On December 30, 2013, the IRS issued Revenue Procedure 2014-12, setting forth a safe harbor for federal historic rehabilitation tax credit (HTC) transactions. Investors have been skittish about HTC deals ever since the 2012 federal appellate court decision in the Historic Boardwalk Hall case, which disallowed the allocation of HTCs to an investor. The IRS issued Revenue Procedure 2014-12 in order to provide more predictability regarding HTC transactions. The IRS will not challenge allocations of HTCs if the provisions of the safe harbor are satisfied. The safe harbor is generally effective for allocations of HTCs made on or after December 30, 2013. It is expected that HTC deals will now be structured to satisfy the provisions of the safe harbor. For more information on the safe harbor, please see Ulmer & Berne’s Client Alert.
Earlier this fall, the National Park Service celebrated the 35th anniversary of the popular Federal Preservation Tax Incentives Program, which has helped in the preservation of historic structures across the U.S. and particularly in Ohio with its wealth of historic buildings. Because of the program’s numerous possible benefits and its important role in fueling economic growth in surrounding communities, property owners and developers should consider utilizing tax credits on applicable building projects.
But before making the leap, it’s helpful to better understand the requirements and limits of the program. Here are 10 key points to consider before you get started:
1. Your building needs to be historic.
First, you need the right kind of building. If it is on the National Register, or a contributing factor in a historic district, then you are all set. If it is not, you can get the building placed on the National Register or have the district expanded so as to include your building. In either case, this process will likely take a year. This is known as a Part 1 approval.
2. Your plans need approval from the state historic preservation office (SHPO).
Some say this may be the biggest disadvantage of using historic tax credits. SHPO needs to approve your plans, both inside and out. This is known as the Part 2 approval.
3. Your rehabilitation must be substantial.
In order to qualify for the federal historic tax credits, your rehabilitation plan must be substantial – in the eyes of the IRS, this means the rehabilitation costs must exceed your basis in the property.
4. You typically need a third-party investor.
There are two factors necessitating the need for a third party investor. First, the credit must offset a tax liability. Most individuals do not have a large enough liability, therefore, most of the investors are C-corporations. The second issue is created by the passive activity loss rules. Basically, only a full time real estate professional can use the credits against active income. C-corporations are not subject to the passive activity loss rules.
5. Historic Boardwalk has impacted how these deals are structured.
In the Historic Boardwalk case, the IRS successfully argued that the tax credit investor was not a real partner and therefore could not be allocated the credits. The IRS said that the investor must have real upside (not just from being allocated the credits) in the economics of the project (i.e., cash flow and appreciation) and real downside (i.e., the developer cannot completely indemnify the investor). The industry is waiting to hear from the IRS who has promised to issue a revenue procedure outlining a safe harbor for these investments.
6. Your building cannot be transferred for five years.
The Internal Revenue Code provides that the taxes offset by the credits are subject to a pro rata recapture if the property or a controlling interest in the owner is sold in the five-year period after the property has been placed in service. This makes it difficult to condominium-ize a project and investors will want to make sure you have a truly viable project so that they are not faced with the prospect of foreclosure.
7. Be careful when you work with a nonprofit.
Generally, the IRS does not allow a nonprofit to be involved either as a part owner or as a tenant of the building. Having the nonprofit form a subsidiary that elects to be taxed on its income can solve the issue. The use issue is trickier. Having the nonprofit use less than 50% of the space is the simplest way. If however, the nonprofit used the building before and will use more than 50% afterwards, you will need to contact a tax credit professional.
8. There are both federal and state historic credits.
The federal credit is equal to 20% of the qualified rehabilitation expense (QRE). Provided you comply with the NPS standards, the credits are available to a project. The state of Ohio also has a historic tax credit program. That credit is equal to 25% of the same QREs but is currently capped at $5 million. The state credit is subject to a very competitive allocation process. There is a scoring sheet where job creation and economic development rank very high. Unlike the federal credit, a portion of the “credit” can be a refund, up to $3 million.
9. What is included in a QRE?
A QRE is the base on which the credit is calculated. It includes all the hard costs of construction as well as soft costs, including developer fees, construction interest and professional fees. It does not include the acquisition price, enlargements, work outside the building or personal property expenditures.
10. You will need a bridge lender.
This is sometimes the most difficult part. Most of the investor’s equity comes in after construction and after the Part 3 has been obtained. The Part 3 is the final sign off by the SHPO that confirms that the project was completed in accordance with the approved Part 2. A bridge lender has to be comfortable assuming the risk that the project will be completed and the Part 3 will be obtained. Most lenders require either a guaranty from a deep pocket or outside collateral, in addition to a pledge of the capital contribution to be made.
