Section 8 Contracts (Comparability Studies)
Section 236 Interest Reduction Payment "Decoupling"
Tax Credits and Tax-Exempt Bonds
Housing Update is a publication of Pepper Hamilton LLP. The material in this newsletter is based on laws, court decisions, administrative rulings and congressional material, and should not be construed as legal advice or legal opinions on specific facts.
Requirements for this year’s HOPE VI funding round were included in the FY2000 HOPE VI NOFA, released February 24, 2000. Approximately $563.8 million was made available this year, with $513 million reserved for revitalization grants and $50 million for demolition projects. Revitalization awards for 18 communities have now been announced. As some direction to these awardees, HUD has this year instituted a safe harbor and maximum fee range policy for use in review of mixed finance proposals. The standards are not necessarily new, as we have seen them generally applied to proposals submitted previously, but they have been fleshed out over the last year, and will now be used to evaluate all public housing mixed-finance plans.
A. HOPE VI Revitalization Awards
The following is a listing of announced grantees:
Washington, D.C. - $30.8 million
Tucson, Arizona - $12.7 million
Milwaukee, Wisconsin - $11.3 million
Mercer County, Pennsylvania - $9 million
Savannah, Georgia - $16 million
Durham, North Carolina - $35 million
Newport, Kentucky - $28.4 million
Chicago, Illinois - $35 million
Biloxi, Mississippi - $35 million
Tacoma, Washington - $35 million
Seattle, Washington - $35 million
Memphis, Tennessee - $35 million
Chattanooga, Tennessee - $35 million
Oakland, California - $35 million
Richmond, California - $35 million
Norfolk, Virginia - $35 million
Danville, Virginia - $20.6 million
Camden, New Jersey - $35 million
Pepper Hamilton was most pleased to see that two of its clients were among this year’s grantees.
We have worked with the Camden, New Jersey Housing Authority over the last year and a half in its restructuring and application for HOPE VI and other funds. The Authority will use its award to revitalize the Westfield Acres development, which, when completed, will contain 270 public housing rental units, 30 tax credit rental units and 233 affordable home-ownership units, as well as a 12,000-square-foot community center. Grant monies and other leveraged funds will also pay for development of a 19,000-square-foot commercial center.
In Newport, Kentucky, where Pepper Hamilton is part of a team led by Jan Rubin Associates, the Newport Housing Authority will use grant funds to revitalize the Peter G. Noll, Booker T. Washington and McDermott-McLane housing projects. The HOPE VI grant will help to develop 150 public housing rental units, 96 market-rate units and 67 affordable housing rental units. The grant will also be used as leverage for funding economic and commercial development along the Newport waterfront, part of the City of Newport’s overall neighborhood and waterfront revitalization program, which is expected to initiate $300 million worth of economic redevelopment.
We congratulate all of this year’s recipients, and wish them good luck with their efforts to transform their communities. For those cities that have been unable to obtain HOPE VI funding, there remain viable options to combine public and private funds for implementation of substantial rehabilitation and new construction projects.
B. Safe Harbor Standards for Mixed-Finance Development
Over the last year, HUD has worked to develop safe harbor and maximum fee ranges for public housing mixed-finance developments. Until now, guidance on acceptable fee ranges by outside service providers has been less than explicit, and this new direction on HUD approval limits is expected to expedite the mixed-finance proposal review and approval process.
HUD will give cursory review of those fee arrangements that fit within its safe harbors. The Department also has set maximum terms, fees above which will only be approved in significant justification and unusual circumstance. The following is a brief summary of some of the HUD fee limits:
Net Developer Fees. For mixed-finance projects including tax credit investment, the safe harbor is set at 9 percent or less of total project cost, noting that projects without tax credits should have fees below the 9 percent level. The developer fee maximum is set at 12 percent of project costs. Developer agreements including fees above 9 percent should demonstrate a shifting of risk or burden onto the more highly paid developer. This shifting might include: large developer guarantees; developer responsibility for obtaining financing and equity investment; developer responsibility for site control, where it is obtained from other than the housing authority; developer responsibility to address small or complex projects, which may include unusual environmental, legal or political issues; or developer bears a large percentage of predevelopment costs.
PHA Administrative/Consultant Costs. In both HOPE VI and non-HOPE VI mixed-finance developments, housing authorities are expected to limit authority overhead and costs of outside consultants (i.e., program manager, development advisor, relocation specialists) to 3 percent of total project budget. The 3 percent safe harbor, however, can be exceeded by as much as 3 percent, for a maximum ceiling of 6 percent of total project budget.
