Tax issues

Leveraging LIHTCs

New IRS guidelines provide safe harbor for nonprofit partners.

As the need for affordable housing increases across the country, more com-mercial real estate devel-opers are partnering with nonprofit companies to leverage access to low-income housing tax credits as a source of project financing. Earlier this year the Internal Revenue Service issued new guidelines that provide a safe harbor for newly formed organizations intending to participate in LIHTC projects.

Under the guidelines, nonprofit organizations that comply with the safe harbor provisions should receive favorable determination of tax-exempt status. While the guidance specifically applies to newly formed nonprofits seeking exemption from federal income tax, its scope affects all LIHTC transactions by establishing standards applicable to LIHTC nonprofit/for-profit joint ventures.

Proof of Charitable Purpose

In their IRS exemption applications, nonprofits must describe their proposed activities, including identification of specific housing projects and how project participation will accomplish the organizations' charitable purposes consistent with Revenue Procedure 96-32. Newly formed organizations that plan to participate in LIHTC transactions but have not yet identified specific projects for participation will not satisfy the safe harbor and may be denied exemption altogether. Applicant organizations also must adopt and submit a conflict of interest policy.

Applicant organizations must submit the following written representations in lieu of final governing documents to be within the safe harbor.

Statement of Charitable Purpose.
The governing documents of LIHTC project limited partnerships or limited liability companies must state that the LP or LLC will operate housing that it owns in a manner that furthers its charitable purposes by providing decent, safe, sanitary, and affordable housing for low-income persons and families, including elderly or physically handicapped individuals.

Charitable Purposes Must Prevail.
The governing documents also must include a provision stating that, in the event of a conflict between the obligations of the applicant organization to operate the LIHTC LP or LLC in a manner consistent with charitable purposes and any duty to maximize profits for the for-profit investors, the charitable purposes contained in the governing documents will prevail.

Specific Requirements

Written representations regarding management of the LIHTC entity should give participating nonprofit organizations sufficient control over LIHTC entities to ensure that they will accomplish charitable purposes.

Consent May Not Be Unreasonably Withheld. If applicant organizations are required to obtain the consent of limited partners or investor members regarding certain matters not involving day-to-day operations, investors may not withhold such consent unreasonably. The guidance identifies a number of permissible consent rights, including the sale or refinancing of LIHTC projects and the acquisition of additional property. Other non-enumerated consent rights also may be included; however, if those additional consent rights become too extensive, the IRS may object.

Removal Only for Cause. Limited partners or other members only can remove an applicant organization as general partner for cause, and notice must be provided to the applicant organization that states the cause and allows the organization a reasonable period to cure any deficiencies.

Written Representations

LIHTC transactions typically are structured so that the nonprofit organization, acting as general partner or managing member, is obligated to provide guarantees to the investors to protect their investments. In such cases, the IRS has included certain guidelines within the safe harbor that are designed to minimize the potential exposure of charitable assets for private use.

Construction Contracts. LIHTC LPs and LLCs must enter into fixed-price construction contracts with bonded contractors or those that provide a performance letter of credit or adequate personal guarantee. If an operating deficit guarantee is required of an applicant organization, liability must be limited to not more than five years from the date the project achieves break-even operations or limited to an amount equal to no more than six months of operating expenses.

Tax Credit Guarantees. Any tax credit guarantees made by nonprofit organizations to investors must be limited. The limitation may be adopted through either of the following approaches.

First, if the LP or LLC governing document includes separate tax credit adjuster provisions, each separate adjustable provision must be limited to an amount that does not exceed the aggregate amount of developer and other fees (both payable and deferred) that the applicant organization or any affiliate is entitled to receive in connection with the project.

Second, any applicant nonprofit organization payments must be treated as capital contributions or loans to the LP or LLC and their repayment must take priority over any other distribution of residual assets to partners upon sale or refinancing of the property. Payments under this approach may be unlimited in amount.

Tax credit adjuster provisions that combine these two approaches would be permissible.

Rights of First Refusal.
The new safe harbor requires applicant organizations to secure rights of first refusal to acquire projects at the end of the LIHTC compliance period under Internal Revenue Code section 42(i)(7). However, an organization's board of directors must review any project purchase to ensure that the purchase price is "reasonable and consistent with the organization's charitable status" and does not exceed fair market value.

Repurchase Guarantees.
If applicant organizations must guarantee to repurchase the investors' interest in the LPs or LLCs in case of failure to meet certain fundamental requirements relating to the viability of projects, the repurchase price may not exceed the amount of capital contributions. Mark up of the repurchase amount to cover syndication costs would not be permitted.

Environmental Reports.
Applicant organizations are required to protect themselves from environmental liability by reviewing an independent Phase I environmental report on any proposed project.

Michael I. Sanders, JD, and Jerome A. Breed, JD

Michael I. Sanders, JD, is the head of Powell Goldstein LLP\'s tax department in Washington, D.C. Contact him at (202) 624-7308 or Jerome A. Breed, JD, is a partner with Powell Goldstein LLP in Washington, D.C. Contact him at (202) 624-7221 or


A Charitable Remainder Trust Case Study

Winter 2022

Selling a rental property allowed one CRE professional to establish cash flow via a charitable remainder trust. 

Read More

A Future for Infrastructure

Spring 2021

With potential bipartisan support for infrastructure, could 2021 be the year for a breakthrough in Washington, D.C.?

Read More

3 Tax-Specific Paths to Liquidity for Real Estate Investors

Winter 2021

The 2020 CARES Act, passed amid the initial outbreak of COVID-19, opens doors for real estate investors.

Read More

Forming a Tax Plan


The real estate industry generally fares well under the 2017 Tax Cuts and Jobs Act, but many new provisions heighten the importance of advance tax planning for real estate investors.

Read More