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With real estate markets having rebounded from the latest bust, lenders are once again funding major renovations, including rehabilitation projects that benefit from federal historic preservation tax incentives. A lucrative (but complex) program for developers and tax investors since inception in 1976, historic tax credit (HTC) projects had returned to favor following the Financial Crisis of 2008. While an appellate court decision sent a chill through the market in 2012,[i] a new set of IRS tax guidelines applicable to HTCs at the beginning of 2014 has set the groundwork for HTC projects to flourish once again. The lender who understands the intricacies of HTCs will have a clear advantage in an arena that promises attractive opportunities in the coming years. This primer on HTCs offers a starting point to such an understanding.


The HTC program, administered by the National Park Service (NPS) in conjunction with the applicable State Historic Preservation Office (SHPO), provides for a reduction in, and a credit against, federal income taxes of up to 20% of the cost of rehabilitating certified historic structures[ii].  The HTCs, claimed in the year rehabilitation is completed, remain subject to recapture if it fails to meet the program’s ongoing requirements during the ensuing five-year period. While most real estate developers do not have sufficient income to fully utilize the tax credit, developers may pass HTCs through to high-income tax investors that do[iii]. The transaction may not be structured as a sale of HTCs; instead the tax investor must become a partner in the real estate transaction.[iv] Still, HTC transactions are typically structured to provide the tax investor a financial incentive to sell its interest back to the developer at the conclusion of the recapture period.

Developers and tax investors typically utilize one of two distinct deal structures:

  • Single-Tier Structure. In the single-tier structure, the tax investor is admitted as a partner of the property-owning entity (which is entitled to claim the HTCs).


  • Master-Lease Structure. The property owner leases the property to an entity owned at least 99% by the tax investor[v]. The master lessee in turn obtains a 10% stake in the property owner. The property owner incurs the qualified rehabilitation expenditures but is permitted to pass the HTCs to the master lessee, and to the tax investor through its interest in the master lessee.

The advantages of the single tier tax structure are its simplicity and lower transaction costs. The master lease structure, on the other hand, has the advantages of not reducing the property owner’s basis in the property by the amount of the HTCs and permitting the developer, rather than the tax investor, to claim depreciation.  It also permits the developer greater control over the property’s cash flow.  Another benefit of note to lenders in a master-lease structure is that foreclosure will not result in a termination of the master lease, so long as the parties have entered into a subordination, non-disturbance and attornment agreement (SNDA), and therefore is generally not a recapture event.[vi]


Just as the economy was rebounding from the latest recession, a federal appellate court in New Jersey issued a decision in 2012 that stalled the market’s revitalization.[vii] The court’s ruling in Historic Boardwalk Hall LLC v. Commissioner, 694 F.3rd 425, held that the tax investor lacked a meaningful stake in the success or failure of the partnership owning the property, and therefore  not a bona-fide partner in the transaction and consequently not entitled to claim its HTCs. The ownership structure utilized in the Historic Boardwalk case was sufficiently typical of the way HTC deals were being structured to significantly dampen the market for new HTC deals. The widespread backlash resulting from the Historic Boardwalk case, however, led the IRS to issue Revenue Procedure 2014-12 on December 30, 2013 and a clarification on January 8, 2014 (collectively, the Guidelines), describes a “safe harbor” for structuring new HTC transactions. With the safe harbor in place as a guide post, the expectation is that the industry players will return to the market[viii]. As the tax experts work through the kinks in the Guidelines, and successful structuring precedents are established, many anticipate the HTC market to return unabated.[ix]

