Issue: What are the various disposition options and related accounting for year 15 lowincome housing tax credit (LIHTC) projects?

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1 Issue: What are the various disposition options and related accounting for year 15 lowincome housing tax credit (LIHTC) projects? Analysis/Input Generally, nonprofit sponsors that are involved in LIHTC projects will exercise one of the following options at the end of the 15-year LIHTC compliance period: 1. The nonprofit sponsor will acquire the investor partnership interest and continue to operate the partnership entity; 2. The nonprofit sponsor will acquire the investor partnership interest and re-syndicate the property; 3. The nonprofit sponsor will acquire the investor partnership interest with the intent of selling the property to a third party; or 4. The partnership will sell the property to a third party. The fourth option generally occurs when the investor and general partner cannot come to terms on how to exit the LIHTC transaction, and the general partner does not exercise a buyout option. Most investors plan to dispose of their investor partnership interests at the end of the 15-year compliance period. Accordingly, the partnership agreement may contain a buyout option of the investor s partnership interest. The buyout option price is typically the greater of the fair market value of the partnership interest (determined by a third party appraisal) or the amount of investor unpaid benefits plus exit taxes. Also, the partnership agreement may contain a put option that obligates the general partner to purchase the property or the investor partnership interest at the end of the compliance period. In this case, the partnership agreement will include a formula to determine the put price. Finally, the exit transaction may be structured as a partial sale and partial charitable donation. If the market value of the property exceeds the debt on the property, the charitable donation will mitigate exit taxes for the investor (see the Tax Accounting Considerations section below for additional information on exit taxes). Accounting Issues and Mechanics GAAP Accounting Considerations The Four Options Nonprofit syndicators who will acquire the investor partnership interest and continue to operate the entity (option 1) will generally set up a new LLC to acquire the investor partnership interest. Accounting for the acquisition of the investor partnership interest will vary depending upon whether a change of control over the partnership has taken place. If the partnership was already determined to be controlled by the entity acquiring the investor partnership interest (and should therefore, have already been consolidated), then the transaction will be recorded at cost and no gain or loss would recorded. If acquisition of the investor partnership interest results in new control over the partnership, then the acquisition may be accounted for using either the book value of the partnership interest or its fair value. Additionally, soft debt is often forgiven after the transfer of the partnership interest to the nonprofit sponsor. Accounting for operations continues normally; due to control remaining the same 1

2 as before the change in interest, and operations will continue to be consolidated into the parent organization. The accounting considerations for a nonprofit sponsor that will acquire the investor partnership interest and re-syndicate the property (option 2 above) are generally the same as those for option 1. The nonprofit in this situation will re-syndicate the property with a new limited partner at some point in the future. If there is no change in the control structure, consolidation of the entity into the parent company will continue as before. For the nonprofit sponsor that will acquire the investor partnership interest with the intent of selling the property to a third party (option 3 above), the accounting considerations will generally be the same as options 1 and 2, until the sale of the property occurs. The nonprofit sponsor will consolidate the property until the property is sold to a third party at some future date. Once the property is sold, the nonprofit sponsor will accordingly record a gain or loss on the sale of the property. Similar treatment will apply when the partnership sells the property outright at the end of the 15-year compliance period (option 4 above). It is important to note that while the nonprofit sponsor will likely continue to consolidate the partnership after year 15, in many cases the nonprofit sponsor will own 100% rather than 1% of the partnership and will therefore take additional loss at the parent entity. Lenders may have questions about the effect the change in ownership and additional loss will have on financial covenants. Nonprofit sponsors should consider discussing these changes with the lenders early on. See Exhibits A and B for examples in which the nonprofit sponsor acquires the investor partnership interest with varying balances of the limited partner s capital account. GAAP Accounting Considerations Consolidation The consolidated financial statements of the nonprofit sponsor will likely remain substantially the same before and after the 15-year compliance period. The nonprofit sponsor generally consolidates the property before the end of the 15-year compliance period due to general partner control. Once the nonprofit sponsor purchases the investor partnership interest, the nonprofit sponsor will continue to have control over the partnership. Since control has not changed, there is no revaluation of the property at fair market value. The purchase of the investor partnership interest should not have any effect on the statement of activities since the year 15 transaction is capital in nature. GAAP Accounting Considerations Interest is greater than the limited partner capital account If the purchase price of the investor partnership interest is greater than the limited partner capital account, the nonprofit sponsor will record the purchase at book value or at the amount paid. Generally, if there is a material difference between the amount paid for the investment and the nonprofits proportionate equity in the investee s net assets at acquisition, the difference should first be related to specific assets of the investee. Any difference that cannot be related to specific assets is considered to be attributable to goodwill. The nonprofit, would then adjust the investment account and investment earnings by an amount 2

