HomeMy WebLinkAboutStaff Report 2891
City of Palo Alto (ID # 2891)
Finance Committee Staff Report
Report Type: Action ItemsMeeting Date: 6/19/2012
June 19, 2012 Page 1 of 5
(ID # 2891)
Summary Title: PA History Museum Business Plan for Roth Building
Title: Palo Alto History Museum's Business Plan for a Roth Building Lease
From: City Manager
Lead Department: Administrative Services
Recommendation
After the Finance Committee’s (FC) review of Palo Alto History Museum’s (PAHM) business plan
for the Roth Building and the historic tax credit program, PAHM is requesting that the FC
recommend to the Council:
1. that the PAHM be given approval to pursue a historical tax credit with an investo r
and that the lease be amended to facilitate this tax credit by extending the term to
50 years and by assigning the lease to a newly formed Limited Liability Company
(LLC)
2. that the lease also be amended to permit PAHM to sublease some of the space to
for-profit institutions
Executive Summary
At the Finance Committee’s (FC) request and as a condition of its lease option agreement on
the Roth Building, the PAHM has submitted its Business Plan. Staff has generated a series of
questions on the plan and PAHM has decided to respond to these at the FC meeting of June 5,
2012. Responses to these questions are necessary to evaluate the viability of the business plan
and to PAHM moving forward with leasing and rehabilitating the Roth Building . In addition,
there are outstanding issues surround the lease option agreement that require resolution in the
near future.
Background
Background information on the Roth Building since the City’s acquisition in April 2000 a s well as
interaction with the Palo Alto History Museum is extensive and long standing. After an RFP for
use of the Roth Building was distributed, Council accepted PAHM’s proposal in April 2004.
Instead of presenting the history of dealings with PAMF here, staff has attached the last City
Manager Report to the Finance Committee (Attachment A). This contains pertinent
background information and a summary of the Federal Historic Tax Credit (FHTC) Program that
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PAHM proposes to use to partially fund capital improvements to the Roth Building. Questions
from staff on the FHTC and responses from PAHM in Attachment A are most helpful in
understanding this relatively complex program.
At the October 18, 2011 FC meeting, PAHM’s consultant was present to respond to the
Committee’s questions on the FHTC. Most of these focused on the legal and business
relationships involved in structuring the tax credit. For example, further information on the
Master Tenant structure and the relationship between PAHM and the investor was requested.
In particular, the Finance Committee wanted confirmation that the City’s vision for the Roth
Building would be maintained during the 50 year lease period, particularly in the event of a
default by the investor.
In addition, the FC queried representatives from PAHM on its busi ness plan for the Roth
Building and requested information on the projected budgets for running and maintaining
operations at the Roth Building (Attachment B – Minutes from October meeting). PAHM
responded that it was developing a Business Plan and would deliver it to the FC before
expiration of its current option to lease.
Discussion
On April 4, 2012, City staff met with PAHM to review their preliminary business plan and to take
stock of all remaining information needs to fulfill the option requirements. After the meeting,
staff sent to PAHM a series of questions on their pro -forma that would be helpful in assessing
the viability of the business plan. Staff has selected the most pertinent questions for FC
consideration (below) and PAHM responded to questions in the attachments to the May 23
Business Plan (Attachment C) and will be available to answer questions at the June 5 FC
meeting.
Revenues and Sources of Income
1. Staff believes Council gave firm direction that occupants of the Roth Building were to b e
non-profits, yet a for-profit entity is proposed as a tenant. This change in direction
needs justification and discussion with Council for their approval. Does this change have
any impact on the historical credit proposal and structure?
2. Does a 5% annual lease escalation conform to other office leases in the area? This
amount is higher than the average CPI of around 3% over the last decade.
3. What is the % contingency built into the $6.3 million project cost and when was project
cost last estimated?
4. On facility rental, does $40,000 reflect competition from other local facilities trying to
generate income?
5. What is the source of grants starting at $100,000? Are the increments shown in years
2+ realistic given challenges facing grant institutions?
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6. In general, what are the Museum’s back-up plans should some of the more key revenue
assumptions not materialize e.g. grants, donations, facility rentals?
7. We do not believe “in-kind” contributions should appear as a source of revenue. By
definition, these are donations of goods and services and not cash. What the Council
and institution investing in the operation for a tax credit will want to see is the
availability of revenue (cash flow) to cover expenses. At best, in kind donations offset
potential expenses.
Expenses
8. Please inform as to level of FTE for the Admin Assistant and Archivist. We assume
Executive Director will be full-time.
9. Please check benefit rate. While it may include all of the basics like social security,
Medicare, worker’s compensation, is there the possibility of additional, if minimal,
health care coverage, especially for the Executive Director?
General
10. If there is a requirement that revenues must equal a minimum of 75% to obtain
historical credit benefits, it appears that with an $11,000 shortfall in revenue this target
would not be met. It would appear there’s not much margin for error in meeting this
target. Is the Historical Museum confident this requirement can be met over time?
11. A Finance Committee member expressed a desire to have a firm, written commitment
for occupancy of the museum by a revenue generator e.g. Chamber of Commerce. Does
Museum intend to address this?
