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In August 2012, the Historic Boardwalk Hall case brought deals with a very common and appealing transaction structure to a crashing halt.


Court Ruling Slows Historic Tax Credit Projects

  • Luke Pope
  • 12/3/2013

The Federal Rehabilitation Credit, also known as the Historic Tax Credit (HTC), has been a great source of funding for developers for the past 35 years. It is a means of acquiring funding without incurring high levels of debt. But a 3rd U.S. Circuit Court of Appeals ruling has erased much of the appeal of the credit, putting the brakes on some existing projects and leaving the future of new projects in limbo.

Under current law, a federal income tax credit of 10 to 20 percent is allowed for qualified rehabilitation expenditures (QREs). Funding is often obtained through outside investors with large tax liabilities (typically large corporations) who contributed capital to these rehabilitation deals in exchange for the majority of the credits.

The basic transaction calls for an investment in a partnership at some cost below the value of the credits. There would be a nominal preferred rate of return on the original investment. After the five-year recapture period for the HTC, a put or call option would be exercised by the developer to allow the investor to exit the deal.

Historic Boardwalk Hall case

In August 2012, the Historic Boardwalk Hall case brought deals with this appealing transaction structure to a crashing halt. The Appeals Court ruled that unless there was economic risk to the investor, there was no partnership, and the credits could not be transferred to the investor. If the deal looks more like a sale of tax credits than a true partnership, the deal will be at risk in an IRS examination.

What does this mean for developers and investors?

Since the Appeals Court ruling, there has been a shortage of investors willing to invest in HTC projects. When investors are interested in a project, the amount they are now willing to contribute has decreased because they are required to accept some risk.

For the developer, there is no longer a guarantee that the investor will exit after the five-year recapture period. If a project is performing well, investors may not want to exit the deal, and developers will now be required to pay fair market value to force the exit. This more complicated exit scenario eliminates the appeal of allowing outside investors into the deal in the first place.

Existing deals

Deals already in place are not invalid where the facts indicate that the deal meets the IRS standards for a true partnership. For instance, call options must be structured at fair market value and must be reasonably likely not to be called. As a general rule in cases like these, as a credit partner’s economic risk decreases, tax risk increases.

Waiting for guidance

Options for structuring HTC projects remain uncertain. The Supreme Court has declined to review the Historic Boardwalk Hall case, so unless a similar case arises, it stands as the standard for HTC deals. Developers, investors, and the professionals who help structure these deals hope for more straightforward guidance soon. The IRS Priority Guidance Plan includes guidance for rehabilitation tax credits. But for the present, it appears there may be fewer investors ready to come forward to accept higher levels of risk.