Third-Party Cost Sharing. HUD will expect to see the housing authority split third-party costs with the developer by at least a 75/25 ratio. The developer may be reimbursed for its 25 percent at closing out of available funds.
Property Management Fees. HUD’s safe harbor provides for a fee of 6 percent of gross income, or an alternative per-unit fee based on market conditions. Fees higher than this will require significant justification.
Program Manager Fee. HUD will prefer to see a fixed-price contract with payment based on the meeting of specific milestones. The fee must also fit within the administrative/consultant costs described above.
Legal Fees. Housing authority funds may not be used to pay developer legal costs prior to closing. This is intended to motivate projects towards closing. There is no cap for PHA legal fees, but HUD will review all legal costs for the proposed project.
HUD will consider whether contract terms abide by its safe harbor policies when reviewing predevelopment and development agreements, program manager contracts, mixed-finance proposals and other negotiated contracts. Housing authorities, developers and consultants should consider HUD’s guidelines when negotiating terms and drafting documents for HUD review.
Section 8 Contracts (Comparability Studies)
On June 29, 2000, HUD released revised procedures for establishing market rents in evaluating renewal terms for expiring HAP contracts. Notice H00-12 allows owners some flexibility and advantage over prior guidelines, which often left projects subject to subsidized rents at less than comparable levels. The new procedures cure several difficulties faced by owners under previous procedures, and have so far proven beneficial to certain of our owner clients.
Each year owners of subsidized projects with approaching HAP contract expirations must evaluate the terms for renewing their Section 8 subsidy. Current renewal procedures provide several options to owners depending on their circumstance.
Mark-Up-to-Market allows most below-market rate properties to renew at rents increased to market levels or at current rents adjusted by an Operating Cost Adjustment Factor (OCAF). Properties with rents already at market levels may renew at current rents. Properties with rents above market rates must either enter HUD’s Mark-to-Market program, or renew at subsidy levels reduced to comparable market rents (for a comprehensive discussion of owner renewal options, please see the May 2000 issue of the Housing Update).
The key to Section 8 renewal levels continues to be the comparability study. Most HUD renewal options require that an owner obtain a comparability study and submit it to HUD not later that 120 days prior to contract expiration. Those hoping to obtain contract renewals at the highest possible subsidy levels are best served by an accurate comparability study that reflects high market rents in their area. HUD’s revised comparability study procedures allow for greater accuracy in determining local market rent levels.
A. Prior Comparability Study Rules.
Under prior rules, as contained in Notice H99-36, an owner choosing not to opt-out at contract expiration was, in most cases, required to engage an independent appraiser to prepare a comparability study for submission to HUD not later than 120 days prior to contract expiration. Among other things, instructions contained in the Notice prohibited the use of subsidized or partially subsidized properties as comparison projects.
For other than Mark-up-to-Market renewal applications (renewals of contracts with rents at or below market without a rent increase), HUD was not required to obtain its own comparability study for comparison to the owner’s. Instead, the Hub Director was instructed to use "judgment" in accepting or rejecting the owner’s market evaluation.
For Mark-Up-to-Market renewals, after receipt of the owner’s study, HUD would obtain its own market study, and H99-36 provided a specific methodology for evaluating the owner and HUD results to determine a final comparable market rent level for the property. Owners were not permitted to negotiate or appeal HUD’s final Mark-Up-to-Market determination.
B. New Comparability Study Rules.
Notice H00-12 now provides project owners with several options for supplying HUD with comparability data. The revised procedures also allow the use of unsubsidized units in partially subsidized properties as appropriate for evaluation of market rents.
Below Market Properties. Projects with expiring contracts that provide subsidy at or below comparable market rent levels generally have two options for contract renewal. They may request a renewal at current rent levels, increased by an OCAF. Owners requesting this renewal option may request a contract of between one and five years. If they choose a one-year renewal, the following year, upon expiration, they may either opt out of Section 8 or choose to go through the renewal process again. Alternatively, owners may choose to renew under Mark-Up-to-Market procedures. Not all projects are eligible for this treatment, but those that are will receive a new contract with rents increased to comparable market rent levels. Owners choosing this option must commit to remain in the Section 8 program for five years.
Under prior guidance, all below-market rent properties with expiring HAP contracts were required to engage an independent appraiser to prepare a comparability study for submission to HUD. Under H00-12, owners of properties wishing to renew at current rent levels without a Mark-up-to-Market adjustment, or those ineligible for Mark-up-to-Market, are able to renew their contracts without obtaining a comparable market study, where facts strongly suggest the renewal rents will be below market rents.
