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Can Residents be a General Partner?

Can Low Income Housing Tax Credits be used to finance housing Co-ops? Almost all tax-credit co-ops in Massachusetts have been set up with the Co-op as a General Partner, but in the rest of the country, most developers feel that this is not possible. A recent ARCH article alluded to the National Equity Fund’s practice of prohibiting resident organizations as general partners. That article led to a number of conversations, which eventually led us to conduct the following interview between Daniel Kraus of Holleb and Koff, attorney for the National Equity Fund and Jonathan Klein, General Counsel for the Community Builders. ARCH presents this interview in hopes of informing the debate on this important subject.

Daniel Kraus: What started this whole controversy back in 1988 was IRS Notice 8891. The Notice was originally just additional certification requirements, but at the end of the notice they put a paragraph that said that final regulations will provide that property owned or leased to a tenant cooperative or corporation or a tenant stockholder will not qualify for Low Income Housing Tax Credits.

The IRS then got a call from the Minnesota Housing Agency that said that a Minnesota law provided that property leased to tenant housing cooperatives is exempt from property taxes, so as a result 99% of all Low Income Housing Tax Credit deals in Minnesota are leased to tenant cooperatives.

So the IRS put out a letter ruling that said that what they were really trying to avoid was Low Income Housing Tax Credit Tenants getting tax credits. Now I wasn’t aware of that many low income tenants who needed tax shelters. But anyway, the ruling says that when we do issue final regulations, they will state that the intent of the rule was to preclude the members of any cooperative that owns or leases qualified property from claiming Low Income Tax Credits with respect to that property.

It went on to say that because a leasehold cooperative does not have any ownership interest in the property, that is, it is not entitled to any credits, depreciation, interest, real estate taxes or other benefits, that the property will qualify for the credits. This notice is relied upon by everyone, although theoretically a letter ruling applies only to the party who requested it.

The position that we have advised to NEF therefore is that you can lease to cooperatives so long as the co-op does not have any ownership interest. We have avoided having the co-op serve as the general partner of the partnership because general partners are supposed to have 1% of everything the co-op produces, meaning that the co-op will have a small share of the credits, losses, etc., which is what the letter ruling says you can’t do.

Jonathan Klein: I don’t think it says that - the ruling says the stockholders cannot receive the tax credits, depreciation, etc. The co-op is a corporation, not a partnership, not a sub-chapter F, so that the members do not get the tax benefits.

Now there are special provisions under Section 216 that say that you can pass through interest deductions and real estate taxes. There is no special provision that says that you can pass through tax credits.

DK: The notice says specifically that no credits, depreciation deductions, interest, real estate taxes or other benefits are available to the lessees or tenant members, and under 216 co-op members can get interest and real estate tax benefits.

JK: Section 216 does allow some benefits to be passed through, but Section 216 only applies to cooperatives that own real property. Co-op members who are members of a co-op which is a general partner cannot get interest deductions or depreciation deductions or real estate tax benefits because Section 216 applies to cooperatives that own real property, and a cooperative that owns a general partnership interest in a partnership has no ability to pass through tax benefits to its member stockholders.

So if you look at the intent of the IRS ruling that says that we don’t want low income tenants getting Low Income Housing tax benefits, the answer is that they don’t.

DK: We felt that it wasn’t all that clear that if the cooperative was the general partner that the members wouldn’t be entitled to the real property tax deductions. And further, we felt that we could structure the transaction so that the co-op gets the benefits, i.e. the management benefits and the purchase option.

So we felt that as long as we could achieve the same ends and be certain that we don’t have a problem, why tempt fate?

JK: I don’t think everyone agrees that you can get the same benefits, and I give you this example: let’s say we were going to buy a property together and I said "I’ll be the general partner and I’ll give you a lease". You might not like that. It is a different relationship. You can pass through many of the rights, but it is not the same.

DK: Practically, though, when we have talked to non-profits that have wanted to set up these cooperatives, we have never had one say "Oh no, I want to be a general partner."

Another way of setting this up might be that you set up the partnership under state law with a zero percent interest in the partnership.

JK: That is something I have done in the past. Not with a zero percent interest but with a .001% interest, because there is a question of whether you are a partner with a zero percent interest.

Groundbreaker: From our work, the co-op’s role with respect to the partnership can be a marketing issue. When people move in, they want to understand what they will be a part of. It is already a little tough saying, you are going to be part of a corporation that owns the property. It is even tougher saying you are going to be part of a corporation that owns nothing but rents the property from a partnership that owns it. There are some people who that makes just a little too nervous.

DK: It is important to point out that most of the deals that I have worked on have had a purchase option at the back end - a below market purchase option. So that restores the element of ownership after 15 years.

JK: Let me give some background on why we do things differently in this part of the country. Back in 1983 or 84 when we at Brown Rudnick Freed and Gesmer, and in particular John Achatz, did the first syndicated co-op, we thought that the way to give the tenants the maximum control, where the tenants were our clients and that’s what they wanted, was to make them the general partner.

When tax credits came along, the general notion was that if you wanted to do a syndicated co-op, the way to do it was to make the co-op the general partner.

DK: Are you aware of any case in which the IRS has blessed a non-leasehold Tax Credit Co-op?

JK: No. Nor am I aware of any case where they have challenged it, or where a ruling was requested. It is our practice not to request letter rulings. You read the law and figure out what it means.

DK: My allegiance is more to the syndicators and the investors - that’s who I represent. I have a clear indication from the IRS that a leasehold co-op is acceptable. I do not have such a clear signal for general partner co-ops. So given the statement from 8891 that you don’t get any credits, that’s a pretty big hit.

JK: Here is our reasoning that produces the opposite result. First of all, it says final regulations will be forthcoming. That was eight years ago. Number two, the statement was a statement out of nowhere.

DK: Correct.

JK: Number three, the statement referred to co-ops as they are defined in Section 216, which is a fairly narrow definition. And number four, if you ask anyone at the IRS what they had in mind, they were worried that deductions could be passed through to an actual member. You put all this together, and you say we are doing this for members, and you can easily set up a cooperative that does not comply with 216. If you do that, then the notice is not applicable at all. Finally, there is no possibility that the benefits would flow through to the members.

Then you say what interest would the IRS have in upsetting this apple cart? Although you could say that this is an all or nothing issue, it is pretty easy to come to the conclusion that it is a non-issue. And we have not had trouble getting responsible investors or responsible counsel to agree with that position. In fact, the issue doesn’t even come up.

DK: I agree - if you structure it so that it does not meet 216 guidelines then you are OK. Number 2, I agree with you that the Service has no benefit in attacking this structure. But I have seen a lot of cases where the Service has no such benefit, but they have attacked, and I have seen cases where they have won.

JK: I’m not disagreeing with your point of view which is to say that if I can do something that is 98% as good, why should the investor take any risk at all. The other side is that maybe we think it is only 75% as good, and there is no risk for the investors.

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