Public Law No. 115-97 (once known as the Tax Cuts and Jobs Act) (the Act) became law on December 22, 2017. While nearly two months have passed, there are still many unknowns. This brief outline covers some of the questions being asked in the current and ever-evolving environment of affordable rental housing.
New Affordable Rental Housing Development
Corporate Tax Rate Decrease
The Act reduced the corporate tax rate to 21%. This impacts affordable housing development financed with the low-income housing tax credit (LIHTC). At what price will credits be sold following the Act? There is a general rule of thumb that prices drop by one cent for every percentage change in the corporate tax rate. Fortunately for today’s deals, developers are facing a 4% (or roughly four cent) decrease given that the industry had settled on a presumed corporate tax rate of 25% following the 2016 Presidential election. What does that mean for deals pending and waiting on reservations of LIHTC? Such deals may face lower pricing and need to fill gaps left in budgets with additional financing sources. Of course, each transaction is unique, and the particular parties may find other ways to address this change, including investors reducing their internal rate of return and syndicators accepting a lower fee.
Change in Investor Pool
Given reduced corporate tax liability, investors may have less need for LIHTC. Will there be fewer economic investors going forward or have such investors already departed this market following the election and ensuing industry uncertainty? A similar question may be raised as to investor appetite for qualified multifamily revenue bonds.
With fewer economic investors, LIHTC will largely attract investors with Community Reinvestment Act (CRA) needs. This may negatively impact communities outside of a CRA footprint. The reentry of Fannie Mae and Freddie Mac into the market, announced in November of 2017, may help counterbalance the CRA area investment trend as they have noted that they will focus on underserved markets; earlier this month, Fannie Mae announced its $100 million LIHTC fund. However, will Fannie Mae’s recently reported fourth quarter loss cause a course reversal? The Treasury Department has also discussed reviewing CRA, and any changes may further impact investors and where investments are made.
A further consideration is the impact of the Base Erosion and Anti-Abuse Tax (BEAT). Investors subject to BEAT because of specific base-eroding payments to related foreign persons may limit their participation or exit the market based on the risk of losing part (through 2025) or all (starting in 2026) of the benefit of LIHTC.
The opportunity to defer paying taxes on gains and potentially step-up basis based on holding periods may attract investors to invest gains in qualified opportunity funds that in turn invest in a limited number of population census tracts, primarily low-income communities (LIC) but also certain tracts contiguous with designated LICs (limited to 5% of tracts designated), designated by the chief executive officers of the states. Such officers need to nominate the census tracts to be designated as Qualified Opportunity Zones by March 21, 2018 (unless one thirty-day extension is sought). The number of census tracts that may be designated may not exceed 25% of the number of census tracts in the state that are LICs (or 25 tracts if the state contains fewer than 100 LICs). The Treasury Department also has to go through administrative procedures to create the regulations and allow for implementation.
Existing/Closed LIHTC Deal
Business Interest Expense Limitation/Electing Alternative Depreciation System
LIHTC partnerships may elect to use the alternative depreciation system (ADS) method to avoid the interest expense cap under the Act. At this point, opinion seems to be split with respect to electing the ADS method for pre-2017 housing transactions: Will it mean the old 40-year ADS life or the new 30-year life for residential rental property?
Lower Tax Rate Beyond the Compliance Period
The lower tax rate may lead to (a) a lower exit price when a LIHTC investor exists a LIHTC partnership based on a reduction in exit taxes and (b) a smaller tax bill associated with cancellation of debt income for for profit entities.
Impact of Things Beyond the Act
While a few variables outside of the Act have already been mentioned, there are others to note that may impact affordable rental housing:
Bipartisan bills in the House (H.R.1661) and the Senate (Affordable Housing Credit Improvement Act of 2017 (S.548)) that would bolster the Federal LIHTC program were introduced in March 2017. These include a 50 percent increase in the annual allocation of LIHTC that would be phased in over five years as well as other benefits such as establishing a minimum 4 percent rate for credits used to finance acquisitions or used in bond-financed developments and extending the discretionary 30% basis boost to 4% bond-financed transactions, among other changes.
FY 2019 Budget (and Addendum) Unveiled by the President. In addition to concern over funding levels proposed, the affordable housing industry is noting that “[t]he Budget reflects the President’s commitment to fiscal responsibility by reforming programs to encourage the dignity of work and self-sufficiency . . . .” It has been reported that “reforms” may include families that receive voucher or public housing assistance paying the higher of 35% of (a) their household’s gross income (without deductions) or (b) earnings from working 15 hours a week at the federal minimum wage as well as work requirements of up to 32 hours a week for adults who are neither elderly or disabled.
Bipartisan Budget Act of 2018. This raises non-defense spending (FY 2018 - $63 billion; FY 2019 - $68 billion), but how much will be allocated to the Transportation, Housing and Urban Development (THUD) bill and the Department of Housing and Urban Development?
In the coming days and months, the questions being asked today may be answered and new questions may arise, but the environment for affordable rental housing will most certainly continue to evolve.