A Bit of Life Post Historic Boardwalk Hall: Some Historic Tax Credit Deals Close as Industry Awaits Guidance

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In the 15 months since the jarring federal appeals court decision in Historic Boardwalk Hall, which prompted a sharp reduction in the availability of investor equity for new real estate projects planning to use federal historic rehabilitation tax credits, some deals have moved forward and closed, according to sources. Some have had modified structures compared to typical pre-HBH transactions while others have been little changed, they say.

Meanwhile, the industry anxiously awaits the release of promised formal tax guidance regarding acceptable partnership structures for historic tax credit transactions from the Internal Revenue Service.

“It is among our top priorities,” U.S. Treasury Attorney-Advisor Craig Gerson told a Washington, D.C. seminar sponsored by the Institute for Professional and Executive Development (IPED) on October 18. “We recognize that there is an urgent need for this guidance in the industry and we are putting it through as quickly as we can.”

Gerson wouldn’t predict when the guidance will be issued. But he said, “Our thought is that we will issue guidance in the form of a revenue procedure, which is to say guidance that will provide a safe harbor that – if taxpayers meet it – we’ll not challenge their allocation of credit.”

“As we think through that,” Gerson said, “we are trying to come up with parameters that suggest that the deal that’s being struck between the developer and the tax credit investor will retain some element of entrepreneurial risk to share the upside and downside [in] the project that we think is needed in order to qualify as a tax partnership.”

 

Landmark Decision

In Historic Boardwalk Hall, the U.S. Court of Appeals for the Third Circuit held that the investor in a transaction challenged by the IRS wasn’t entitled to receive federal historic tax credits because it wasn’t a bona fide partner in a partnership for federal tax purposes. The court said this was because the investor lacked a meaningful stake in the success or failure of the enterprise generating the tax credits – the renovation and operation of Atlantic City’s historic former convention center. The court contended that the investor was fully protected against financial risk and the loss of tax credits and assured of a preferred return by guarantees and other features, and lacked any meaningful potential upside from the transaction beyond the tax credits and a preferred return.

After the decision, some major corporate investors stopped or sharply cut back their investment in new historic tax credit deals due to uncertainty about what partnership structures would pass muster with the IRS. Some investors paused but then resumed investing after getting advice from counsel regarding modified structures felt to be safe from challenge in the wake of Historic Boardwalk Hall.

The decision appears to have caused the greatest reduction in closings of “stand-alone” transactions planning to use only federal historic tax credits, and lesser impact for “twinned” deals combining historic with new markets or low-income housing tax credits.

Still Actively Investing

At the IPED seminar, panelists Mary Thompson of Bank of America Merrill Lynch and James Patchett of Goldman Sach’s Urban Investment Group said their companies are still investing in historic tax credit transactions but with modifications to their structures as the result of Historic Boardwalk Hall. For example, each said they now typically contribute at least 20% of their anticipated total equity upfront in order to take some construction risk. “There is no more pay as you go,” said Patchett. “You’re putting your capital in sooner.”

Patchett said the historic deals Goldman Sachs has been investing in still have a call option for the developer at fair market value, but “we prefer generally not to have a put.” In addition, he said, “We generally are incorporating flips as to cash flows beyond a certain [time] period, once we are able to show a certain level of return.”

A “flip” is a structure in which the size of the investor’s and the general partner’s interests in the partnership changes drastically at some future point after the investor has realized a certain level of return, such as 99%/1% in favor of the investor at the outset to something like 5%/95% in favor of the general partner when the flip occurs.

 

Modifications to Deal Features

Washington, D.C. tax attorney Jerry Breed, a partner at Bryan Cave LLP, said there were significant changes in the structures of the four or five stand-alone historic tax credit deals he has worked on that closed after the Historic Boardwalk Hall decision came down. These projects were of varied types, including mixed-use commercial/retail/residential, purely residential, and theaters.

Breed said some of the transactions have no priority preferred return for the investor while others have a small priority preferred return – typically 1% – that is not guaranteed. Pre-HBH, he said, a priority preferred return of 2% or 3% was typical, in some cases guaranteed and in other cases accrued and made up from future cash flows or residual proceeds if there wasn’t enough cash to fully pay it currently.

Breed said the deals were structured to provide the investor with a larger share of excess cash flow from the project during its operation, dependent on the project’s success. He indicated this was achieved by reducing fees and additional or supplemental rents paid to the landlord pursuant to a master lease.

“Pay-in schedules have been accelerated,” Breed said, noting at least 20% of the investor’s anticipated total capital is contributed at closing. “In the past it was frequently a smaller payment in upfront and more back end loaded,” he said.

Pre-HBH it was “not abnormal” to see a little bit of investor capital come in at closing and 90% come in at project completion, CPA Mark Einstein, a partner at CohnReznick LLP, said at the IPED conference.

As for guarantees provided by the general partner to the investor, Breed indicated that some of the guarantees at 100% were still provided, such as environmental and completion of construction. But he said operating deficit guarantees were reduced, capped, and burn off at a faster rate compared to what was typical before, and tax credit guarantees generally cut back to 80%.

Some of the transactions incorporated flips, Breed said.

He indicated that the partnership structures for his closed deals since HBH have all been different, with no uniform features and percentages. All, though, utilized the traditional master tenant structure.

Other sources also reported a variety in the structures of historic tax credit transactions closed since Historic Boardwalk Hall.

CohnReznick’s Einstein said he’s worked on four or five stand-alone historic transactions that have closed since the Historic Boardwalk Hall decision. Some had structures similar to those of pre-HBH deals, while others had some changes, such as more money in earlier by the investor, smaller guarantee percentages such as 80% for tax credit guarantees, and a larger participation in cash flow and other economics by the investor.

Einstein said his firm is currently exploring possible new twists in a couple of historic tax credit deals it is working on that haven’t closed, where the approach would be similar to a joint venture between the general partner and the investor. Under this approach, each would receive a preferred return of equal size, and, afterwards, share in cash flow in different amounts based on their economics, with the investor ending up with more cash flow if the project does well.