Renewal Without Comparability Study. Owners not interested in, or ineligible for, Mark-up-to-Market renewals (do not want to commit to a five-year renewal, are ineligible due to long-term use restriction or low REAC inspection score, etc.) may now choose an alternative method to determine market rent ceilings for their new HAP contracts. Rather than obtaining a comparability study to establish a market rent, owners may instead select from two options for determining a default market rent cap.
FMR Rents. The first option allows owners to renew at or below a default market rent calculated using HUD Fair Market Rents (FMR) for the area where the property is located. Rather than establishing a true comparable market rent, an owner may choose to accept an artificial market rent, set at 75 percent of FMR. Under this option, owners may demonstrate that their current rents, adjusted by an OCAF, or budget-based increase, will not exceed 75 percent of FMR, and they may then receive a renewal for one to five years with rents set at or below this default market cap (future renewals adjusted by an OCAF or budget-based review). This option will be attractive to projects in areas with high FMRs, but will of course hold little interest for owners with projects in regions where FMRs are set well below actual market levels.
Partially Subsidized Projects. Owners of partially subsidized projects have an additional alternative. Rather than obtaining a comparable market rent study, the owner of such a project can also accept a default market rent cap. The default market rent for Section 8 units in a partially subsidized project will be set at the average of all rents paid by unsubsidized tenants in that property. So long as subsidized unit rents do not exceed those of the project’s market rent units, the owner can request a HAP contract renewal at current rents adjusted by an OCAF. In order to be eligible for this option, at least 25 percent of a project’s units must be rented to tenants paying full rent, without the benefit of any tenant rental assistance, federal, state or local. Additionally, the unsubsidized units must be of substantially identical quality, amenity and size, and the occupancy of unsubsidized units must not be significantly below that of subsidized units.
Neither option is mandatory. An owner eligible for either may choose instead to obtain and submit to HUD a comparability study establishing a comparable market rent cap for renewal. In either case, HUD may reject an owner’s request to renew under these alternative methods. Under the FMR cap method, HUD may determine that the project is of unusually limited appeal or quality. HUD may also determine that unsubsidized units in a partially subsidized project are of significantly greater quality, or suffer high vacancy indicating rents being charged are too high. If HUD does reject the owner’s request, it will issue a short-term HAP renewal to allow the owner time to engage an appraiser to perform a complete comparability study.
Mark-Up-to-Market Comparability. The most popular option for owners of eligible projects with current rents below comparable market levels will likely be renewal of their contracts at subsidized rents increased to market levels under Mark-Up-to-Market procedures. Notice H00-12 did not change the requirement that owners requesting Mark-Up-to-Market treatment submit a full comparability study; nor did the Notice introduce any appeal process in the event HUD’s determination of comparable rents differed greatly from that of the owner’s appraiser. Nevertheless, the notice does give greater detail on comparability study requirements and proscribes more definite criteria to be considered by appraisers.
According to the Notice, comparable units should:
1. be in the same market area
2. not be receiving rental assistance (although unsubsidized units in partially subsidized projects may be used)
3. be located in projects of similar size, age, design, etc.
4. have similar neighborhood characteristics (crime, employment, transportation, etc.)
5. provide similar amenities and services (this is most important for elderly projects)
6. not be rent restricted of controlled (HOPE VI, LIHTC, 236, BMIR, etc.).
Perhaps most significant, the revised comparability procedures allow for consideration of unsubsidized units in subsidized projects. Prior guidance disallowed the review of any units in a subsidized property, even where those units rented at market rates, and provided the only source of truly comparable housing in the area. We have worked with several clients of elderly and handicapped housing properties attempting to find unsubsidized but similar projects in their area.
For Mark-Up-to-Market renewals, HUD must obtain its own comparability study to compare to the owner’s. If these two studies differ, which we are surprised to find is almost always the case, HUD will use a formula contained in Notice 99-36 to determine final comparable rents. HUD’s determination of rents for Mark-Up-to-Market projects may not be appealed and must be accepted by the owner.
Obtaining appropriate comparability figures has been difficult for many specially designed projects in small cities, where all elderly projects may be subsidized to some extent. Additionally, HUD field offices have been bound by rules requiring that they abide by the findings of their appraiser. Where HUD’s comparability study is in error, or less than reasonable, some offices have nevertheless felt bound by its results when setting rents.
