On June 30, 2023 Judge Peter B. Krupp if the Suffolk County Superior Court in Massachusetts issued a decision that may have far reaching consequences for affordable housing throughout the country. The case was Tenants’ Development Corporation v Amtax Holdings 227, LLC and Alden Torch Financial, LLC.
There has been a dispute over the last several years between not-for-profit sponsors of affordable housing projects, like TDC and organizations representing the interest of the for profit investors, not to mention their own interests, like Alden Torch. You need to know a bit about the Low Income Housing Tax Credit (LIHTC) to understand the dispute and appreciate the Solomonic wisdom of Judge Krupp’s decision and also the burning question that he leaves unanswered.
About LIHTC Section 42
LIHTC (Section 42) arose from the Tax Reform Act of 1986. Every year credits are apportioned to the states based on population. State housing agencies award the credits to project sponsors with some preference given to not for profit sponsors. NFP sponsors, in effect, sell the credits to investors. Only you can’t sell federal tax credits. The way it is done is through a partnership owning the project with the tax benefits overwhelmingly allocated to investors, typically banks. The credit is doled out over ten years and then subject to recapture for another five. After Year 15, there is another fifteen year requirement of maintaining affordability enforced by the state housing agencies.
There was some hope that not for profit ownership could help toward forever affordability. So a provision was included in Section 42 to help encourage sale to a not for profit sponsor after year 15 at a possibly bargain price. It is Section 42(i)(7):
“(A)In generalNo Federal income tax benefit shall fail to be allowable to the taxpayer with respect to any qualified low-income building merely by reason of a right of 1st refusal held by the tenants (in cooperative form or otherwise) or resident management corporation of such building or by a qualified nonprofit organization (as defined in subsection (h)(5)(C)) or government agency to purchase the property after the close of the compliance period for a price which is not less than the minimum purchase price determined under subparagraph (B).
(B)Minimum purchase price – For purposes of subparagraph (A), the minimum purchase price under this subparagraph is an amount equal to the sum of the principal amount of outstanding indebtedness secured by the building (other than indebtedness incurred within the 5-year period ending on the date of the sale to the tenants), and all Federal, State, and local taxes attributable to such sale. Except in the case of Federal income taxes, there shall not be taken into account under clause (ii) any additional tax attributable to the application of clause (ii).”
You don’t have to have this provision in your deal. You are allowed to. The intellectual reason that it could not just be a straight up bargain option as opposed to a right of first refusal was that the straight up bargain option could imply that the partnership didn’t “really” own the property which would prevent the credit from going to the investors.
The Dispute
One of my real estate friends told me that rights of first refusal are terrible things to have outstanding. If the property is worth substantially more, it will be hard to get anybody to go to the trouble of making a bona fide offer. On the other hand, the typical ultimate investor in the deals is a bank and the deals are underwritten to give them a good return on the tax benefits alone. Generally that sort of behavior is frowned on, but IRS, inferring congressional intent, allows it when it comes to LIHTC.
So when TDC proposed to Alden Torch that they give up the partnership interest in the project for $7,737,812 million, the “exit tax”, they may have been surprised when Alden Torch refused. Alden Torch expressed an interest in having the property put on the market. Alden Torch had acquired the management of Amtax in a bulk purchase which made it one of the country’s largest holders of interests in affordable housing projects. Alden Torch has gained a reputation for trying to get more out of projects in Year 15. They are referred to as an “aggregator”. They object to this characterization. Generally not for profit sponsors do better in the court of public opinion compared to so called aggregators. In actual courts, the results are mixed.
TDC went ahead and marketed the property. Lo and behold they got an offer from another not for profit. TDC then attempted to exercise the ROFR. The computed exit tax had come down to $5,382,900 million thanks to the Tax Cuts And Jobs Act of 2017. Alden Torch made a filing against the property that prevented the transfer.
