A powerful tool for real estate developers is tax optimization. However, without a proper understanding of tax incentives, these benefits may not be utilized fully. Also, while tax incentives may be a catalyst for a development, there may still be capitalization issues faced by the developer who cannot wait for the tax incentives to come until after the completion of the project. The best solution for these problems may be through the monetization of tax credits prior to the start of the project.
Tax incentives that are able to be monetized effectively are the New Market Tax Credit, the Low Income Housing Tax Credit, and the Historic Rehabilitation Tax Credit, among others. These tax credits can offer significant benefits that the developer or partnership must be in a position to utilize. In many cases the developer or their investors may not be the best candidates for tax credits because their tax liability may be too low or because they are already receiving tax incentives from previous projects. Capitalization may also be an issue in getting the project off the ground, thus setting the framework for using a tax equity partner.
The role of the tax equity partner in the partnership structure will be an investment of capital up front for the right to a special allocation of all the tax incentives in the future. Many of these incentives require the beneficiaries of the tax incentive to hold onto their portion of ownership for a certain period of time after the benefit is given. There will be a planned exit strategy for the tax equity partner to remain in compliance with the holding requirements. Upon exiting the deal the tax equity partner will no longer retain any interest in the development project.
The value of tax credits to corporations or high-net worth individuals should not be underestimated. A $10,000 tax credit is a dollar-for-dollar deduction on the taxpayer’s liability that year. However, that $10,000 will shield over $28,000 in profits from taxation. When these tax credits are traded at a discount, the benefit becomes even greater. The market for tax credit monetization will continue to rise as more investors see opportunities through tax savings.
The overarching goal of tax structuring from the developer’s point of view should be economic efficiency and creating the most return through creative financing and structuring. Lowering the developer’s upfront equity requirement by utilizing tax incentive monetization is a strategy that will give more financial flexibility and allow for a more advantageous capitalization structure. The tax partner contribution will be counted as equity when the developer is applying for financing. Thus, the amount of debt available to the developer will increase because the loan-to-value constraints will be harder to reach. This will lower the developer outlay and increase the potential returns.
Should you have a need or opportunity to take advantage of favorable tax structuring for real estate development, please contact any of the Senior Directors at Metropolitan Capital Advisors www.metcapital.com.