Tax credit development is used as an incentive for promoting the development of more affordable housing into the market place. This ranges from multifamily housing to single family housing and assistant living facilities. The tax credit incentive offers tax deductions to private equity investors as a way to pump more investment dollars into the housing market. Private equity investors experience a 100% tax credit deduction per dollar invested. These deductions are taken off from the investors ordinary income for normally around a 75% to 85% of their investment. Below is the general structure of a traditional tax credit project.
• Both tax credits and tax deductions are available only to the owners of a property. That makes it necessary to structure the ownership of a low-income housing project carefully, so tax benefits go to the parties to whom you want them to go.
• A tax credit syndication normally is done using a real estate structure called a limited partnership. In this structure, the project is owned by a legal entity called a limited partnership. The limited partnership has a limited partner and a general partner.
• Control of the project, reporting responsibilities and tax matters need to rest with its sponsor. This is done, typically, by having the sponsor create a single-purpose subsidiary to be the general partner of the partnership.
• The general partner normally retains a 0.01% ownership interest in the partnership. The general partner is typically a single-purpose, for-profit subsidiary of the sponsor.
• Usually, there are tax benefits to the partnership if the general partner is a for-profit rather than a nonprofit corporation. These stem primarily from a more rapid depreciation rate on the project, which reduces taxable income and, by extension the partnership’s income taxes.
• An investor who can use the project’s tax benefits purchases, as the limited partner, a limited partnership share in the partnership. The ownership share purchased by the limited partner typically is 99.99% of the partnership.
• It is important for legal reasons that a limited partner making such an investment in a project not have any responsibility for normal operations of the project. The “limited” portion of a limited partner refers to liability. The limited partner’s risk is limited to loss of its financial investment. If it has operating responsibility, its liability may increase to match the general partner’s. Most limited partner investors do not want that risk.
• Tax benefits are handled differently from operating responsibility. Most tax benefits need to be available to the investor in the project. This allows the limited partner to maximize its equity investment in the partnership.
• In return for its equity investment in the partnership, the limited partner gets most of the low-income housing tax credits available to the project. It also receive the tax benefits related to any tax losses generated through the project’s operating costs, interest on its debt and non-cash deductions such as depreciation and amortization.
• Because the limited partner owns 99.99% of the partnership, it receives 99.99% of the tax credits and tax losses generated by the project. This is the way the limited partner gets virtually all of its financial return for its investment.
If done correctly, the developer, the tax credit equity syndicator and most importantly, the community where the development is done will benefit greatly project. Tax credit development is one of the most successful government enhanced programs in the marketplace and they yield great long-term benefits to community revitalization and redevelopment.