On June 30, 2023, Judge Peter B. Krupp of the Suffolk County Superior Court in Massachusetts issued a decision that may have far-reaching consequences for affordable housing across the country. the case was Tenants’ Development Corporation v. Amtax Holdings 227, LLC and Alden Torch Financial, LLC.
There has been a dispute in recent years between non-profit sponsors of affordable housing projects, such as TDC, and organizations that represent the interests of for-profit investors, not to mention their own interests, such as Alden Torch. You need to know a little about the Low Income Housing Tax Credit (LIHTC) to understand the dispute and appreciate the Solomonic wisdom of Judge Krupp’s decision and also the burning question it leaves unanswered.
About LIHTC Section 42
LIHTC (Section 42) grew out of the Tax Reform Act of 1986. Each year credits are allocated to states based on population. State housing agencies grant loans to project sponsors with some preference over non-profit sponsors. NFP backers, in effect, sell the credits to investors. You just can’t sell federal tax credits. The way this is done is through a partnership that owns the project with the tax benefits allocated overwhelmingly to investors, usually banks. The credit is spread over ten years and is then subject to recovery for another five. After year 15, there is another fifteen-year requirement to maintain affordability imposed by state housing agencies.
There was some hope that nonprofit ownership could help achieve permanent affordability. Therefore, a provision was included in Section 42 to help encourage a sale to a non-profit sponsor after the 15th year at a potentially bargain price. It is Section 42(i)(7):
“(A) In general, no federal income tax benefit shall be rendered unallowable to the taxpayer with respect to any qualified low-income building simply because of the right of 1st rejection held by the tenants (cooperatively or otherwise) or by the resident management corporation of such building or by a qualified nonprofit organization (as defined in subsection (h)(5)(C)) or a governmental agency to purchase the property after the close of the compliance period for a price not less than than the minimum purchase price determined under subparagraph (B).
(B) Minimum Purchase Price: For purposes of subparagraph (A), the minimum purchase price under this subparagraph is an amount equal to the sum of the principal amount of outstanding debt secured by the building (other than debt incurred within the 5-year period ending on the date of sale to tenants), and all federal, state, and local taxes attributable to such sale. Except in the case of federal income taxes, no additional tax attributable to the application of clause (ii) will be taken into account under clause (ii).
You are not required to have this provision in your contract. You have permission to. The intellectual reason why it could not simply be a direct negotiation option rather than a preemptive right was that the direct negotiation option might imply that the partnership did not “really” own the property, thus preventing credit from going to investors.
One of my real estate friends told me that preemptive rights are terrible things to watch out for. If the property is worth substantially more, it will be difficult to get anyone to bother to make a bona fide offer. On the other hand, the typical last investor in the deals is a bank and the deals are written to give them a good return on tax benefits alone. In general, that kind of behavior is frowned upon, but the IRS, inferring the intent of Congress, allows it when it comes to LIHTC.
So when TDC proposed to Alden Torch that he relinquish the partnership’s interest in the project for $7,737,812 million, the “exit tax,” they might have been surprised when Alden Torch refused. Alden Torch expressed interest in putting the property on the market. Alden Torch had acquired management of Amtax in a massive buyout that made it one of the country’s largest shareholders in affordable housing projects. Alden Torch has earned a reputation for trying to get more out of projects in year 15. They are known as an “aggregator”. They object to this characterization. In general, non-profit sponsors do better in the court of public opinion compared to so-called aggregators. In royal courts, the results are mixed.
TDC went ahead and marketed the property. Lo and behold, they got an offer from another non-profit. TDC then attempted to exercise the ROFR. The calculated exit tax had been reduced to $5,382.9 billion thanks to the Tax Cuts and Jobs Act of 2017. Alden Torch filed a filing against the property which prevented the transfer.
