CLARIFYING NONPROFIT PURCHASE RIGHTS IN AFFORDABLE HOUSING.

• Author: Weiss, Brandon M.
• Position: A Taxing War on Poverty: Opportunity Zones and the Promise of Investment and Economic Development

Introduction 1160 I. Background 1164 A. The LIHTC Framework 1164 B. The ROFR Provision 1166 C. The Proliferation of Disputes 1168 II. Housing Policy and Tax Policy Mismatch 1172 A. Evolving Housing Policy 1172 B. A Collision with Tax Policy 1173 C. Theoretical Approaches to Resolving the Mismatch 1175 III. Addressing the ROFR Problem 1176 A. Federal Level 1176 B. State Level 1180 Conclusion 1182 INTRODUCTION

Two important questions emerged during the excellent symposium hosted by the Fordham Urban Law Journal in February 2021 on the topic of A Taxing War on Poverty: Opportunity Zones and the Promise of Investment and Economic Development. The final panel of the day addressed the future of Opportunity Zones, (1) former President Trump's primary economic development initiative, under the new Biden Administration. Given the panoply of critiques that have been levied at Opportunity Zones, (2) the panel concluded the day by considering a couple of key issues: 1) what else might the federal government do with the billions of dollars in annual forgone tax revenue in lieu of providing the Opportunity Zone incentives and 2) given scarce policymaking bandwidth, what else might be a higher priority in the new administration's community development policy agenda than salvaging this troubled Trump initiative. Elsewhere, I am writing on the former, arguing that the foregone revenue would be better spent increasing direct rental assistance to the lowest-income U.S. households. (3) This brief Essay considers the latter and offers one time-sensitive alternative.

Unlike the Opportunity Zone program, which does not require the provision of any particular goods or services, (4) the federal Low-Income Housing Tax Credit (LIHTC) (5) program has produced more than three million units of generally high-quality affordable housing for low-income households across the United States. (6) While also no stranger to critique, (7) the program remains politically popular on a bipartisan basis--Congress recently significantly increased the tax credit (8) and is currently considering legislation to do so again. (9) Biden campaigned on a promise to expand the credit "with a $10 billion investment." (10) LIHTC essentially is the only significant federal program that provides annual support for the construction of new low-income housing. As a permanent tax credit created in 1986 that appears here to stay, it is worth improving.

Unfortunately, as discussed herein, disputes are proliferating around the country that threaten the ongoing affordability of LIHTC housing of a particular type: namely, projects owned by nonprofit developers that are nearing the end of their initial restricted use term." The disputes center on limited partner investors in LIHTC projects attempting to thwart the ability of nonprofit general partners to exercise statutorily and contractually defined "rights of first refusal" (ROFRs) to purchase a given project at the end of the initial compliance period from the tax credit partnership at below-market levels set by Congress. Such efforts by investors--described herein as the "ROFR problem"--frustrate congressional intent, violate long-held norms and expectations in the industry, are costly for nonprofits to litigate, jeopardize the ongoing affordability of an already scarce federally assisted housing stock, and threaten to displace low-income tenants. Investors use such efforts to, for example, pressure nonprofits into buying them out at high prices or force lucrative sales of the projects to third parties. (12) The fact that these efforts are increasingly being made by so-called "aggregators," (13) new investors not party to the original partnership that purchase LIHTC interests nearing the end of their initial rent-restricted terms, is all the more reason for alarm.

These disputes have begun to draw media coverage and broader attention to the issue. (14) In one high profile case in southern Florida not far from Miami Beach, a nonprofit has spent $1.5 million litigating the ROFR issue against HallKeen Management, a Massachusetts-based investor that purchased Bank of America's interests in a LIHTC project for approximately $400,000 and then sought to force a sale to a third party for $21 million. (15) In another case involving a Brooklyn affordable housing complex in the gentrifying neighborhood of Bushwick, New York State Attorney General Letitia James filed an amicus brief in a ROFR dispute supporting the nonprofit developer against SunAmerica Housing, an investor affiliate of American International Group, Inc. (AIG). (16) Such cases are likely to grow significantly in number as, year after year, an increasing number of LIHTC developments reach the end of their initial use restriction periods.