As previously published In the November 2013 issue of Properties Magazine
Did you turn 65 (or older) during 2013? Happy Birthday! Have an AGI over $30,000?
If yes, congratulations, you are among the lucky few in Ohio who may still qualify for the Homestead Exemption!
Under the recently enacted H.B. 59 which established Ohio’s budget for 2014, there are numerous changes coming that will affect residential homeowners.
While lawmakers are starting to hear from their constituents, including those approximate 40,000 Ohio households who may lose out on eligibility next year, and bills to reverse the changes are being introduced, under the coming budget, homeowner’s will see the eventual elimination of the ten percent and two and one-half percent real property tax rollbacks on future levies and the loss of the automatic eligibility for those turning 65 under the Homestead Exemption, which has been adjusted from an age-test to a means-based test.
Under the old law, any Ohio landowner who currently lives in their home and that home is their primary residence, qualifies for an exemption if:
• He is at least 65 years old or will reach age 65 during the current tax year; or
• He is certified totally and permanently disabled, regardless of age; or
• Is the surviving spouse of a qualified homeowner, and who was at least 59 years old on the date of the spouse’s death.
Eligible homeowners were able to shield $25,000 worth of the market value of their home from local property taxes. For example, an eligible homeowner residing in Shaker Heights, Ohio could save up to $950 per year under the exemption.
Under the new law, the exemption will only be available to eligible taxpayers with household incomes that do not exceed $30,000, as measured by their Ohio adjusted gross income for the preceding year. That amount will be indexed to inflation each fall and is expected to be around $30,400 for tax year 2014.
Existing homestead exemption recipients will continue to receive the credit without being subject to the income test. Ohio does allow for late exemption filing for first time recipients. Eligible homeowners, including those who turned 65 or older during 2013 have a ‘save’ and can file a late application during a one-time six (6) month window. If approved to receive the exemption retroactive for the 2013 tax year, those homeowners will remain eligible for future years event if their AGI exceeds the new income limitation. And, the eligibility is “portable” if the owner moves his or her primary within the State.
Applications can be obtained from your County Auditor or Fiscal Office can be filed as early as January 6, 2014 but no later than June 2, 2014.
Following the publicized overhaul of the Cuyahoga County Board of Revision, property owners and practitioners alike should be aware of the Board’s recent changes in procedures regarding hearing notices to Complainants, in addition to the implementation of the Board’s updated Rules of Valuation Procedure (which quietly went into effect December 2011).
When a property owner has filed a Complaint seeking a reduction in excess of $50,000 market value in valuation on their property, under Ohio Revised Code 5715.19(B), the Board of Revision must notify the affected school district of the filing of the Complaint and afford them the opportunity to file a Counter-Complaint in opposition. In contrast, there is no requirement under the ORC requiring the Board of Revision to notify the Complainant of the filing of the Counter-Complaint. Instead, in past years, the Board of Revision would “informally” notify a property owner that a Counter-Complaint had been filed by sending the property owner a copy of the hearing docket before the scheduled hearing referencing both the Complaint and Counter-Complaint.
Under their updated procedures, the County Board of Revision has stopped distributing hearing dockets to Complainants. Instead, under Section IV (C) of their updated Rules of Valuation Procedure, the Board of Revision relies upon the counsel for a Counter-Complainant to contact the Complainant. Counsel is now required to certify to the Board of Revision that they served a copy of the Counter-Complaint to the Complainant at the address as stated on the Complaint. This rule went into effect beginning with the Counter-Complaints that were filed in May 2012. Knowledge of, and compliance with, the new rule this past spring was spotty. Of course, ignorance of the pending Counter-Complaint is no excuse for a Complainant’s failure to serve the Counter-Complainant with evidence in advance of the hearing.
Property owners and practitioners seeking a reduction in value in excess of $50,000 in market value before a Board of Revision should ASSUME that they are being opposed and should contact the Board of Revision to inquire if there has been a Counter-Complaint filed in their case (http://www.bor.cuyahogacounty.us/find_complaint.asp) and should closely follow the Board’s rules.