3 that represents the additional depreciation or amortization related to the difference as if it were actually recorded by the property. If the difference between the amount paid for the investment and the nonprofit s equity in the investee s net assets at acquisition is immaterial, the nonprofit sponsor may consider taking losses to match the investment and underlying net assets. GAAP Accounting Considerations Interest is less than the limited partner capital account If the purchase price of the limited partner interest is less than the limited partner capital account, the nonprofit sponsor may need to record impairment at the partnership level. The lower purchase price may be an indicator of impairment of a long lived asset at the property level. The organization should review the asset for impairment in accordance with their normal accounting policies and make any impairment adjustments as needed. Tax Accounting Considerations The withdrawing investor limited partner will need to consider exit taxes and how they are calculated. Exit taxes occur when the cumulative tax losses exceed the investor s invested capital, resulting in a negative tax capital account. Upon disposition of the investor s partnership interest, or disposition of the project, the investor will recognize a taxable gain, resulting in an exit tax liability. See Exhibit C for an example calculation of exit taxes. CFO Group Input and Conclusion The CFO Group believes that some of the key considerations to keep in mind when accounting for year 15 transactions include: 1. Being aware of when the compliance period ends; 2. Implementing the correct accounting for the disposition option that was chosen; 3. Considering exit taxes and exit tax ramifications on the proposed disposition option; 4. Forecasting or projecting out the disposition prior to year 15; and 5. Consulting with accountants, the development team and others upfront about the options available for year 15 transactions and how structure will impact accounting. Additionally, nonprofit sponsors may want to keep in mind that investors may be willing to exit the transaction prior to year 15, especially if there are many accumulating losses that reduce the capital account. 3

4 Acknowledgements STRENGTH MATTERS gratefully acknowledges the work of staff from Novogradac and Company LLP, The Reznick Group, and Lindquist, von Husen & Joyce LLP and the following individuals that contributed to this paper: Allison Clark, The John D. and Catherine T. MacArthur Foundation, Chicago, IL Ann Clift, Foundation Communities, Austin, TX Vince Dodds, Mercy Housing, Inc., Denver, CO Gayle Harrold, Madison Park Development Corporation, Boston, MA Caroline Horton, AEON, Minneapolis, MN Joe Kasberg, National Church Residences, Columbus, OH Chris Madden, NeighborWorks America, Kansas City, MO Jeff Reed, Community Housing Partners Corporation, Christiansburg, VA Jon Schwartz, Community Housing Works, San Diego, CA Harry Thompson, Community Preservation & Development Corporation, Washington, DC D Valentine, BRIDGE Housing, San Francisco, CA Mary White Vasys, Vasys Consulting Ltd, Chicago, IL Laura Vennard, Preservation of Affordable Housing, Inc., Boston, MA Last Updated February 15, 2011 DISCLAIMER This paper contains certain recommended financial reporting best practices for nonprofit affordable housing organizations that develop and own affordable housing in the United States. This paper was developed by a working group comprised of chief financial officers from certain leading nonprofit affordable housing organizations active in the networks of NeighborWorks America, Housing Partnership Network and Stewards of Affordable Housing for the Future, as well as representatives of socially responsible lenders, working in conjunction with representatives from Novogradac and Company LLP, The Reznick Group, and Lindquist, von Husen & Joyce LLP, three independent public accounting firms. This publication should not be construed as accounting or other advice on any specific facts or circumstances. The contents of this paper are intended for general informational purposes only, and you are urged to consult your accountants and other professional advisors concerning your specific situation and any financial reporting or accounting questions you may have. For further information, contact info@strengthmatters.net. 4