The Guidelines’ overarching requirement is for the tax investor’s partnership interest to “constitute a bona-fide equity investment with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership”[x], without taking tax attributes into account. The tax investor’s economic interest may not be reduced by unreasonable developer fees, lease terms or other arrangements, a test necessitating a comparison with non-HTC transactions. Underwriting based on non-HTC transactions has increased as a result. Most transactions are structured conservatively until a consensus develops as to the practical limitations of the “commensurate rule” and to how much leeway the IRS and courts are likely to permit. The tax investor must fund at least 20% of its capital contribution before the property is placed into service. The developer is required to maintain at least a 1% interest and the tax investor to maintain at least 5% of its largest percentage in each material item of partnership gain, loss deduction and credit, meaning that after the recapture period the tax investor’s partnership interest can be structured to automatically flip from 99% to 5%, thereby creating an incentive for the tax investor to exit at the end of the recapture period.[xi] The Guidelines sought to eliminate certain forms of developer guarantees including most notably a guaranty of the tax credits themselves. The inability to obtain a guaranty of the HTCs, as before, is expected to result in stricter underwriting of transactions by tax investors. Guarantees may not contain minimum net worth covenants.  As a result, look for tax investors to “piggyback” upon lender net worth requirements.


Because HTCs are personal to the entity that originally claimed them, HTCs are not part of the lender’s collateral. Although the lender does not benefit directly from HTCs, it can still receive significant indirect benefits from lending on an HTC project.

The tax investor’s very involvement in the transaction can be a source of comfort to the lender in that the tax investor will add its own underwriting and oversight requirements to the transaction. The project will also require certification by the NPS and SHPO, which provide another layer of oversight. Further, the Guidelines now require that all fees payable to the developer and its affiliates be reasonable.

The capital structure also will benefit from the tax investor’s involvement in the transaction. The tax investor typically infuses large amounts of funds prior to construction reducing the potential for the project ending up “out of balance.” Moreover, the tax investor’s equity must remain in the deal for at least five years after completion of the renovations, helping to reduce the loan-to-value ratio of the project and the need for other forms of risky capital, such as mezzanine financing.


A lender foreclosing on a project that has benefited from HTCs is not subject to any state or federal restrictions specific to HTCs. However, the prudent lender will still need to address certain issues relating to HTCs. We have outlined below a few of the more salient issues that lenders may face.

  1. SNDA

If the master-lease structure is utilized, the relationship between the tax investor and lender will be governed by an SNDA. The primary effect of the HTC SNDA is to subordinate the master lease to the lien of the mortgage in exchange for the lender’s agreement not to terminate the lease following a foreclosure, a concession which the tax investor will require in order to avoid a resulting recapture event.  In fact, the tax investor will often insist that the lender agree not to terminate the master lease even if the master lessee is in default under the master lease, a so-called “standstill” or “SNDA-on-steroids” provision.

While the steroids provision at first glance appears objectionable to the lender, agreeing to such a provision in exchange for a concession from the tax investor may make strategic sense. For example, in an SNDA with an office or retail space tenant, the lender-post foreclosure-could be faced with a non-rent-paying tenant. In this situation it is essential that the lender has the right to terminate the lease and remove the tenant. However, with an HTC master lessee, there is no real chance of the master lessee committing a material default since the master lessee is merely a pass through entity for the property’s real economics and because the lender, in any event, will be able to foreclose on the developer’s pledge of the managing member interest in the master lessee and thereby cause the master lessee’s compliance with the master lease[xii]. Regardless, the lender should insist on the right to terminate the master lease once the recapture period has expired.

For its part, the tax investor will want to prohibit the transfer of the property through foreclosure (or deed-in-lieu of foreclosure) to a disqualified transferee. Such a transfer could result in a recapture event or loss of credit. The lender, meanwhile, will want the freedom to foreclose and to further transfer the property. A frequent compromise is to permit the lender to foreclose in exchange for an agreement that any subsequent offer to purchase the property made by a disqualified transferee will trigger a right of first refusal for the tax investor.

The lender needs to obtain a release from any liability for the developer’s obligations to the tax investor should the lender foreclose on the developer’s pledge. If the tax investor insists on its own right to remove the developer as managing partner of the master lessee, the lender should limit such replacements to cases involving the developer’s willful misconduct, fraud or other malfeasance and require the tax investor to supply a replacement managing partner with the requisite operating experience.



