On Nov. 2, the House Ways and Means Committee released draft statutory text (the "Bill") of the proposed Tax Cuts and Jobs Act (the "Act"), the long-awaited Republican tax reform bill. On Friday, Nov. 3, Kevin Brady, Chairman of the House Ways and Means Committee, released a markup of the Bill incorporating minor changes (the "Chairman’s Mark"). On Monday, Nov. 6, Chairman Brady proposed some additional amendments to the Bill, none of which affects the provisions discussed herein. If passed in its current state, the Chairman’s Mark would deal a devastating blow to the community development industry through elimination of various programs that have been successful in incentivizing economic development, specifically including the rehabilitation tax credit ("HTC") program and the new markets tax credit ("NMTC") program. The following is a summary of the portions of the Chairman’s Mark that relate to the HTC and NMTC programs, along with some initial thoughts on their implications.
Overview of HTC Program
Under Section 47 of the Internal Revenue Code of 1986, as amended (the "Code"), a taxpayer is eligible for an HTC of up to 20 percent of the “qualified rehabilitation expenditures” ("QRE"s) incurred in connection with the rehabilitation of a qualifying building. In order to be eligible for the credit with respect to QREs, the qualifying building must be “substantially rehabilitated,” meaning QREs during a 24-month period (or 60-month period in the case of certain “phased rehabilitations”) selected by the taxpayer generally must exceed the taxpayer’s adjusted basis in the qualifying building at the beginning of this rehabilitation period. Most HTC-generating rehabilitations are “syndicated,” meaning a tax credit investor agrees to partner with a developer to provide funding for the rehabilitation primarily in exchange for an allocation of HTCs. Syndicated HTC transactions are structured using either single-tier or lease pass-through structures. Under a single-tier structure, the project sponsor admits a tax credit investor as a partner in a tax partnership that owns and rehabilitates the qualifying building. Under a lease pass-through structure, the property owner elects to pass the HTCs through to a master tenant partnership pursuant to a master lease as permitted under current Section 50(d)(5) of the Code. The project sponsor then admits a tax credit investor as a partner in the master tenant. The HTC enables many developers to complete rehabilitation projects that otherwise would not have gone forward.
Proposed HTC Repeal
Section 3403 of the Chairman’s Mark (the "Amendment") repeals the HTC for all QREs paid or incurred after Dec. 31, 2017. While initially appearing to eliminate the HTC within weeks, the Amendment does provide some relief in the form of a “transition rule” for taxpayers that can meet certain requirements. Specifically, section (c)(2) of the Amendment (the "Transition Rule") provides that in the case of QREs in respect of any building (1) owned or leased by the taxpayer at all times after Dec. 31, 2017, and (2) with respect to which the 24-month rehabilitation period begins not later than 179 days after the enactment of the Act, the Amendment shall only apply to such QREs paid or incurred after the end of the taxable year in which the 24-month rehabilitation period ends. Assuming the Chairman’s Mark is enacted on or before year-end in its current form, qualifying projects should be entitled to HTCs on QREs incurred (1) during a 24-month rehabilitation period that would begin not later than mid-2018 and end 24 months thereafter in 2020, (2) before the start of such rehabilitation period and (3) prior to the end of taxable year 2020.
Impact of Proposed Amendment
- Transactions for which a building has achieved final “placed in service” (i.e., ready for its intended use) on or before Dec. 31, 2017, generally should not be affected by the Amendment.
- Transactions that have “closed” (i.e., tax credit investor has been admitted as a partner in either the property owner or the master tenant) before Dec. 31, 2017, but with respect to which work will continue after Dec. 31, 2017, should be able to rely on the Transition Rule and, thus, generally should not be affected by the Amendment, as long as the 24-month rehabilitation period begins within the time frame permitted under the Act.
- Note that the foregoing is not without exception. For example, a portion of QREs could be lost in certain situations that involve an extended construction period. Also, the impact on “phased rehabilitations,” which under current law may benefit from a 60-month rehabilitation period, are uncertain.
- It is possible that transactions that have not “closed” before year-end could rely on the Transition Rule. Careful consideration and planning would be necessary in these situations.
- For example, it appears that by structuring tax ownership of the qualifying building in a tax partnership by year-end, a developer may preserve its ability to bring a tax credit investor into the tax credit structure and generate HTCs at a later date.
- Careful scrutiny of a taxpayer’s rehabilitation timeline (and perhaps some restructuring of such timeline) also would be required to ensure the rehabilitation period could begin before the Transition Rule’s 180-day window expires.
Overview of NMTC Program
Under Section 45D of the Code, a taxpayer holding a “qualified equity investment” is eligible for an NMTC equal to 5 percent of such investment for each of the first three years of such investment, and 6 percent of such investment for each of the next four years of such investment (i.e., a total credit equal to 39 percent of such investment). Historically, low-income communities have suffered from a lack of investment. The NMTC program has successfully attracted private investment to such communities. Benefits of the program to qualifying low-income communities include creation or retention of hundreds of thousands of jobs, construction of over 100 million square feet of new space and the catalyzing of additional private investment.
The PATH Act, which was enacted in December 2015, extended the NMTC program for five years, from 2015 to 2019, at $3.5 billion in annual credit authority, for a total of $17.5 billion. The CDFI Fund, which administers the NMTC program, combined the 2015 and 2016 authorizations, and awarded $7 billion of NMTC allocation on Nov. 17, 2016. The industry expects awards with respect to the 2017 authorization to be made in early 2018.
Proposed NMTC Repeal
Section 3406 of the Chairman’s Mark eliminates NMTC allocation authority after 2017, meaning the allocation authority for years 2018 and 2019 would be rescinded despite the PATH Act. We believe that the 2017 round is preserved regardless of whether awards are made after calendar year 2017, although the industry is currently seeking further clarification on this important point.
Focus on the Fight – Those who feel strongly about preservation of development credits should focus their immediate efforts on reaching out to members of Congress and their staffs to remind them of the importance of such credits to community development. Baker Hostetler’s tax credit finance and economic development incentives team is available to assist in those efforts by providing contact information and talking points.
Understand the Process – We are still in the very early stages of the legislative process towards tax reform. If tax reform legislation passes, it is almost certain to be significantly different from the Chairman’s Mark.