Thus began the state court action. In the process, TDC raised the stakes by getting a recalculation of the ROFR price that had the exit tax portion, the amount of cash going to Amtax set to $0. Like the previous “exit tax” calculations, the $0 one was the work of CohnReznick. This has led Alden Torch to sue CohnReznick. I covered it in March, including a discussion of partnership tax principles at work. Judge Krupp did not wade into those issues, noting that CohnReznick’s new calculation may be inconsistent with the “minimum profit” calculations that allowed Amtax to take losses to make its equity account negative. Instead, following the decision of the Massachusetts Supreme Court- Homeowners Rehab, Inc v Related Corporate V – referred to a HUD manual that discusses the calculation of the exit tax.
TDC was suing for ROFR enforcement and damages for tortious interference with contract, something under the consumer protection, defamation of title, and implied covenant of good faith and fair dealing statute. Alden Torch filed a counterclaim for breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty of the utmost loyalty and good faith, abetting a breach of fiduciary duty, tortious interference, a statement that the exercise of ROFR was invalid, a statement that the ROFR purchase price must include exit taxes, and violations of the consumer protection statute.
You don’t always get what you want
Neither party got everything they wanted, but it seems they got what they needed. Most claims and counterclaims are dismissed, but TDC can exercise ROFR and Amtax gets its exit taxes. I may be exaggerating a bit to call this Solomonic, but I’m sticking with it. The parties end up where they could have been in 2017 except for all the money they spent on legal fees. However, as the child of depression-era parents, it’s hard for me to be so upset about something that gives people jobs. On the other hand, I would prefer to see resources go towards affordable housing.
As for not getting what I want, I was disappointed that Judge Krupp wasn’t more involved in the exit tax calculations. He indicates that the defendants have “the right to a favorable statement on this matter.” However, the actual statement is “Purchase prices under the ROR Agreement must be calculated to include the limited partners’ exit tax liability as a result of the sale of the property.” Worryingly, CohnReznick’s $0 calculation was intended to do just that. It would have been nice to have more guidance and really great if there was a number. If this was the US Tax Court, there would have been an instruction to do the calculation.
There’s one thing the judge wrote that I really liked in a bit of a perverse way. “The parties have not pointed to any regulation, IRS guidance, or case law for their interpretation of this language, and I have found none.” I’ve never been able to find anything and I know where to look, so it’s a consolation that I’m not missing anything. It’s worth noting that after year 15, the IRS doesn’t really have a dog in the fight, so the lack of guidance isn’t surprising.
What is really worrying is that this ROFR price is in many contracts. Often it doesn’t matter as the project is worth less than that. When calculated, it appears to be some sort of rough, quick application of the corporate tax rate extracted and applied to the negative capital account. However, the actual language is “all federal, state and local taxes attributable to said sale”. In the various presentations, the discussion indicates that those taxes are the responsibility of Amtax. But Amtax is a society. In reality, it is the investors who are affected by the taxes. And we can’t really say what those taxes are precisely without digging up investor returns and doing an with and without calculation. This is profoundly impractical.
The rough and ready reverse of the envelope number is fine if the parties are not willing to make a big deal out of it. The IRS has no interest in it. But now we find people fighting over the number, and we learn that there really isn’t any authority on exactly how it should be calculated.
Beth Healy, who has been covering the case for WBUR has South End real estate group wins court victory, but may owe investors millions.
“The decision is a victory for TDC, in a case that has been widely watched in the affordable housing industry, as some investment firms have sought to extract higher profits from federally backed housing deals. The ruling means TDC can continue to house hundreds of low- and moderate-income people at South End properties it has managed for decades.
But Alden Torch Financial, the Denver-based investment firm that was trying to force the sale of the buildings, also won on a key issue: Judge Peter Krupp ruled that TDC must pay Alden Torch’s “exit taxes” as part of the purchase price.
That could run into millions of dollars, according to TDC attorney David Davenport. He said the housing group is considering an appeal..”
I asked Davenport if there was any agreement on what the exit tax number is. He replied, “No sir.”