Despite the prohibition on appeals for Mark-Up-to-Market comparability determinations, in some cases we have been able to work with the HUD field office to request that their appraiser look at additional considerations or adjustments before making their appraisal final. In others, where no wholly unsubsidized comparable projects have been available (elderly projects in small urban areas or rural projects) some clients have had to accept rent increases to less than truly comparable levels. In these cases, we have advised acceptance of short-term renewals while pressure moved HUD’s latest rules forward. The ability to utilize partially subsidized projects as part of the comparability study will likely result in equitable treatment of these properties upon the expiration of their short term contracts. Additionally, owners accepting one- and two-year renewals under the prior comparability procedures may now have an opportunity to revisit their rents upon contract expiration under H00-12 revised criteria.
Comparability for Other Projects.
Owners of projects ineligible for Mark-Up-to-Market, or the alternative methods for establishing a default market cap as described above, or those receiving above-market subsidized rents but willing to accept renewals at rent levels reduced to market, are still required to obtain and submit to HUD a comparability study.
In non-Mark-Up-to-Market renewals, the field office is not instructed to obtain its own appraisal for comparison. Notice H00-12 requires that no owner appraisal for these renewals may be rejected prior to review by a state-certified general appraiser who has concluded rejection is warranted. Acceptance of the owner’s study, however, does not require the HUD appraiser’s concurrence.
Rejection letters must contain either instruction that the study must be redone or specific challenge to conclusions, with suggested alternative treatment. Whether an acceptance or rejection, HUD’s results should be forwarded to the owner within 30 days of owner submission. HUD may also ask the owner’s appraiser to provide additional information to assist in its review. The new notice contains a specific and multi-level appeal process for owners differing with HUD’s determination. The time periods for owner action, however, are short, and any appeal activities should be undertaken without delay.
In all cases, given the need for planning a project’s future long before the date of its HAP contract expiration, as well as the back log of appraisal reviews we have seen in many field offices, all owners of Section 8 projects with upcoming expirations should become familiar with renewal, notice and comparability study requirements. We have had much greater success in assisting owners obtain HAP contract renewals on favorable terms where they have investigated their options and circumstance well prior to contract expiration. Where owners have been inattentive until the final weeks of their contract terms, they have incurred additional costs and, in some cases, obtained less favorable results than would have otherwise been the case.
Section 236 Interest Reduction Payment "Decoupling"
Over the past three years, HUD has approved more than 30 restructuring plans for Section 236 projects involving the termination of FHA insurance, while retaining the benefits of interest reduction payments (IRP) for application to additional financing. Our experience has largely involved the transfer of ownership to a new entity, utilizing additional debt for purchase costs and rehabilitation. The retention of the IRP has been critical to ensuring units remain affordable while allowing these aging projects to receive the substantial rehabilitation they require.
Each such restructuring has, in the past, proceeded with significant negotiation between HUD and the potential purchaser. The procedures and outcomes for such transactions were ill defined, and generally accomplished on a project-specific basis, in consideration of individual circumstance.
On May 16, however, HUD issued Notice H00-8, containing guidelines for these transactions. The new guidelines were published in response to increased interest in preservation of Section 236 projects and specific authorization for the decoupling of IRP contained in the FY2000 HUD/VA Appropriations Act, passed last October (P.L. 106-74). The Act added Section 236(e)(2) to the National Housing Act, along with other modifications, allowing for IRP to be transferred from the prepaid mortgage to new financing.
The Notice describes two mechanisms by which additional debt may be incurred in order to provide for refinancings, purchases and rehabilitation of Section 236 projects, while retaining the benefits of IRP. Both types of transactions require an extension of property use restrictions, as well as the retention of limitations on distributions to property owners.
Section 236(b). Under Section 236(b) transactions, FHA insurance is terminated and a HUD-approved state or local agency must agree to purchase the uninsured mortgage. The original mortgage remains intact and is "wrapped" with additional financing. The remaining IRP is generally securitized to provide support for a portion of this additional debt. Any mortgagee may provide the new financing, but the state or local agency will be largely responsible for project oversight.
Section 235(e)(2). Under Section 236(e)(2) transactions, the Section 236 mortgage is prepaid, and the IRP is applied to the new financing. The IRP may be reamortized to provide interest reduction over a longer period (with a corresponding reduction in monthly IRP benefit). Any mortgagee may provide the new financing, provided a public agency agrees to provide project oversight. If no state or local authority is willing to provide oversight, the Notice requires that a HUD-approved lender act as mortgagee and the new mortgage be FHA-insured.
