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How the New U.S. Tax Law Affects Community Development Projects

June 4, 2018

By Dina ElBoghdady, Urban Land Institute

As Congress cobbled together the biggest tax overhaul since 1986, they nearly wiped out the essential sources of funding for large-scale community development projects—namely, three federal tax credit programs that attract private investment for neighborhood revitalization. Developers, financiers, and municipalities pushed back and managed to keep most of what they wanted intact. But now they are dealing with what some of them describe as the new tax law’s unintended consequences.

One of those unintended consequences: a signature component of the tax act—the reduction of the tax rate on corporations to 21 percent from 35 percent—threatens to diminish the relative value of tax credits. Developers qualify for tax credits from the federal government to help raise equity for their projects. Corporations typically invest in the projects and use the tax credits to offset their federal tax liability. But with the lower tax rate now in place, developers fear that investor appetite for the tax credits may wane.

At issue are the low-income housing tax credits (LIHTCs) that help finance the construction and upkeep of affordable rental units, the federal historic tax credits (HTCs) that preserve historic properties, and the New Markets Tax Credits (NMTCs) that support economic growth in impoverished communities. Early drafts of the tax bill would have scaled back or eliminated all of these tax incentives; when they survived, many developers were relieved—but then braced themselves for more setbacks, says Phillip Kash, a principal at HR&A Advisors, a Washington, D.C.–based consulting firm that specializes in real estate services. “Nobody died, but everybody got hurt,” says Kash, a leader of the firm’s affordable housing team. “We are just so relieved that we’re willing to swallow the pain and find ways to deal with it.”

While the three tax credit programs are not the sole source of funding for any one project, they are widely viewed as the pillars of massive community development projects, often used in combination with other financing tools, says Aaron Seybert, social investment officer at the Kresge Foundation in Troy, Michigan. That is why the industry is closely watching how these public/private partnerships will fare. “When you cut a few inches off the leg of a table, you can never be sure how things will calibrate,” says Seybert, a former JPMorgan Chase community development banker. “Right now, we just don’t know how the market will settle.”

Low-Income Housing Tax Credits

In the affordable housing arena, LIHTCs are crucial because they enable developers to build homes with less debt and thereby offer lower rents. But the industry almost lost a key portion of the program late last year when the House version of the tax bill called for eliminating private activity bonds, which more than half of affordable housing projects have been using recently to qualify for the LIHTC. Scrapping the bonds would have effectively wiped out as much as two-thirds of affordable housing production—a loss of roughly 788,000 to 881,000 rental units over ten years, according to Novogradac & Company, an accounting firm based in San Francisco, California, that specializes in real estate services.

Even before Congress took up its tax bills, some real estate projects were affected by the anticipation of lowered tax rates. Rodger L. Brown Jr., managing director of real estate development at Preservation of Affordable Housing Inc. in Boston, says a bank that planned to invest in one of his projects pulled its letter of intent off the table just a few days after Donald Trump was elected president. The bank expected that he would soon make good on his campaign promise to slash the corporate tax rate, and the bank wanted Brown’s firm to lower the price of the low-income housing tax credits in the deal.

“By then, it was too late in the process for us to rearrange our capital stack,” Brown notes. “The pricing risk suddenly was shifted from the investor to us. To quote them, they said: ‘We want you to share in our pain.’” To make the deal work, Brown says his nonprofit firm agreed to reduce the tax credit pricing if the corporate tax rate went down. It honored that commitment, which has left little room to pay for construction change orders and may cut into the firm’s development fee by hundreds of thousands of dollars by the time the project is completed, Brown says.

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