To fund historic development (such as Shockoe Bottom warehouse conversions), developers agree to transfer historic tax credits to investors in exchange for upfront funding. State and federal tax credits can be combined for a total of 45 percent of a project’s construction costs.
The court ruled recently that in some cases that transfer of credits might be considered a sale and subject to taxes. Developers and investors have avoided paying such taxes with carefully crafted partnership agreements, but the court’s decision showed that they are not foolproof.
That means developers who have long since finished projects could get a tax bill. And it could lead to a slowdown in the volume of new projects coming online.
To better understand how tax credits are used as a financing tool and the ramifications of this decision, BizSense turned to Tom Kasper of Kasper Mortgage Capital. The company serves as a matchmaker on such deals, putting developers together with companies or individuals that want the credits. Below is an edited transcript.
Richmond BizSense: What does this decision mean for historic tax credit development in Virginia?
The 4th Circuit has not determined that these credits are always property and that you can’t always have them allocated to partners in a partnership. It will probably be about case by case determination.
RBS: Who is most affected by this decision?
TK: Probably for-profit developers that did deals in the past. There might be deals done years ago where you can’t change anything. A number of developers got money in good faith and soon could get a knock on the door from the IRS with an agent saying, “You know that money you got 10 years ago? You owe a third of it to us because it was never capital. It was always income.”
RBS: What about ongoing projects? How might they be affected?
TK: It is sort of a fork in the road. Do you accept the decision of the court or do you want to add some belt and suspenders to support or increase arguments for calling it a partnership transaction and not a sale? There is no black letter law here.
RBS: So there are many ways a partnership can be structured?
TK: There are certain rules that you have to follow for the credits to be allocatable. You can run yourself around the whole spectrum of how to structure a deal to meet these criteria. In this particular case, the facts are at the loosey-goosey end of the spectrum.
RBS: How concerned are developers that the IRS will seek to pry taxes out of completed deals?
TK: I’ve talked to a few people who volunteer that they are concerned about it, yes.
RBS: And what kind of response has there been among investors?
TK: There is an element of uncertainty that is not a positive. We have one transaction right this second and are at the point of determining structuring. We are in discussion with the investor on how we want to proceed at this moment.
RBS: Do you think this decision will hurt historic redevelopment in the long term?
TK: It may be a speed bump in the sense of slowing down deals, but surely people will come up with ways to carry on. If the law says you have to be a duck, people will then do everything they can to look and act like a duck and the judge will decide if you are a duck or not.
The prospects are bright for the future of tax lawyers no matter what.