Thus commenced the state court action. In the process TDC raised the stakes by getting a new computation of the ROFR price which had the exit tax portion, the amount of cash going to Amtax set at $0. Like the previous “exit tax” computations the $0 one was the work of CohnReznick. This has prompted Alden Torch to sue CohnReznick. I covered that back in March including an analysis of the partnership tax principles at work. Judge Krupp did not get into those issues or note that CohnReznick’s new computation may be inconsistent with the “minimum gain” computations that allowed Amtax to take the losses to run its capital account negative. Instead following the Massachusetts Supreme Court decision- Homeowners Rehab, Inc v Related Corporate V – he referred to a HUD manual which discusses the exit tax computation.
TDC was suing for enforcement of the ROFR and damages for tortious interference with contract, something under the consumer protection statute, slander of title and of the implied covenant of good faith and fair dealing. Alden Torch counterclaimed for breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty of utmost loyalty and good faith, aiding and abetting breaches of fiduciary duty, tortious interference, a declaration that the ROFR exercise was invalid, a declaration the the ROFR purchase price must include exit taxes and violations of the consumer protection statute.
You Don’t Always Get What You Want
Neither party got all they wanted, but it appears that they got what they needed. The claims and counterclaims are mostly dismissed, but TDC gets to exercise the ROFR and Amtax gets its exit taxes. I may be exaggerating a bit in calling this Solomonic, but I’m sticking with it. The parties end up where they might have been back in 2017 except for all the money they spent on legal fees. As the child of depression era parents, however, it is hard for me to be that upset about something that gives people work. On the other hand I would rather see the resources going towards affordable housing.
As far as not getting what I want, I was disappointed that Judge Krupp did not engage more thoroughly on the exit tax computations. He indicates that the defendants are “entitled to a favorable declaration on this issue”. The actual declaration, however, is “The Purchase Prices under the ROR Agreement must be calculated to include the exit tax liability by the limited partners as a result of the sale of the property”. What is troubling is that CohnReznick’s $0 computation purported to do that. It would have been nice to have more guidance and really great if there were a number. If this were US Tax Court there would have been an instruction to do the computation.
There is one thing that judge wrote that greatly pleased me in a perverse sort of way. “The parties have not pointed to any regulations, IRS guidance, or case law for their interpretation of this language, and I have found none.” I was never able to find anything and I do know where to look, so it is a comfort that I did not miss anything. It is worth noting that after Year 15 the IRS does not really have a dog in the fight, so the lack of guidance is not surprising.
What is really disturbing is that this ROFR price is in a lot of contracts. Often it does not matter since the project is worth less than that. When it is computed it seems to be a kind of rough and ready application of the corporate tax rate grossed up and applied to the negative capital account. The actual language though is “all Federal, State, and local taxes attributable to such sale”. In the various filings the discussion indicates that those taxes are a liability of Amtax. But Amtax is a partnership. It is actually the investors who get hit with the taxes. And we cannot really say what those taxes are precisely without digging up the investor returns and doing a with and without computation. This is profoundly impractical.
The rough and ready back of the envelope number is fine if the parties are not inclined to make a big deal out of it. The IRS does not have any interest in it. But now we find people fighting about the number and we learn that there is really no authority at all for exactly how it should be computed.
Other Coverage
Beth Healy who has been covering the case for WBUR has South End housing group wins court victory, but may owe investor millions.
“The decision is a victory for TDC, in a case that’s been widely watched across the affordable housing industry, as some investment firms have tried to wring larger profits from federally backed housing deals. The ruling means TDC can keep housing hundreds of people with low and moderate incomes in the South End properties it has run for decades.
But Alden Torch Financial, the Denver-based investment firm that was trying to force a sale of the buildings, also won on a key matter: Judge Peter Krupp ruled that TDC must pay Alden Torch “exit taxes” as part of the purchase price.
That could amount to millions of dollars, according to TDC’s lawyer, David Davenport. He said the housing group is considering an appeal.”
I asked Davenport about whether there was any agreement on what the exit tax number is. He responded “No sir.”