Part I of this Essay provides relevant background on the LIHTC program as outlined in Section 42 of the tax code, describes how the ROFR problem arises within this legislative framework, and presents a snapshot of the disputes unfolding around the United States. Part II explores on a theoretical level how the problem emerges as a mismatch between modern housing policy and tax policy: modern housing policy attempting to leverage private sector involvement in the delivery of low-income housing without sacrificing long-term affordability and tax policy requiring that investors be "true owners" of real estate projects in order to reap the tax incentives. This Part also considers several varying conceptual approaches to resolving this mismatch. Part III takes up the least disruptive and most politically palatable approach to resolution--within the context of the current LIHTC framework--and considers how the Biden Administration can work with Congress to resolve the problem legislatively, using the Affordable Housing Credit Improvement Act of 2019 as a point of departure. It also argues that state housing finance agencies should amend their credit allocation rules to ensure that tax credits flow to projects with strong nonprofit purchase rights.

If the Biden Administration hopes to prioritize community development policies that are certain to have an immediate and positive impact on the lives of low-income U.S. households, it will place the ROFR problem at the top of its policy agenda and work swiftly with Congress to enact a legislative fix.

1. BACKGROUND

   1. The LIHTC Framework

      Congress created the Low-Income Housing Tax Credit (LIHTC) program as part of the Tax Reform Act of 1986. (17) Successor to the public housing program as the dominant means by which the federal government provides financial assistance for the development of low-income housing, the program is based on a model of leveraging private sector equity and expertise. (18) Elsewhere, I have described the mechanics at length. (19) For relevant purposes here, a typical transaction involves a real estate developer applying to a state housing finance agency for an award of federal tax credits. If the application is successful, the developer generally enters into a limited partnership as the general partner with a private investor limited partner--usually a bank or other large financial institution with the annual tax liability to make the nonrefundable credits of value. (20) The limited partner investor provides the equity needed to build a new affordable housing development and, in exchange, the partnership allocates the lion's share of the tax credits, depreciation deductions, and other tax benefits to the investor. These benefits alone typically provide the investor with a healthy return on investment. (21)

      Relevant timeframes are key to understanding the ROFR problem. Section 42 of the tax code provides that investors claim the tax credits annually for ten years. (22) LIHTC housing is subject to certain income-eligibility requirements and rent limits for an initial 15-year compliance period (23) and, for projects starting in 1990, an additional 15-year extended use period. (24) For the first 15 years, the tax credits are subject to recapture by the Internal Revenue Service (IRS) if, for example, the developer violates the rent or income restrictions or if the project falls into serious physical or financial distress. (25) After the first 15 years, tax credit recapture by the IRS is off the table and state housing agencies are primarily responsible for programmatic enforcement.

      Both for-profit and nonprofit developers are eligible to apply to state housing finance agencies for an award of LIHTCs. In addition to other benefits, (26) nonprofits generally are much more likely than for-profits to maintain rents at below-market levels even beyond the expiration of legally required restrictions. (27) As such, Section 42 requires that states award at least 10% of their tax credits to projects that involve nonprofit developers, though states may exceed that floor. (28)

   2. The ROFR Provision

      Hoping to promote long-term affordability, Congress included a provision in Section 42 to facilitate the ability of nonprofit developers to buy out the limited partner investor after the initial 15-year compliance period. (29) The provision, Section 42(i)(7), is structured as a safe harbor--it ensures that none of the tax credits allocated to the investor will be disallowed by the IRS as the result of a qualified tax-exempt nonprofit holding a below-market "right of first refusal" to purchase the property after the initial 15-year compliance period. (30) In a typical real estate transaction, a "right of first refusal" grants the holder the right to purchase the property if the holder is willing to match the price of a third-party offer. However, in this case, the tax code defines ex ante the price at which the nonprofit will purchase the project upon the exercise of a Section 42 ROFR: essentially, the outstanding debt on the property plus any "exit taxes" that result from the sale--a price often referred to as "debt plus taxes." (31) As a safe harbor, the provision does not require...