Affordable Rental Housing: Tax Credits & Financing AHS gratefully acknowledges the use of materials developed by the Virginia Community Development Corporation.

Affordable Rental Housing:Tax Credits & Financing

AHS gratefully acknowledges the use of materials developed by the

Virginia Community Development Corporation(AHS has deleted slides and made minor edits on others )

Historic Tax Credits

Historic Tax Credits− Provide a dollar for dollar reduction in taxes due to a

taxing body. − How do they work:

Federal credit of 20% of the improvement cost of certified historic buildings – used to offset federal taxes.

Virginia credit of 25% of improvement cost – used to offset VA taxes

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Historic Tax Credits

Historic Tax Credits (continued) Credits reduces the depreciable basis by an amount equal to

the tax credit Example: A historic building costs $300,000 ($100,000 of

this is land). The owner spends $700,000 to rehab the building for residential use.− Historic Credit (Federal) - $140,000 (20% of $700K)− Annual Depreciation - $27,636− ($200K+$700K-$140K / 27.5)

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Historic Tax Credits

Historic Tax Credits (continued) Property must be listed on the National Register or

included in an historic district and identified as a contributing structure.

Rehab must follow the Secretary of the Interior’s guidelines for rehabilitation of historic properties

Credits can only flow to an owner of the property

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LIHTC – A Primer

Everything You Need to Know but Were Afraid to Ask

Low Income Housing Tax Credits

Low-Income Housing Tax Credits: Provide a 10-year stream of tax credits to owners in

projects that provide housing for lower income families Individuals are not good targets for LIHTC investment

− IRS passive activity loss rules limits losses of individual taxpayers ($9600 maximum).

− Individuals can’t use some of the other tax benefits associated with these projects

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LIHTC – A PrimerCredit Categories

Four separate and distinct credits permitted:– Acquisition – credit of ≈4% for acquisition of qualified

buildings– Rehabilitation – credit of =9% of the qualified rehab costs– New Construction – credit of =9% of the qualified

development cost for low-income units in newly-constructed buildings

– Federally-financed – credit of ≈4% for acquisition, rehab and or new construction of projects using Federal subsidy

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LIHTC – A PrimerRehab / New Construction

Credit =9% per year for 10 years Rehabilitation and related expenses must be

minimum of $6,000/unit and the work must be completed within a 24-month period

To achieve $6,000/unit minimum threshold, rehab expenditures may be allocated to all the units in a building

If project has mixed-income units, low-income units must be similar to market units

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LIHTC – A PrimerRestrictions

Income Restrictions – restrictions on the income of tenants

Rent Restrictions – restrictions on the rent that can be charged for the units

These restrictions apply for AT LEAST 15 years

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LIHTC – A PrimerOversight

Low-Income Housing Tax Credits are allocated to states by formula; Virginia’s allocation managed by Virginia Housing Development Authority (VHDA),

States must detail how they will allocate credits to projects, specifically the 9% credits

States prepare a Qualified Allocation Plan

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LIHTC – A PrimerOversight

A Qualified Allocation Plan details: Selection criteria used to determine priorities

appropriate to local conditions Gives highest priority to projects with lowest

intermediary costs Preference to projects serving lowest income

tenants and obligated for longest periods Provides procedure for notifying IRS of non-

compliance encountered

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LIHTC – A PrimerOversight

In developing the QAP, a State’s designated agency must provide opportunities for public input

The public is given an opportunity to review and respond to a proposed QAP

A public hearing must be held no sooner than 14 days after publishing the plan

Under law, the Governor must approve a QAP following the public hearing

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LIHTC – A PrimerThe Virginia Program

Virginia’s allocation divided into 8 pools: Northern Virginia Richmond Tidewater Small MSA Rural Non-Profit Local Housing Authority At-Large – any unallocated credits

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LIHTC – A PrimerThe Virginia Program

Amenity Preferences– Brick siding– EarthCraft or LEED– Community rooms– Larger living spaces– Extra bathrooms– Location close to public transportation

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Financing andDebt Service

The long-term impact of financing

Financing and Debt ServiceOverview

Financing falls into different categories depending on:− The STAGE of the development process− The NEED that the financing fills

Some of the different types of financing include:– Predevelopment – for costs associated with the planning of a

construction project– Construction – short-term financing of real estate

construction– Permanent (aka Take Out Loan) – long-term

financing to cover period of indebtedness of note.