The IRS “at-risk” tax regulations provide that the amount of a project’s non-recourse financing cannot exceed 80% of the credit base of the qualified rehabilitation expenditures. If a proposed non-recourse mortgage loan will push the project beyond the 80% threshold, there are steps the prospective lender can take to avoid a potential loss of HTCs?  One solution is to have the master lessee, in its capacity as a partner of the property owner, assume any deferred developer’s fee[xiii], thereby removing non-recourse financing in the amount of the fee from the property owner’s balance sheet (the assumption of the fee would then be treated as a capital contribution to the property owner by the master lessee). Alternatively, the developer could guaranty a portion of the mortgage loan (thereby making that portion recourse) in an amount sufficient so that the “at-risk” rule is not violated. Before accepting such a guaranty, however, the lender should assess the bankruptcy consolidation risk created by obtaining a guaranty from an affiliate of its borrower.

At first glance, the complexities created by master leases, SNDAs, “at-risk” rules and other aspects of historic tax redevelopment projects and the tax regulations that govern them may appear to the lender more like a sentence to prison confinement than an avenue for exploration. But, the lender willing to master the finer points of historic tax credit transactions may very well find itself at the forefront of an already established market now ready to explode with new possibilities for fruitful exploitation.

[i] According to the U.S. Department of the Interior, since its inception the HTC program has been utilized in over 40,380 completed projects worth approximately $73,000,000,000 (as of fiscal year end 2014).

[ii] Many states offer a similar historic tax credit program to the federal program. Although, we limit our discussion to the federal program, many of the issues and benefits are applicable to most or all of the state programs as well.

[iii] A small cadre of large corporations, such as Chevron and Bank of America, are the usual players in the HTC market.

[iv] For ease of drafting and readability, we refer throughout this article to “partners” and “partnerships” but the HTC rules apply equally to limited liability companies and their members.

[v] The master lease must be for a term of at least 80% of the length of the applicable recovery period, which means for commercial properties a term of at least 32 years.

[vi] A transfer to a “disqualified transferee” could still result in a recapture but the set of “disqualified transferees” is essentially limited to tax exempt organizations such as governmental entities, foreign persons and REITs.

[vii] According to the U.S. Department of the Interior, approved HTC applications declined by nearly 25% over the three year period commencing in 2009.  By 2013,  according to the NPS, the number of approved projects had risen to 1,155 (representing approximately $6,730,000,000 in project costs), a healthy but not spectacular 26% increase over 2012—the enthusiasm for HTCs that arose with the return of a robust real estate market having been dampened by concern over the implications of the Historic Boardwalk decision.

[viii] According to the Journal of Tax Credits published by Novogradac & Company LLP (February 2014 Volume V, Issue II, pg 3),  “HTC investors interviewed shortly after the issuance of the [Guidelines] were generally positive [and]…believed they would come back into the market.” Developers interviewed for the article also generally supported the notion that the Guidelines would encourage developers to do HTC transactions.

[ix] According to the U.S. Department of the Interior, the number of approved HTC projects in 2014 was almost exactly the same as 2013, as many of the market players would not embark on new deals until the tax experts had worked through the finer details of the Guidelines.

[x] Rev Proc 2014-12. Section 4.02(2)(b).

[xi]The Guidelines prohibit the developer from obtaining a call option to acquire the tax investor’s interest at the end of the recapture period, a favored form of protection utilized by developers prior to the issuance of the Guidelines. However, the significant reduction in ownership interest at the end of the recapture period should be sufficient incentive for the tax investor to exit the deal of its own volition.

[xii] The lender will typically receive a pledge of the developer’s interest in the master lessee.

[xiii] HTC deals typically contain large deferred developer’s fees since, in addition to being income to the developer, these fees may be included within the tax base and thereby increase the amount of the HTCs available to the tax investor.  Although the tax regulations are not clear on the point, many experts believe that a deferred developer’s fee should be included in the calculation of non-recourse debt.