Extended Use Restrictions. In either scenario, the owner will execute a new use agreement requiring that the project continue to be operated under rules governing Section 236. If the term of the IRP is not extended, the use restrictions will extend for a term of five years beyond the original Section 236 mortgage maturity date. If the IRP is extended, under a 236(e)(2) transaction, the use restrictions will remain in place for five years beyond the new IRP term. Most of these projects, however, are 25 to 30 years old. The original mortgage amortization would not extend beyond the term of any tax-exempt bond or tax credit use restrictions that would be executed as a result of such programs being utilized as part of the new financing structure.
In addition to the extended use restriction, H00-8 also makes clear that no tenants currently residing in Section 236 projects may be subject to involuntary displacement as a result of decoupling. This requirement seems to provide a protection for tenants, even if their incomes exceed 100 percent of median income. The restriction will be most troubling to owners and purchasers hoping to utilize tax credits as a source of funding. Over-income tenants will require a reduction in tax credit eligible units, reducing potential tax credit proceeds. This difficulty will not necessarily be mitigated by enhanced vouchers, as these may be made available to tenants with incomes at 80 percent of area median income (AMI), and tax credit units must be restricted to families earning no more than 60 percent of AMI.
Restricted Rents. The Notice also provides some uncomfortable rent restriction requirements. Rents for unsubsidized projects under either 236(b) or 236(e)(2) will be restricted to 236 Basic Rents, although owners may request an increase using 236 budget-based procedures. For this purpose, new financing may be included in the budget-based rent increase request as an operating expense.
Projects with Section 8 contracts may request that their rents be established under HUD’s current Section 8 renewal policies, which allow for Mark-Up-to-Market, less an amount calculated based on the benefit the project receives from IRP payments.
In both cases, rent increases are capped at comparable market rents (although rents will not be reduced if Basic Rents are currently above comparable market levels ). Notwithstanding the potential for higher rents, however, Hub directors are prohibited from approving rent increases of greater than 10 percent (although HUD Headquarters may approve higher rents). With only a 10 percent rise in rents, and given the condition of this aging portfolio, it is likely that many transactions will be unable to provide sufficient debt funding to finance the substantial rehabilitation that is required. Funding shortfalls may be further exacerbated where tax credit equity is reduced due to tenants with incomes greater than the LIHTC limits.
Distributions. Distributions to owners are restricted under either type of restructuring. Where the original 236 mortgage remains intact (i.e., 236(b) transaction), the distribution will be based on 6 percent of the equity invested at the project’s original Section 236 financing. This essentially restricts cash flow to owners based on a distribution calculation made 25 to 30 years ago. Where there will be new FHA insurance or a Risk Sharing Loan with new equity from tax credit investment, the owner may receive an annual distribution "based on a 10 percent on 10 percent of the amount of the new mortgage debt."
Applications. Proposals for Section 236 IRP restructuring or decoupling must be submitted to the Multifamily Hub office with jurisdiction over the project. The Hub must review the financial feasibility of the plan, taking potential rent increases and rehabilitation into account.
While we have seen successful restructurings in the past, even prior to publication of H00-8 we have seen failures where substantial rehab requirements exceeded the potential for rent increases and other funding, even where 100 percent of the units were tax credit eligible and other local funding was made available. Although the Notice goes far in standardizing the treatment of these transactions, we expect that individual project tenant profiles, physical characteristics, locations and subsidy availability will continue to require unique planning and considerations. In our experience, these projects do not fit into any single cookie-cutter mold.
Tax Credits and Tax-Exempt Bonds
A. Legislative Activity
As was the case last year and the year before, several bills have been introduced in Congress to increase the Low Income Housing Tax Credit ceiling. Despite support from the administration, the affordable housing industry and dozens of co-sponsors, no increase has so far been enacted into law.
On March 9, the House passed, as part of its minimum wage bill (H.R. 3081), an incremental increase in the tax credit cap from $1.25 to $1.65 per capita over a four-year period beginning in 2001, with a subsequent indexing to inflation. H.R. 3081 also included an acceleration of the scheduled increase in private activity bond volume cap. Currently, the bond volume cap will increase beginning in 2003, and then continue to rise over the following four years until it sets at the greater of $75 per capita or $225 million.