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Financing and Debt ServiceOverview

Different types of financing (continued):– Bridge – temporary or interim loan made between a short-

term (construction) and permanent financing. Also used to bridge between extended equity pay-in

– Gap – additional funds necessary for completion of construction or purchase of property. Fills a “gap” between equity and debt.

– Mini Perm – a construction loan that rolls into a short-term (usually five years or less) permanent loan

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Financing and Debt ServiceOverview

Financing consists primarily of grants and loans Grant – normally funds given by a public entity for an

enterprise deemed advantageous. Grant funds may have conditions. Property cannot be sold or used for another purpose for a period of time.

Loan – money lent with conditions:− Amortizing – payment of debt in regular installments of principal

and interest− Deferred – payment made at a future date− Forgivable – after a period of time or condition is met, debt is

wiped clean− Interest – amount or percentage of money charged for use of a

principal sum of money− Term – maturity or period of time from beginning to end of a

payment of a loan

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Financing and Debt ServiceOverview

Equity Financing: consists of the owners money Owner’s cash downpayment Equity from the sale of Tax Credits There will be the expectation of a return on investment

− Fees− Appreciation− Cash flow− Tax benefits

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Financing and Debt ServiceOverview

Loans are usually secured and grants are often secured to ensure that the conditions of the award are adhered to

Security is - real or personal property pledged to help guarantee an amount of indebtedness

Types of security and some security terms are:– First or Primary Position: Interest in property whereby the

security is guaranteed by the value of the property and no other rights to property exist

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Financing and Debt ServiceOverview

Types of security and terms (continued): Subordinate: Interest in property which may take a second

or third position behind first Title: Legal evidence that one has right of ownership to

property Lien: Legal instrument placing an encumbrance against

property for money. All liens are encumbrances, but not all encumbrances are liens. Normally, a secured interest created by a mortgage

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Financing and Debt ServiceFinancing Sources

CDBG Administered locally or by States Can be structured as a loan or a grant – depends on

project circumstances NOT treated as federal subsidy In Virginia, up to $700,000 available on competitive basis

– for locally-controlled CDBG will depend on local prioritization and process

Must serve people below 80% AMI

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Financing and Debt ServiceFinancing Sources

Tax-Exempt Bonds Government or 501(c)(3) issued Bond purchasers don’t pay taxes on interest income -

allows better interest rate due to tax exempt nature Eligible for non-competitive 4% LIHTC credits if subject to

volume cap and allocated to state for housing Most subject to volume cap for housing are issued by HFA

or local government entity

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Financing and Debt ServiceFinancing Sources

Tax-Exempt Bonds (continued) Work best for acquisition / rehabilitation projects where

acquisition is a significant part of project At least 50% of project costs have to be financed by

proceeds from bond Project must support debt service for 50% of project (as

bond proceeds are 50%) Typically better where strong 60% market exists – allows

higher rents

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LimitedPartnerships

And other forms of ownership

Limited PartnershipsBackground

Limited Partnerships are business entities that are neither corporations nor partnerships

Unlike Partnerships, not all partners have the same legal involvement in the day to day management of the business

Unlike Partnerships, some partners have limited liability Unlike Corporations, the benefits pass through the entity

to the Partners

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Limited PartnershipsSummary

Typically, project sponsors realize cash by using a limited partnership to sell the project to investors without relinquishing control

The limited partnership is 99% owned by investors (tax credit purchasers). The sponsor retains a 1% interest, acts as the general partner, and manages the project’s business affairs (retains control).

As 99% owners, investors receive 99% of cash flow, tax shelter, and appreciation – the general partner can charge a reasonable fee for services

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Limited PartnershipsLimited Liability Company

Alternative to Limited Partnership Has most of the benefits of an LP while allowing

more flexibility for investor participation in management

It is a corporation that is taxed like a partnership or sub S corporation

Management is centralized Liability is limited State law was amended to allow LLCs

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