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.
Many institutional investors refuse to dispose of ownership before the 15 year federal compliance period is up or require some type of collateral to protect them from tax credit recapture.
CMR Risk & Insurance Services, Inc. has developed an exclusive surety product to protect against tax credit recapture and interest penalties due to any non-compliance that they may arise after disposition. This product is provided by an A+ “superior” rated insurance company and covers the entire compliance and audit discovery period.
The quick response is YES. While recapture risk for general operational risks is low as state housing agencies really work with operators to keep affordable housing affordable the primary exposures that lead to recapture are foreclosure and casualty losses.
It is estimated that 80% of all LIHTC assets operate at little to no cash flow. When a property or partnership interest is purchased it is often financed with new debt. Any change in economic conditions around a property (manufacturing retraction, employment center relocating, etc.) or a spike in any of the major operating expense categories (interest rates, insurance rates, etc.) can have a serious affect on a project that was operating with close to no positive cash flow. This razor thin margin can turn into a not worthwhile project in a short time.
While foreclosure in itself may not lead to recapture it often does as this will extinguish the Land Use Restriction Agreement (LURA), which is a requirement to be in compliance with Section 42, and a lender has little incentive to attempt to reinstate a LURA after all credits have been claimed. Even if the desire is there they may not be able to operate quickly enough within the required time frame to request a LURA reinstatement.
A large exposure for recapture risk is casualty loss. While casualty loss in itself does not lead to tax credit recapture, it will if the project is not restored to the same condition within a “reasonable” period of time. The issue here is that it may not be possible or worthwhile to rebuild to the same condition.
Building and Zoning laws change. Ten to Twelve years after construction new laws could exist requiring greater set backs or height restrictions that make it impossible to rebuild back to the same size, which would lead to tax credit recapture.
In addition, catastrophe insurance such as Earthquake, Hurricane/Windstorm always comes along with a percentage deductible in exposed areas that can range from 2% wind/hail in minor exposed areas to 15% Earthquake near a fault line. Therefore while a project may be properly insured it may not make economical sense to come out of pocket ~10% of the total reconstruction costs on a zero cash flow project with little to no equity due to new debt levels.
CMR has partnerships with insurance companies to issue the bond that are rated at least A+ (Superior) XV (greater than $2 billion in capital/surplus) by A.M. Best with substantial surety departments that are part of large national insurance conglomerates.
The bond form itself offers extremely broad protection. The form is merely 2 pages and responds to recapture due to any non-compliance event, as long as the event occurs post ownership disposition, and has no specific time limitation as to when the bond expires or when a claim can be made.