5 EXHIBIT A THE NONPROFIT ACQUIRES THE LIMITED PARTNER INTEREST AND THE LIMITED PARTNER CAPITAL ACCOUNT IS ZERO (OR LESS THAN THE PURCHASE PRICE) Assumptions: Limited Partner capital account is zero at year 15 The nonprofit entity acquires the limited partner interest for $50,000 Remaining useful life of the real estate investment is 12½ years The nonprofit continues to consolidate the project Results: The new Limited Partner investment is recorded on the nonprofit books at cost or in this case $50,000, as follows: Purchase of partnership investment $50,000 Cash $50,000 The nonprofit now owns 100% of the project through wholly owned subsidiaries; however the cost basis to the parent is $50,000 higher than the basis they acquired. This difference, if material, should be amortized over the remaining life of the underlying real estate. Each year the entry to amortize the $50,000 basis would be as follows: Depreciation expense $4,000 Purchase of partnership investment $4,000 This entry allows the nonprofit, to adjust the investment account and investment earnings by an amount that represents the additional depreciation or amortization related to the basis difference as if it were actually recorded by the property. This entry would be done until the difference is eliminated. For consolidation purposes the $50,000, net of accumulated depreciation would increase the property book value and the depreciation of $4,000 would increase the project's depreciation expense. 5

6 EXHIBIT B THE NONPROFIT ACQUIRES THE LIMITED PARTNER INTEREST AND LIMITED PARTNER CAPITAL ACCOUNT IS GREATER THAN THE PURCHASE PRICE Assumptions: Limited Partner capital account is $100,000 at year 15 The nonprofit entity acquires the limited partner interest for $50,000 Remaining useful life of the real estate investment is 12½ years The nonprofit continues to consolidate the project Results: The new Limited Partner investment by the nonprofit is recorded at cost or in this case $50,000, as follows: Purchase of partnership investment $50,000 Cash $50,000 The nonprofit now owns 100% of the project through wholly owned subsidiaries; however the cost basis of the parent is $50,000 less than the basis they acquired. The nonprofit entity reviews its investment for impairment and determines tha tthe project investment is only valued at $50,000. The project entity must incur an impairment charge and write the asset down to its fair value. That entry would be as follows: Impairment expense - property $50,000 Property $50,000 This entry now aligns the book value of the project assets to the purchase price of the project. In this situation the investment account on the nonprofit will easily eliminate in consolidation with the capital account of the project investment. If the nonprofit determines in its review of the investment that there is no impairment of the property, there would then be a carrying difference in the nonprofit's basis of the partnership investment and the equity of the capital account. In the example above, there would be $50,000 of excess capital at the property level that would not be eliminated in consolidation. This excess would appear in the consolidated financial statements as capital and would remain a difference until the investment is disposed or an impairment charge is made. 6

7 CALCULATIONS OF EXIT TAXES EXHIBIT C The Limited Partner sold its interest in the partnership to the General Partner for a sales price equal to the debt plus exit taxes. The capital account balance for the Limited Partner is ($100,000). The Limited Partner's tax rate is 35%. Exit Tax Calculation: ($100,000) x 35% = $35,000 exit tax To gross up the exit tax in order to cover the tax on the exit tax (income to investors), apply a gross up factor of 1 + tax rate (1 + 35% = 1.35) The grossed up exit tax would be: $35,000 x 1.35 = $47,250 7