirements that must be fulfilled to be eligible for this tax credit. First, the abandoned building must be revitalized for commercial use. Second, the building must have been abandoned for at least five years. The building will be considered “abandoned” if at least two thirds of its space has been vacant for those five years. Third, the business owner must invest at least $500,000 into the renovations. The taxpayer who revitalizes the site of the abandoned building would be eligible for a 25% state income tax credit. Like other state income tax credits, these credit could be syndicated, or “sold” in essence, to raise capital for the project.
The bill (H4802) was passed by the House of Representative on April __, 2012 by a vote of 108-0. It was co-sponsored by state reps Rick Quinn (R-Lexington) and James Smith (D-Richland). So far, it has received significant bipartisan support with over 30 lawmakers signing onto the bill, and no one has voiced opposition to the bill. The proposed bill has also received the support of the State Fire Fighters Association, Police Chiefs Association, Palmetto Trust for Historic Preservation, the Greater Columbia Chamber of Commerce, and the Affordable Housing Coalition of South Carolina, among others. The bill is now awaiting consideration in the Senate, where it stands a very good chance of becoming law this year.
In addition to saving dilapidated buildings through tax credit incentives, the bill is also expected to create new jobs, further stoking an economy that is still recovering. Steve Wukela, the mayor of Florence, is another ardent supporter of the bill for precisely this reason. “If you can get the marketplace in there to revitalize these properties, it changes the whole complexion of the community, particularly downtown,” Wukela said of the bill’s potential to save his struggling city. This new tax credit, should it make it through the legislature and be signed into law, would provide the incentive necessary for these markets to “get in there and revitalize the properties.”
Source: “Lawmakers propose tax breaks for revitalization efforts,” by Patricia Burkett, published at SCNow.com.
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at 10:01 PM
Monday, February 27, 2012
Certain transactions can be construed as “disguised sales” under federal tax law (Virginia Historic Tax Credit Fund 2001, LP v. Comm., Cite as 107 AFTR 2d 2011-1523)
Developers, investors, and professionals beware... last year's decision by the Fourth Circuit Federal Court of Appeals involving Virginia state tax credits has game-changing implications for the tax credit industry.
The state of Virginia has a program where it uses tax credits to provide an incentive for developers to renovate and rehabilitate historic property. Once the state approves and certifies the renovation, the developer becomes eligible for tax credits for up to 25% of expenses incurred, which can offset state tax liability. A partnership can allocate the tax credit disproportionately among the limited partners.
The principals in this case created funds structured as four linked partnerships that would then partner with historical property developers. The funds would provide capital for completed projects and, in exchange, receive state tax credits from the developers. These tax credits would then be used as incentives to solicit investors to become limited partners in the funds - in exchange they would be allocated a proportion of the tax credits. In practice, these limited partners would own a .01% interest in the funds and were explicitly told that they would not receive “any material amounts of partnership income or loss.”
From November 2001 to April 2002, investments in fifteen different projects generated an investment/tax credit ratio of $0.55 on the $1.00. In May 2002, the fund owners bought out all the investors for .1% of their contributions.
The principals of the linked funds reported the transactions as “partnership expenses.” The Commissioner characterized the transactions as disguised sales for the following reasons:
- The investors were not “bona fide partners” in the funds, but rather mere purchasers.
- The transactions between the partnerships and investors were “disguised” sales under I.R.C. § 707.
Something is considered a sale under § 707 if: (1) the transfer of money “would not have been made but for” the transfer of property in exchange; and (2) the later transfer “is not dependent on the entrepreneurial risks of partnership operations.”
The Appeals Court held that even if they accept that the investors were bona fide partners, the transactions were still “disguised sales.” The credits were considered property for federal tax purposes. The “allocations” of credits to the “limited partner” investors were really transfers of something valuable in exchange for money. The partnership status of the investors was “transitory” in nature, and the receipt of credits was not dependent on the success or failure of the partnership ventures.