Earlier this month, the US Congress voted to repeal certain new 1099 reporting requirements that had many smaller landlords in this country crying foul. In essence, expanded 1099 reporting requirements were to take place under the health care reform laws in an effort to raise underreported income. The net effect would have been to impose upon all taxpayers receiving rental income (i.e., all landlords) an obligation to issue a 1099 to the IRS and to any contractor who provided in excess of $600 of service to the taxpayer relative to the rental income. While this may not have been a burden for a commercial landlord, everyone with a two-family, vacation rental, or college student renting a spare bedroom had reason for concern. Elimination of this burdensome reporting requirement comes as some good news in an otherwise still rebounding segment of our economy.
Ohio Housing Council Issues Alert That Sales Tax Must Be Listed Separately on Invoices for Taxable Services
The Ohio Housing Council (the "Council") recently issued the following alert: "Sales tax must be listed separately on invoices or the buyer may be charged by the State of Ohio for the tax." According to the Council, the State of Ohio has been assessing sales tax and penalties to contractors and property management companies for tax services they purchased when the invoice did not break out sales tax as a separate line item. Thus, per the Council, invoices for taxable services, such as landscaping or painting, must contain a separate sales tax line item instead of the simple phrase "sales tax included." The Council advises contractors and property managers to review all invoices to make certain that property tax is listed separately.Continue Reading...
The Ohio Department of Taxation has been enforcing the obligation to pay sales taxes by contractors and property managers for services received when the invoices do not separately identify sales tax as a specific line item. Look at all of the invoices received for any services contracted for and make sure that sales taxes are separately broken out. This will avoid an assessment for the unpaid sales tax and related penalties. Of course the obligation can be shifted to the provider of the service by inserting appropriate language in the contract or invoice.
Remember Enron and off-balance-sheet accounting scandals? The efforts to clean up these accounting practices are still in the works and are about to hit the world of commercial real estate—arguably at the worst possible time. The Financial Accounting Standards Board (FASB) (which is endowed with the power to decide U.S. generally accepted accounting principles) and its international counterpart, the International Accounting Standards Board (IASB) are hoping to enact a new lease accounting standard by 2013. The Securities and Exchange Commission in a 2005 report to Congress estimated that the current lease accounting standards which went into effect in 1976 allow tenants to keep about $1.25 trillion in future liabilities off-balance-sheet.
Currently, a lease may be shown on a tenant’s balance sheet as either a capital lease which is treated on the balance sheet much like a finance transaction or as an operating lease which is mostly off-balance sheet. The FASB and IASB believe that investors are not getting a full picture of a tenant’s obligations when the lease is treated as an operating lease because the lease payments are recognized as an expense when they are incurred or paid rather than all of the rental payments for the term appearing as a liability on the balance sheet.
In 2001 when Congress repealed the estate tax for the far off year of 2010, with the estate tax returning in full force in 2011, everyone assumed that Congress would act to revise the 2001 law before January 1, 2010. However, to everyone’s surprise, Congress did not act. The new year has come and gone and so has the tax—at least for now. But is this a good result? Is 2010 a “good year to die”?
First, although there is no estate tax in 2010, in 2011 there is a $1,000,000 exemption and 55% tax on the remainder of the estate.
Second, the estate tax could change before the end of the year. There is precedent for Congress retroactively restoring taxes that have been upheld by the courts. This means that while there is still time for Congress to do something about the estate tax repeal, what they may agree to is unknown.
Third, in 2009 and 2011 the basis of an asset inherited or received will receive a step-up in basis to the value as of the date of the owner’s death (or the alternate valuation date six months later). In 2010 there is no step-up in basis, but instead there is a carry-over of the decedent’s basis to beneficiaries. However, an estate representative can elect assets for a basis increase of up to $1,300,000 and an additional $3,000,000 of basis increase if there is a surviving spouse of the deceased. Anything exceeding those amounts is subject to carryover basis—the basis for the heir is the same as the basis for the deceased. On very large estates that may have held real estate, stock and other assets for decades, the carryover basis may be a fraction of the current fair market value of the asset which will result in a large taxable gain to the heir when the asset is sold.
Fourth, most wills and trusts are currently drafted on the assumption that there is a federal estate tax. Language in trusts often refers to the exempt portion of the estate, but under the current repeal this language does not make sense since all of the estate is exempt.
Fifth, the tax rate for lifetime gifts has been lowered from 45% to 35%. But again, it is unclear if Congress will change this tax rate if they patch the estate tax. That makes this year a year of uncertainty for lifetime gifts as well, although the $1,000,000 lifetime gift exemption is still in effect.
Be careful not to assume that your assets (e.g. cash, securities, business interests, real estate, retirement accounts and the face value of life insurance policies) fall below the exemption. Now is the time to review your family’s assets, your beneficiary designations and your estate planning no matter the current value of your estate. Check back here periodically for updates on this issue as Congress is expected to act sooner or later.
