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Could uncertainty in the tax credit market help developers?
In May 2013 the US Supreme Court declined to hear an appeal regarding the historic rehabilitation credits for a state authority's purported partnership with a credit investor to redevelop the Atlantic City's Historic Boardwalk Hall. Taxand USA discusses how this case could affect the tax credit market.
A key issue in the case of the Historic Boardwalk is the theory that a traditional credit investor must have significant economic upside and/or downside, as ultimately determined by the IRS, to be respected as a partner. This theory provides the IRS with the discretion to apply a similar line of reasoning to all types of credit transactions.
While the IRS has indicated that it plans to provide safe harbour guidance on a fast-track basis, it appears likely that the structure of a qualifying transaction will involve a significant increase in the amount of risk assumed by a credit investor.
One could argue that the IRS's position may ultimately be a healthy turn of events for the overall market by increasing the number of small real estate or other developers who choose to sponsor credit-based transactions such as alternative energy, low-income housing and new market tax credit programmes as a means to enter the market. Previously, many smaller real estate developers found the amount of the required guarantees in typical credit-based transactions to be a significant, if not prohibitive, barrier to entry into this market.
In light of the limited upside in many incentive tax credit deals, the Historic Boardwalk case may place pressure on the ability of credit investors to demand guarantees to protect against their downside risk. As a result, the days of a complete guarantee against downside risk of the credit investor are changing. What remains to be seen is the extent to which the guarantees are reduced.
The market for incentive credit partnerships should be alive and well, particularly since the IRS has indicated that it does not view the Historic Boardwalk decision as a mandate to examine and recast all credit transactions. The shift of risk from the sponsor to the credit investor may have a short-term impact, and possibly a long-term impact, on the pricing of credits, but the market is expected to respond to the changes efficiently, and the forthcoming safe harbour guidance will hopefully ease the friction.
On the brighter side, ultimately, this may be a benefit to the market, since sponsors with shallower pockets may be able to enter the game because they may not be expected to make substantial financial guarantees to the credit investors, not only in the event that they engage in disqualifying activities but also in the event a deal underperforms economically.