The holding in this case resulted in bad results for everyone involved. The sale of the tax credits by the funds were treated as sales of capital assets in which they had no basis, such that all of the contributions recieved from investors were treated as taxable capital gains. The investors were treated as having a basis in the tax credits equal to the amount of their investments, so when they utilized the credits to offset their state income, they also were taxed on capital gains to the extent the value of the credits exceeded their investments. This result may diminish the value of the credits and hurt the market over time.
The important point to take away from the case is that the court was important to note that the Court's ruling was very narrow and was based on the particular facts of the case, with special attention being given to the structure of the partnership entities in which the investors contributed their investments. These entities could have been structured in a different way that would likely not have given rise to the disguised sale treatment. Any transaction involving the allocation of state tax credits to investors in exchange for capital should be carefully structured to avoid this result.
at 9:59 AM
Monday, February 6, 2012
For developers doing their first historic rehabilitation tax credit deal in South Carolina, let me fill you in on a valuable piece of advice; make sure you don't sell yourself short on available property tax incentives that may accompany your historic rehab tax credits. In South Carolina, state law authorizes local tax authorities to adopt, by ordinance, a special assessment for eligible historic rehabilitation properties and low income properties. This little known incentive is known as the "Bailey Bill" to those who are familiar with it. It can lock-in the assessed value on the property at its pre-rehab value for up to 20 years. If you haven't had time to crunch your numbers, you should. It could save you hundreds of thousands in property taxes over the life of the special assessment period. The trick is to make sure you get preliminary approval for the Bailey Bill from the local tax authorities before you start construction. First, verify that the local tax authority (city or county) has adopted the Bailey Bill by ordinance. If they have, you should follow the ordinance carefully and make sure you have fully complied with their application process. If they have not adopted the Bailey Bill by ordinance, you can request that they do so before you proceed with your project. Just make sure you apply before you begin, or as soon thereafter as possible, or you may be out of luck.
at 9:50 PM
Tuesday, May 31, 2011
Tuesday, February 1, 2011
Case Study: Sale of tax credits in connection with the rehabilitation of an abandoned upstate textile mill into loft apartments provides equity financing for over 30% of total project costs.
As a primer on how tax credits can help finance development projects, I offer the following example in the form of a case study.
A real estate developer proposed to rehabilitate and develop an abandoned historic textile mill in upstate South Carolina, into approximately 200 loft-style apartments. The developer had completed many successful projects, but had not previously utilized tax credits to provide financing for a project.
The developer utilized federal historic rehabilitation tax credits, South Carolina historic rehabilitation tax credits, and South Carolina mill tax credits for this project. The federal historic rehabilitation tax credit is equal to 20% of the total qualified rehabilitation costs and can be used to offset federal income tax. The state historic rehabilitation tax credit is equal to 10% of qualified rehabilitation expenses and can be used to offset South Carolina income tax. The state mill tax credit is equal to 25% of qualified rehabilitation costs and can be used to offset South Carolina income taxes or property taxes. Total estimated costs of the project were approximately $20 million. The tax credit market and the amount investors are willing to pay for an allocation of such credits is subject to fluctuation. An institutional investor contributed equity to the project in exchange for an allocation of the tax credits and and a modest cash return on their investment.
The transaction was structured to accomplish the following objectives:
- To allocate the tax credits to the investor;
- To allow the developer to maintain control of the project;
- To pay a substantial development fee to the developer (approximately $2.9 million);
- To allow excess cash flow to be retained by the developer when the project exceeded stated performance criteria;
- To provide an exit strategy for the investor after 5 years at the lowest possible cost to the developer (to preserve the historic rehabilitation tax credits the investor must maintain its investment in the project for at least 5 years after completion);
- To ensure that all requirements are met to receive the tax credits and avoid recapture.
The investor provided approximately $6.9 million in equity to help finance the project. The developer received a development fee of approximately $2.9 million over the life of the project, and the developer will be in a position to purchase the investor’s ownership interest in the project for a fraction of the investor’s equity investment (about 15%) 5 to 6 years after the rehabilitation is complete. The combination of tax benefits and monetary returns provided an attractive outcome to the investor.
at 12:16 PM