Affordable Housing Update

    View Author February 2007
    Revenue Procedure 2007-20

    On January 26, 2007, Revenue Procedure 2007-20 (Rev. Proc. 2007-20) was released by the Internal Revenue Service (IRS). Rev. Proc. 2007-20 excludes certain transactions from the definition of "reportable transaction" under Section 1.6011-4(b)(4) of the Income Tax Regulations (Treas. Reg. §1.6011-4(b)(4)). As a result of Rev. Proc. 2007-20, many transactions involving Low Income Housing Tax Credits under Code Section 42 (LIHTC) or New Market Tax Credits under Code Section 45D (NMTC) are no longer "reportable transactions" under Treas. Reg. §1.6011-4(b)(4) solely as a result of certain contractual protections that are in place, as described below. Historic Tax Credit (HTC) transactions, however, remain subject to further scrutiny.

    Rev. Proc. 2007-20 was issued, in part, in response to the affordable housing community's concerns over the enactment of the Tax Increase Prevention and Reconciliation Act (TIRPA) on May 17, 2006, which created new Code Section 4965. Code Section 4965 provides for potentially chilling excise taxes to be levied upon tax-exempt organizations and persons in authority related to tax exempt organizations (such as board members, trustees or managers) when such organizations engage in "prohibited tax shelter transactions." "Prohibited tax shelter transactions" as defined in Code Section 4965, include, among other things, reportable transactions with "contractual protection" as defined in Treas. Reg. §1.6011-4(b)(4). Generally, such "contractual protection" involves fees to a party that are either (1) refundable if all or part of the intended tax consequences from the transaction are not sustained or (2) contingent on the taxpayer's realization of the tax benefits from the transaction. Fees include monies "paid by on behalf of the taxpayer or a related party to any person who makes or provides a statement, oral or written to the taxpayer or related to the potential tax consequences that may result from the transaction." The definition of "fees" does not include fees paid to a person or advisor in that person's capacity as a "party to the transaction," such as reasonable charges for the use of capital or property.

    The broad language of Code Section 4965 left the affordable housing community questioning whether the definition of "contractual protection," and the Code Section's potentially harsh penalties, encompassed transactions in which:
    • A tax-exempt developer makes a statement to the limited partner as to the availability of tax credits and the tax-exempt developer's fee is contingent, or adjustable, based upon the project's receipt of tax credits;
    • A tax-exempt syndicator makes a statement to an investor in the syndicator's fund concerning the project's ability to obtain tax credits and the tax-exempt syndicator's fee from the investor is contingent, or adjustable, based upon the project's receipt of tax credits; or
    • A for-profit syndicator, in the process of undertaking a project with a tax-exempt organization, makes a statement to an investor in the for-profit syndicator's fund concerning the project's ability to obtain tax credits and the for-profit syndicator's fee from the investor is contingent, or adjustable, based upon the project's receipt of the tax credits.

    Because Code Section 4965 applies only to federal income tax benefits, transactions involving solely State Tax Credits were unaffected.

    Against this backdrop the IRS issued Rev. Proc. 2007-20.

    Rev. Proc. 2007-20 alleviates many of the affordable housing community's fears by specifically excluding from the definition of "reportable transaction" with "contractual protection" transactions in which contractual protection is given with respect to LIHTC under Section 42(a) and NMTC under Section 45D(a) (and so eliminating the possibility the transaction could be a "prohibited tax shelter transaction" by reason of such contractual protection). The exception applies to all such LIHTC and NMTC transactions, regardless of when the transactions were entered into. Other exempt transactions include those covered by the following credits:
    • Work Opportunity Credit under Section 51
    • Welfare-to-Work Credit under Section 51A
    • Indian Employment Credit under Section 45A
    • Empowerment Zone Employment Credit under Section 1396(a)
    • Renewal Community Employment Credit under Section 1400H
    • Employee Retention Credit under Section 1400R

    It is important to note that Rev. Proc. 2007-20 appears to except contractual protection only with respect to the tax credits listed above. Presumably, if an integrated transaction contained contractual protections for both a listed credit and other tax benefits, the transaction as a whole could still be a "reportable transaction" for purposes of Treas. Reg. §1.6011-4(b)(4).

    Although Rev. Proc. 2007-20 was a positive response from the IRS, it did not completely address all of the affordable housing community's concerns.

    Rev. Proc. 2007-20, unfortunately, did not mention a similar exclusion for HTC transactions. The IRS's silence with regard to HTC transactions is particularly troublesome because the affordable housing community specifically addressed HTC transactions in their recent correspondences with the IRS. In light of this silence, non-profit synidicators, general partners and developers involved in HTC transactions should continue to be careful with the use of credit adjusters, deferred developer fees, default provisions and buy-back obligations triggered by the availability of credits.

    Squire Sanders will continue to monitor any new updates and clarifications issued in regard to this matter. If you have any questions about how the Revenue Procedure may affect your projects, including possible concerns pertaining to HTC transactions, please contact one of our affordable housing and community development lawyers listed in this Alert.