How low will they go?
Bending to market pressures, Cuyahoga County Auditor Frank Russo recently announced that the County’s 2009 valuation update will likely result in significant decreases in the County’s assessed value of residential homes – with an 8% average reduction across the County.
The media reports note that the State intends to compare Mr. Russo’s proposed values to the actual sales figures from each community and will ultimately approve new fair market values likely between 92% to 94% of the fair market value. The State’s suggestion of a 6% to 8% discount off of the appraised fair market value is really aimed at those properties that have not been recently sold. This “discount” should not be applicable to those non-residential properties where there was a recent arm’s length sale of the property.
School districts (when the sale exceeds the current assessed value) and property owners (when the sale is below the assessed value) actively seek adjustment of the market value of the non-residential properties to an amount equal to the purchase price. The Ohio Supreme Court has held that the purchase price paid in an arm’s length sale is the best indication of the fair market value of real property.
The Auditor’s decision to seek an 8% average reduction in value comes at the close of the property tax complaint filing season which ended March 31. In Cuyahoga County alone, a reported 17,000 decrease complaints were filed at the Cuyahoga County Board of Revision with respect to the 2008 tax year. Compared to the record 10,000 decrease filings last year with respect to the 2007 tax year, the 2008 “off-year” filings (the last year of the 2006-2008 triennium) are extremely notable.
The Ohio Supreme Court Clarifies the Effect of Low-Income Housing Tax Credit Restrictions on the Tax Value of Real Property
In Woda Ivy Glen Limited Partnership v. Fayette County Board of Revision (2009), 121 Ohio St.3d 175, the Supreme Court of Ohio considered whether restrictions on real property resulting from participation in the federal low-income housing tax credit program should be taken into account when appraising the property for real estate tax purposes. The real property at issue consisted of 60 individual parcels, each of which contained a single-family residence. As required by Section 42 of the Internal Revenue Code, the property was subject to certain rent restrictions designed to make the rental rates affordable for low-income families. These restrictions are binding on successor owners and recorded in the chain of title of the property. Utilizing a cost-based valuation for tax year 2004, the county auditor valued the parcels at an aggregate value of $4,854,970, or approximately $80,000 each.
Ivy Glen filed a complaint against the auditor’s valuation, alleging the true total value to be $2,400,000. Rather than using the cost approach, Ivy Glen’s appraiser deemed the 60 parcels to be one economic unit and based his valuation on a rent-income analysis and comparable sales of rental properties. The Board of Tax Appeals (BTA) rejected that approach and instead adopted the county’s cost-based valuation, reasoning that the properties were only two years old and should be valued as though free of any use restrictions imposed under the federal low-income tax credit program. The BTA, relying on the Ohio Supreme Court’s previous pronouncement in Alliance Towers, Ltd. v. Stark Cty. Bd. of Revision (1988), 37 Ohio St.3d 16, that property should be valued in its “unrestricted form of title,” questioned the validity of Ivy Glen’s appraiser taking into account the use restriction on the property imposed in connection with the low-income tax subsidy and affirmed the county’s cost-based valuation of the property.
On appeal, the Court discussed its holding in Alliance Towers and found that, despite holding that “For real property tax purposes, the fee simple estate is to valued as if it were unencumbered,” the Court’s decisions have “broadly acknowledged that ‘all facts and circumstances which may affect the value of property must be taken into consideration.’” The Court then distinguished between “private” encumbrances and those restrictions that are governmental “police power” limitations on use. Under Appraisal Institute guidelines, the former are to be disregarded, while the latter should be considered. Though the Court acknowledged that the federal government does not have a general “police power,” it nevertheless found that the low-income housing tax credit program were a means for Congress to implement public policy and improve the general welfare, and thus qualified as police power restrictions. Since the BTA failed to consider the effect of the low-income tax credit restrictions in valuing the property, the Court vacated the BTA’s decision and remanded it for further proceedings consistent with Court’s decision.
The Ohio Supreme Court’s decision provides an opportunity for owners of low-income housing tax credit property to review their tax valuation and determine if a complaint against the valuation is appropriate. Although the tax complaint filing period for tax year 2008 has ended, tax payers will be able to contest 2009 taxes beginning in January 2010.
On November 26, 2008, LandAmerica Financial Group, Inc. (“LandAmerica”) and its affiliate, LandAmerica 1031 Exchange Services, Inc. (“LES”) filed for Chapter 11 protection from creditors. LES abruptly ceased its 1031 exchange intermediary business two days prior to the bankruptcy filing and LandAmerica sold its Lawyers Title and Commonwealth Title underwriting subsidiaries to Fidelity Title and Chicago Title shortly after the petition date.
