Managing the Exit Tax Burden of the QALICB (Part 2)
Part One of this article explained that when a new markets tax credit (NMTC) investor exercises a put option (the exit transaction) in a leveraged transaction at the end of the seven-year compliance period, it is possible that the qualified active low-income community business (QALICB) will not recognize any cancellation of indebtedness (COD) income. Part One also explained that if COD income is recognized, the amount of income should be the difference between the issue price of the “B loan” and the fair market value of the B loan when the put is exercised.
The following example was used to illustrate these points:
An investor contributes $3 million to Investment Fund LLC in exchange for 100 percent of the membership interests in the fund. The fund borrows an additional $7 million (the leverage loan) and uses its combined $10 million of capital to make a qualified equity investment (QEI) in a community development entity (CDE) in exchange for a 99.99 percent membership interest. The leverage loan has a seven-year term. Only interest is paid until the end of the term. The CDE makes two qualified low-income community investment (QLICI) loans to the QALICB. The A loan has a seven-year term, and the B loan has a 30-year term. Both loans call for interest payments only during the first seven years, generating sufficient interest for the CDE to make the required interest payments on the leverage loan. At the end of seven years, the QALICB refinances its property, repaying the A loan. The CDE distributes the proceeds to the fund, which repays the leverage loan. Shortly thereafter, the investor exercises its put option, selling its 100 percent interest in the fund to an affiliate for $1,000.
Planning to Reduce COD Income
In Part Two of this article, it is assumed that COD income is recognized in the exit transaction. QALICBs have a number of options for planning to reduce the amount of COD income and thus defer the tax burden on the economic benefit from the exit transaction that accrues to the family of entities that includes the QALICB and affiliate (the entity family).
This article first appeared in Novogradac’s Journal of Tax Credits.