ACQUISITION/REHABILITATION: THE 10% ANTI-CHURNING RULE Gary A. Band, Esquire Nixon Peabody LLP 401 9th Street, N.W. Washington, D.C. 20004 (202) 585-8809.

ACQUISITION/REHABILITATION: THE 10% ANTI-CHURNING RULE

Gary A. Band, Esquire

Nixon Peabody LLP

401 9th Street, N.W.

Washington, D.C. 20004

(202) 585-8809

(866) 947-3524 (fax)

[email protected]

LEARNING THE BASICS:

HOUSING TAX CREDITS “101”

IPED, INC.

Arlington, Virginia

October 18-19, 2007

SellingPartnership

GPOld LP

Cash

Property

GPNewLP

BuyingPartnership

THE RULE

- Section 42(d)(2)(B)(iii) of the Code provides that in order to receive acquisition credits the building cannot previously been placed in

service by the taxpayer or by a related person.

- Cliff Test – if “related person” lose acquisitioncredits.

• Prevents taxpayers from “Double Dipping”

• Claiming tax incentives on property and then selling to Related Person and receive Acquisition Credits.

RELATED PERSON TEST

- Section 42(d)(2)(D)(iii)(II) tells you that a “related person” to a taxpayer means 10% or greater common ownership.

- Partnerships - person is related to thepartnership if the person owns, directly orindirectly, more than 10% of the capital interestor the profits, in such partnership.

How do you determine your percentage ownership in a LIHTC Partnership?

LIHTC Partnerships are structured with partners receiving different percentage interests in different items:

- Tax Credits - Cash Flow - Sale/Refinancing Proceeds - Maybe State Tax Credits

The LIHTC industry has prudently decided that if you have a 10% or greater interest in any item in the seller, you have to have less than a 10% interest in all items in the buyer.

Since a developer (GP) tends to have more than a 10% interest in Cash Flow in the old Partnership (the seller), the developer tends to have a 9.9% interest in Cash Flow and in Sale/Refinancing Proceeds in the new Partnership (the buyer).

Not your typical LIHTC business deal if the syndicator/investor has 90.1% of Cash Flow and Sale/Refinancing Proceeds.

So, what typically happens?

- Partnership Management Fee

- Incentive Management Fee

The question is whether or not these fees exceed a reasonable fee which would be paid to a third-party service provider performing the same services.

Anything paid (or payable if there were Cash Flow) in excess of a reasonable fee could be reclassified as additional Cash Flow to the General Partner.

And, since we’re already at 9.9% of the Cash Flow going to the General Partner, there’s no room for error.

The risk is the loss of all of the Acquisition Credits if the General Partner is deemed to really have a 10.01% interest in Cash Flow.

Look at these Cash Flow fees to see if they’re “reasonable.”

For instance, would a third-party service provider agree to be paid only if there were sufficient Cash Flow at that point in the Cash Flow waterfall?

A Cash Flow fee looks more like a real fee, rather than like a Cash Flow distribution, if it accrues, even if there is no Cash Flow available to pay it currently.

Newer Techniques:

- Higher Property Management Fees

– recently saw a property management fee equal to 14% of gross rental income, with the argument that there were very low rents

– the property manager was affiliated with the General Partner

Purchase Money Notes

― Payable by the buying partnership to the selling partnership out of Cash Flow of the buying partnership

― a good appraisal is important – size of acquisition debt must be supported by “as-is” appraisal.

― True Debt analysis – is it secured by a mortgage and do the projections show the debt being repaid?

Co-GP to Receive Cash Flow

- Existing GP has 9.9% of Cash Flow and new Co-GP has 70-80% of Cash Flow.

- Need to closely examine the full relationship between the two GPs.

Ground Lease

- to an affiliate of the seller

- appraisal issue

- market rate ground lease

Development Fee for the Rehabilitation

- especially if minimal rehabilitation

- similar issue with fee to an affiliated general contractor for the

rehabilitation work

Some investors are more risk adverse than others, so find out early on what is acceptable.

The Investor as a “Related Party”

Also, don’t forget the 10% test from the investor side.

10759200

- Usually OK to use the same syndicator as long as the ultimate investors don’t cause a 10% problem.