We recently interviewed CMR’s Principal/President and Surety Practice Group Leader, Travis Pearson on the top questions that we receive regarding the LIHTC Recapture Bond. While the IRS no longer requires a disposition bond (IRS form 8693) to avoid tax credit recapture in the event of ownership disposition in a Low Income Housing Tax Credit Section 42 project, the tax credit recapture exposure still exists. Below you will find the answers from our interview with Travis Pearson:
I thought recapture bonds were no longer needed?
“While that is correct that the IRS no longer requires recapture bonds, in the event of disposition, there are many investors out there that won’t dispose of their ownership within the 15 year recapture compliance period without some type of collateral. Often times that collateral can be a letter of credit or cash, however most investors will accept a recapture bond in lieu of a letter of credit or cash.”
What is a recapture bond?
“A recapture bond is a performance bond guaranteeing what’s in the underlying purchase and sale partnership assumption agreement that states that the buyer is going to continue to operate the property in compliance and pay any tax credit recapture if you are denied. So the bond, again is a performance bond that guarantees that underlying agreement.”
How much do they cost?
“The recapture bond pricing is really based on the time left in the compliance period. Our programs rates are .625% per year left in the compliance period subject to a minimum rate of 1.25%, so anything with 2 years or less left in the compliance period is a rate of 1.25%. That rate is applied to the bond limit and the bond limit is the recapture and interest exposure estimated the year of the transaction date. So in order to determine the price really, the very first thing you need is a recapture analysis and our office can put those together with copies of the 8609’s or credit schedule that show the amount of credits claimed per year. Depending on the size of the project, and what year in the compliance period you are in, will greatly affect the bond limit, which the rate then gets applied to.”
Is a recapture bond insurance?
“It is insurance, but really only for the sellers, so the buyers obtain the bond, but it’s just guaranteeing the performance of what’s in that purchase of sale or partnership assumption agreement. So the bond is just insurance for the seller. It is a performance bond, the surety company does obtain indemnity from the buyer.”
Who does the surety company garner indemnity from?
“That really depends on the structure of the buying group. If the surety company is ok with entity only indemnity, however there has to be an entity that is widely owned and owns a wide range of assets, so really if a true going concern entity. If an entity like that doesn’t exist, and there is only single purpose entities that flow down to an individual, the surety company does require indemnity from that individual in review of personal financial statements.”
Are there any costs or fees with regards to underwriting?
“No there is not. So, we perform a recapture analysis to help determine premium costs and all our underwriting process to get groups approves, there is no underwriting fee or application fee, or anything along those lines. The only cost is the cost of the recapture bond, and that is a transactional cost. It is a one time premium, and the bond is in effect for the remainder of the compliance period and any audit discover period. There is no renewals or requests for additional information, it’s one-time underwriting process, one-time fee for the bond itself, and therefore if the transaction doesn’t close, there are no costs.”
Have you had any claims?
“Yes, we have. As most people are aware, a lot of these Low-Income Housing Tax Credit projects have thin cash flows, therefore foreclosure is a real risk and we have had a couple of claims dealing with foreclosure. The other main claim area is a casualty loss. While casualty in itself doesn’t need a recapture, as long as you rebuild within a reasonable period of time, it will need a recapture if you are unable to build it the same size. So, if there is a setback, and you are only allowed to build 2-stories versus 4-stories or you need a 40 foot setback versus a 20 foot setback, and can’t rebuild, that will trigger a recapture. Or, if you have an earthquake or hurricane, those types of insurance often come with a larger deductible (as high as 10% of the construction value), sometimes it just doesn’t make sense to come out of pocket 10% of reconstruction costs on a project that has a very thin cash flow margin.”
CMR has been issuing bonds for the past 15 years and we have relationships with all major syndicators and investors. Please contact our office if you are interested in reviewing actual bond forms.
Learn More About our LIHTC Recapture Bond Program