Monday, April 6, was the deadline for creditors in each case to file their bankruptcy claims. A review of the filed claims in each case tells quite a tale of woe, with the 1031 exchange customers of LES hit exponentially hard.
As a 1031 intermediary, LES held proceeds from the sale of its customer’s “relinquished property” for 180 days or until “replacement property” was purchased if earlier. For an extended period, LES had been investing its customer’s sales proceeds in auction rate securities (“ARS”), the market for which froze in February 2008. By November, LandAmerica could no longer fund the cash needs for replacement property purchases and this led to the Chapter 11 filing.
Customers who were in the middle of their 180-day replacement period awoke to find that their cash proceeds were not only unavailable (and likely tied up long term in illiquid investments) but that they would not be able to obtain their planned tax deferral under Section 1031 of the Revenue Code. If that was not injury enough, many of these customers already had replacement properties firmly under contract and suffered the insult of potential breach lawsuits by the sellers of those properties.
One LES creditor’s claim is reflective of the many similarly situated customers. Deblu Realty Corporation had almost $1.5 million deposited with LES from the sale of relinquished property, but its proof of claim was not only for that amount but for $373,000 in lost deferral of taxes (at capital gains rates), $3.7 million in potential lost profits on the thwarted acquisition of replacement property as well as yet to be determined amounts for alternate financing costs and legal fees.
In In re Cortner, decided February 4, 2009, the Bankruptcy Court for the Southern District of Ohio held that an Ohio property tax certificate holder was entitled to receive the auction-established rate of interest on its certificate, rather than a reduced, court-determined rate. The creditor held several tax certificates, purchased at auction as described in the Ohio Revised Code, entitling it to payment of delinquent real estate taxes on the debtor’s property. The debtor and Chapter 13 trustee argued for the Court to modify the interest payable on the tax certificates to the “Till” rate of interest. In Till v. SCS Credit Corp., 541 U.S. 465 (2004), the Supreme Court applied a formula to determine the interest rate payable to a creditor receiving installment payments, factoring in the time value of money and risk. The Till rate presumably would have been considerably lower than the eighteen-percent rate the creditor was entitled to based on the auction sale.
The Court rejected the opportunity to modify the tax certificate interest rate, although it noted it could do so because the tax certificates did not qualify as a protected “security interest” under the Bankruptcy Code. The Court based its decision on § 511 of the Code, which applies the interest rate “determined under applicable nonbankruptcy law” to all “tax claims.” Thus, if the certificates were classified as a “tax claim”, the creditor was entitled to the auction-established interest rate set forth under Ohio law. In determining that the certificate was a tax claim, the Court first noted that the certificate was not only a lien holder under Ohio law, but was entitled to the amount owed for delinquent taxes. Further, there is nothing in the Code limiting “tax claim” holders to governmental units. Finally, the certificate bears all the hallmarks of a real estate tax debt in Ohio – the holder receives a super-priority lien on the property and may foreclose if the debt is not paid.
The Cortner decision should encourage investment in the Ohio property tax certificates. Since the debtors on tax certificates are very often financially troubled, any investor would be concerned about having its possible return on the tax certificates adjusted in bankruptcy. The Court here, however, offered a strong analysis of why these interest rates should not be adjusted in bankruptcy, thus protecting the investor’s interest and expected return. With statutory interest rates allowed as high as eighteen percent, the possible profit on a tax certificate is very high.
Many counties in Ohio, Hamilton and Franklin included, have just completed their triennial valuation of real property. In this day and age of falling real estate values and 401(k) balances, saving money is on everyone’s mind. That makes today a good day to review the Auditor’s new value of your property and ask yourself, “Am I paying taxes based upon my property’s correct value?”
Many factors influence property values, and the Auditor’s appraisers, despite their best efforts, are all too often not privy to all the information. The burden therefore falls on the shoulders of the property owner to provide additional information to the Auditor when necessary. In order to do this, a properly completed Complaint Against the Valuation of Real Property form (see links for Hamilton County, Franklin County, and Cuyahoga County forms) must be filed with the Auditor’s office on or before March 31st of the following tax year. This means if you are filing by March 31st of this year, you are actually challenging the valuation of your property as of January 1, 2008. And each county typically has its own set of procedural rules for filing a complaint, so be sure to familiarize yourself with the correct process to avoid dismissal of your case.