The minimum wage legislation, however, is having difficulties of its own, and so, on July 25, the House also passed tax credit and bond provisions as part of its community renewal bill (H.R. 4923). H.R. 4923 would raise the LIHTC cap to $1.75 per capita by 2006, with future increases indexed to inflation. Additionally, the bill would begin a phased-in increase of the private activity bond volume cap in 2001, with incremental increases to follow each year through 2007, and indexing to inflation thereafter. The bill would also make certain administrative changes to the tax credit program, as promoted by Rep. Nancy Johnson (R-CT) over the past two years. Rep. Johnson has repeatedly proposed revising selection criteria for tax credit allocations by state authorities, including the removal of participation by local nonprofits as a criteria and introducing a homeownership incentive.
Although H.R. 4923 appears to be the most likely vehicle for this year’s efforts, the Senate’s version of the bill, S. 2779, is stalled. The bill was unsuccessfully offered by Sen. Rick Santorum (R-PA) as an amendment to the Senate’s estate tax relief bill (H.R. 8). The amendment, however, was rejected — not that the President is likely to sign the Senate’s estate tax relief bill anyway.
B. Private Letter Ruling (PLR) for Tax Credit/Tax-Exempt Bond Project
The Internal Revenue Service recently surprised those involved with tax credit projects partially financed with the proceeds of tax-exempt bonds. The ruling, dated May 30, 2000, but which will not be published until the end of August, provided a stricter interpretation of the tax-exempt bond 50 percent test than some would have expected, and has put some doubt into the ability of developers to use both 9 percent and 4 percent credits in the same acquisition/rehab project.
The entity requesting the PLR had planned to acquire an existing building and land using tax-exempt bonds and 4 percent credits. The bond proceeds exceeded 50 percent of the building and land purchase price, and would be used exclusively for these acquisition costs (and bond issuance costs). With the 50 percent test met, the developer expected to receive 4 percent "automatic" credits, without the need to apply for state housing credit volume cap. The project was to be rehabilitated with the proceeds of taxable bonds and other funds, as well as an allocation of 9 percent rehabilitation credits.
The developer proposed that the rehabilitation work be treated as a separate building, allowing the acquisition portion of the transaction to meet the 50 percent test, thus qualifying for the "automatic" credits. With the tax-exempt bond financed portion distinguished from the rehab portion, the developer could also avoid the rehabilitation being treated as part of a federally subsidized project for the purposes of Section 42(i)(2) of the Code, therefore making the rehabilitation work eligible for 9 percent rather than 4 percent credits.
The Service ruled against the developer on both counts, and muddied the waters a bit about whether personal property might be included among project costs for determining the costs of a building when calculating the 50 percent test.
The developer asked that the Service recognize its use of the not uncommon method of tracking funds to designate the tax-exempt bonds as a financing source used exclusively for the acquisition. Largely ignoring the legislative history it cites in the PLR, the Service concluded that the purchase of the building and the rehabilitation work would not be treated as separate projects. Stating that the rehabilitation would be indirectly benefited by the tax-exempt bonds, and noting that the tax-exempt bonds issued for the acquisition and the taxable bonds issued for the rehabilitation closed on the same date with the same trustee, the Service concluded that the proposed two transactions involved a single financing plan. As a result, the entire project would be considered federally subsidized, making the rehabilitation ineligible for 9 percent credits.
Also noting its view that the aggregate basis of a building for the 50 percent test includes all property, including Section 1245 property (which includes personal property), together with any functionally related and subordinate facilities, the Service concluded that the rehabilitation expenditures would be included in the building costs for determining its total basis. The tax-exempt bonds, issued to finance 50 percent of the building and land acquisition only, would not be sufficient to cover 50 percent of the project’s combined acquisition and rehab costs. Therefore, the project would fail the 50 percent test and not benefit from 4 percent automatic credits.
The ruling is somewhat surprising, given prior guidance by the Service indicating that tracing tax-exempt funds to specific portions of projects would be permissible in certain circumstances. It is possible to structure these transactions with separate financings, but the Service gave little indication as to what circumstances would allow it to conclude that the financings are indeed not part of a single plan. Some tax credit professionals will likely look to tax-exempt bond regulations for guidance, but designing transactions with separate bond "issues" under those regulations will impose significant additional and duplicate costs, and create delays that may be impractical in the context of tax credit projects.
Private letter rulings do not provide precedential guidance. They apply only to those to whom they are addressed. Nevertheless, they do indicate positions the IRS is likely to take in similar circumstances. Those planning to undertake projects similar to that described in this PLR should consult knowledgeable counsel before moving forward.