A recently filed lawsuit against CohnReznick opens a window into a niche form of tax practice – compliance and planning around the Low-Income Housing Tax Credit. The case highlights a current controversy between investors seeking returns and not-for-profits seeking to insure continued affordability and their own interests to be just a bit cynical. We get to discuss some obscure tax issues and reflect on the question of who it is that is actually your client.

About The Low Income Housing Tax Credit

The Low Income Housing Tax Credit was a creature of the Tax Reform Act of 1986. The passive activity loss rules appeared to kill the previous tax subsidy which was a five year write- off. I was working in the field before and during the transition, but was not much involved after the nineties. It was a little chaotic then as there were a variety of models tried. From talking to a few people all on background or off the record it appears that the deals have become somewhat more routine in the last twenty years.

The credit is awarded to states based on population. State housing agencies then allocate the credit to projects. Simplistically the credit is either 40% of 90% of qualified basis. It is claimed over 10 years based on the property operating to ensure affordability in accordance with pretty complicated regulations. After the ten years are up, there are five years in which the credit remains subject to recapture.

In the allocation process there is preference given to not-for-profit sponsors. Of course not-for-profits have no use for the credit. A not-for-profit sponsor will typically control the general partner of the partnership that owns the project, but the overwhelming bulk of credits and losses flow to an investment limited partnership that flows to an investor or investors usually banks. Banks can use the credits and losses and also get Community Reinvestment Act brownie points.

About SETH II

The deal involved in the lawsuit was a 185 scattered site housing project in Boston’s historic South End. The project known as SETH II is owned by Tenants Development II LP (TDLP). The plaintiff AMTAX  Holdings 227, LLC is the 99.99% limited partner in the deal. AMTAX is managed by Alden Torch, which has become one of the major players in the industry. Tenants Development Corporation, a Massachusetts charitable corporation, owns the general partnership interest. It also owned the land which entitled it to ground rents.

What is unusual about this deal is that Alden Torch acquired its interest in the project by purchase from the bankruptcy of the original syndicator. Alden Torch and some other players are sometimes referred to as aggregators. There is a view that they are seeking to get benefits out of the deals that were never intended or bargained for.

Press coverage of this “Year 15” issue tends to be a little one-sided in favor of the not-for-profit sponsors. Alden Torch argued in Centerline Housing Partnership v Palm Communities that the term aggregator is pejorative. David Davenport of BC Davenport has built a legal practice around representing not for profits in Year 15. It is much easier to get comments out of him than it is to get them from Nixon Peabody who tend to represent whatever it is we should call the aggregators. This may account for the dominance of the not-for-profits in the court of public opinion. The aggregators or whatever do much better in federal court.

The ROFR

Life would be much simpler if not-for-profit sponsors could just sell the credits, but that is not how things work. In order to transfer the credits to the investor that can use them, they must be a partner in a partnership that “really” owns the property. The Tax Code assures affordability for the first fifteen years of the project through the threat of recapture. There is an additional fifteen year requirement that is enforced by the state housing agencies.

There is thinking that not-for-profit control can be the key to “forever” affordability. There was a concern though that if there was a simple option for the not-for-profit to acquire the property other than for fair market value after Year 15, then the partnership and hence the investor was not the “real owner”.

So rather than or in addition to a fair market value option a not for profit can have a right of first refusal to acquire the property for a minimum purchase price, which is the sum of  “the principal amount of outstanding indebtedness secured by the building (other than indebtedness incurred within the 5-year period ending on the date of the sale” and “all Federal, State, and local taxes attributable to such sale”.

The secured indebtedness is typically assumed so the money changing hands will be the second part sometimes referred to as “exit taxes”. Industry practice, which seems to meet with no objections is to compute the “exit taxes” by grossing up the maximum federal rate for corporations and something for state taxes. A common back of the envelope estimate is to apply the rate to the deficit capital of the investor limited partner. Presumably the capital accounts are income tax basis.

If things go well the investor gets their credits and the tax benefit of losses. Taxes from “recapture” of losses in excess in basis are reimbursed. And the not-for-profit sponsor has control of the project.  Some projects will not have enough value in them to support even the ROFR price. So it goes.

Regardless of what the law or contracts might actually say the attitude of not-for-profit developers is that the investors should be happy with their credits because that is what they paid for.  And it appears that is how things generally went until starting a few years ago.

The Dispute About SETH II

A simple way to take out the investor out after Year 15 is to redeem their interest for the computed “exit taxes” assuming there is enough value in the project to swing that. That was the case here. In 2017 Tenants Development Corporation proposed that to Alden Torch for the AMTAX interest. CohnReznick had been doing the audit and tax work on the partnership for years at that point. CohnReznick computed an exit tax of $7,737,812 which was the offer made to redeem the interest. That was subsequently reduced to $5,382,990 thank to the reduction in corporate rates due to the Tax Cuts And Jobs Act.

Alden Torch thought that the property was worth more and asked for it to go back on the market.  Tenants Development Corporation got some offers and then notified Alden Torch that they were exercising their ROFR. The litigation around that is currently in the Massachusetts Superior Court for Suffolk County. Alden Torch had been blindsided by the ROFR and was challenging its validity.

While that litigation was ongoing CohnReznick entered into a consulting agreement with Tenants Development II LP to compute the ROFR price. You might think that it would be the mortgage plus something around $5.3 million. Instead they came up with the mortgage plus zero. The argument is that liabilities that went into there are liabilities that went into the computation of the exit tax in a redemption of the partnership interest that are not really secured by the property and their release is not “attributable to such sale”.

That’s what the suit against CohnReznick is about. AMTAX is alleging breach of fiduciary duty, professional negligence and fraud. The complaint implies that the case in Superior Court would have settled by now absent the elimination of any payment for exit taxes.

Minimum Gain

Generally, you can only run a the capital account of a limited partner that does not have a deficit restoration obligation negative to the extent of their minimum gain. Minimum gain is defined as

“The amount of partnership minimum gain is determined by first computing for each partnership nonrecourse liability any gain the partnership would realize if it disposed of the property subject to that liability for no consideration other than full satisfaction of the liabilities”

In an email to Alden Torch explaining the difference between the sale by the partnership and the sale of the partnership interest CohnReznick indicated

“The ‘fourth calculation’ that you reference is a sale of the property at the minimum purchase price as defined in Internal Revenue Code Section 42(i)(7), it is not an exit tax computation. More specifically, it not an exit tax calculation given the unsecured debt situation that exists here.”

They then went on to indicate that they could not get into it any further because of client confidentiality.  The client was TDLP. AMTAX, managed by Alden Torch owns a 99.99% interest in TDLP.

The thing that really puzzles me is how unsecured liabilities could have counted in the minimum gain computation if they are left hanging after a sale.

Reflections

Section 42 is a veritable white collar jobs program providing employment for numerous accountants and attorneys. Key concepts like the exit tax and minimum gain will engage the professionals in deep thought. In the exhibits in the Superior Court litigation there is a deposition of the CohnReznick person responsible for the computation. The AMTAX attorneys asked them if they consulted case law before making the computation. I found that kind of amusing since as far as I can tell there isn’t any to speak of. “Minimum gain” is mentioned only twice in case law and there is no guidance on the 42(i)(7) computation.

I think it may have been a mistake for CohnReznick to accept the engagement to perform the ROFR computation for the partnership given that it appears to contradict previous computations they had made and the disparate interests of the parties. Not to mention that there was litigation ongoing.

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