Fairness Opinion May Provide “Safe Harbor Security” in Historic Tax Credit Deals – March 11, 2014 by Tony Bakale

Industry professionals have had some time now to digest the recent IRS provisions in Revenue Procedure 2014-12, which provides a safe harbor for structuring investments in federal Historic Rehabilitation Tax Credits (HTCs) available under IRC Section 47 (read our 1.03.14 blog post). Some deals in progress may be able to be re-worked to fall within the safe harbor, while others may just be too far down the road to modify at this point. However, I think it is safe to say that any new deals going forward will be structured to meet the safe harbor requirements — or risk scaring off investors.

Deciphering Fuzzy Safe Harbor Requirements

There are many requirements that must be met to qualify for the safe harbor. Some are fairly mechanical and their impact can be modeled out. Others, not so much. Rev. Proc. 2014-12 contains what I will call some “soft and fuzzy provisions,” provisions that no one can ever truly feel confident they have met. One of these provisions, found in Section 4.02(c), states: “The value of the Investor’s Partnership interest may not be reduced through fees … that are unreasonable as compared to fees … for a real estate development project that does not qualify for section 47 rehabilitation credits …” Industry insiders are interpreting this to mean that fees, lease arrangements, etc. between the project, developer and any affiliates must be set at a “reasonable” arms-length amount as compared to what those fees would be in a non-HTC deal. Whenever the IRS uses terms of art such as “reasonable,” “substantially” or “fair,” you can bet those are the areas they will scrutinize in the future.

Consider a Third-Party Fairness Opinion

What can the participants in a safe harbor HTC deal do to help meet the requirements? Generally, the best course of action is to receive what is often referred to as a “fairness opinion.” That is, hire a third-party with industry knowledge, valuation and transfer pricing experience to issue an opinion, similar to a valuation report, that states the fees (e.g., lease rates) being charged are reasonable and comparable to non-HTC deals under the particular deal’s circumstances. This report should establish industry comparables based on both private and non-private deals that are relevant to the particular project. For example, if your opinion covers a master lease situation, are the terms reasonable based on comparables within your project’s region for the type of property subject to the master lease? If the opinion covers property management fees, an analysis should be provided that covers services provided, type of property comparables in the region and type of property. Property management fees for a retail mall will not be the same as property management fees for a commercial industrial building. A report should be specific for your situation and cover all fees charged by the developer and its affiliate. It is important that the issuer of the opinion has a thorough understanding of the project and some industry expertise.

Having a qualified third-party conduct a fairness opinion will, of course, add an additional layer of cost to the deal, but it is better to sleep at night then worry if your deal is going to implode sometime in the next three or four years.

We want to hear from you! We encourage you to share this blog post on social media or contact Tony Bakale at tbakale@cohencpa.com to discuss options for obtaining a fairness opinion for your next HTC deal.

This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.

Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.