The information requested is important to understand the ability of PAHM to renovate the Roth
Building, meet the terms of an historical tax credit agreement, fulfill the lease agreement with
the City, and to provide services to its customers. In addition to the attached pro -forma, staff is
providing a letter and information from PAHM that it wanted the Finance Committee to have
(Attachment D). It is important to note that PAHM’s consultant on the tax credit will be present
on June 19 to answer questions in this important area of the financing. This will be the first tax
credit transaction in which the City has participated.
In addition to transmitting PAHM’s Business Plan, there are a number of outstanding issues
surrounding requirements in the option to lease. PAHM and City staff met on May 23 to discuss
these issues and they will be brought to Council’s attention if they cannot be resolved.
Conclusion and Recommendation
Since the October 2011 Finance Committee meeting, two different Council Members,
unfamiliar with the Historical Tax Credit Program, have joined the Committee. While
background material has been provided, it is likely that additional questions will be raised on
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June 19 on the tax credit program as well as on PAHM’s Business Plan. A consultant will be
present to answer questions on the tax credit. While the City has not participated in this type
of financing in the past, PAHM has made its consultant available to City staff and staff believes
this portion of the Business Plan is viable.
Staff recommends that the Finance Committee meeting receive PAMF responses to staff
questions on June 19. This will provide Committee members and staff information necessary to
assess the viability of PAHM’s Business Plan. The PAHM is asking that Council allow subleases
to for-profit institutions in contrast to Council’s original direction to subleas e exclusively to non-
profits. At this time, it appears appropriate to extend the lease option for another six months
(through December 31, 2012) in case the FC has additional questions on the Business Plan or
requires additional information before a recommendation is sent to the full Council.
Resource Impact
A more thorough understanding of PAHM’s Business Plan will be available once questions
posed by staff and the Finance Committee are answered. Other, potential financial issues will
be addressed when other outstanding lease questions are brought to Council’s attention in the
future.
All costs associated with exploring the historical tax credit program are being paid by PAHM.
The City may incur, however, costs for outside experts (e.g., financial advisor and legal to advise
staff and to review documents should PAHM’s historical tax credit financing plan move forward.
Policy Implications
The PAHM is requesting an exception to previous Council policy that the Roth Building be used
solely to house non-profit entities. To generate the targeted revenue level needed for the tax
credit program, PAHM is proposing in its Business Plan renting to a for profit entity.
The City’s goal of preserving the historical Roth structure could be achieved by PAHM f inancing,
especially since the HTC program is, by design, meant for such purpose. Although the
ownership structure proposed by PAMF and its historical tax credit consultant preserves
ownership of the land through a long-term lease, it is possible that tenants could change should
PAHM not be able to fulfill its commitments. In this situation, it is the investor and not the City
that would determine the new tenant. The Finance Committee and Council should be aware of
this possible scenario.
Attachments:
Attachment A: ID# 2197 (PDF)
Attachment B: Excerpt minutes from October 18, 2011 (PDF)
Attachment C: PAHM Business Plan (PDF)
Attachment D: Letter from PAHM Dated May 18, 2012 (PDF)
June 19, 2012 Page 5 of 5
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Prepared By: Joe Saccio, Assistant Director of Administrative Services
Department Head: Lalo Perez, Chief Financial Officer
City Manager Approval: ____________________________________
James Keene, City Manager
City of Palo Alto (ID # 2197)
Finance Committee Staff Report
Report Type:Meeting Date: 10/18/2011
October 18, 2011 Page 1 of 10
(ID # 2197)
Summary T itle: Historic Tax Credit Program Use for Roth Building
Title: Palo Alto Historic Musuem's Proposal to Use Federal Historic Tax Credit
Program for Adaptive Reuse of Roth Building
From:City Manager
Lead Department: Administrative Services
Recommendation
Staff recommends that the Finance Committee review and provide input on the Historic Tax
Credit financing plan developed by the Palo Alto History Museum.
Background
In April 2000, the City Council approved the $1,957,000 purchase of the Roth Building and its
0.41 acre site for potential development as a “public facility or alternative use if a public facility
is not feasible,” in conjunction with the South of Forest Avenue Coordinated Area Plan (SOFA
CAP).
On May 20, 2002, Council approved a Request for Proposals (RFP) and directed staff to solicit
proposals for the lease of the Roth Building. The RFP specified that: preference be given to
non-profit groups located in or serving Palo Alto; that the property be improved and operated
at no cost to the city; and that public access to the Roth Building restrooms by users of the
neighboring park be provided. In response to the RFP, one proposal was received in November
2003. The Palo Alto History Museum (PAHM) proposed to restore, preserve and improve the
historic Roth Building for use as a museum. PAHM’s proposal was accepted by the Council in
April 2004, at which time staff sent the Museum a draft Option Agreement for its review.
In February 2006, staff received the Museum’s proposed changes to the draft option including a
request that the City contribute up to $300,000 to repair leaking and drainage problems at the
Roth building. On July 10, 2006, Council created a Capital Improvement Program (CIP) for Roth
Building maintenance in the amount of $415,000 to provide funding for interim measures to
prevent further deterioration of the building until the Museum takes over the site. On May 14,
2007, Council authorized the Mayor to execute the Option Agreement and approved a City
contribution of $150,000 for repair of the leaking and drainage problems. The Option
Agreement was executed on June 22, 2007 with a twenty-four month term.
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When the twenty four month period ended, the Museum requested additional extensions
which were granted by the City Manager through December 2011. The Museum cited
difficulties with fund raising due to the severe economic downturn and was in the process of
developing a new financing plan that is discussed in this report.
On April 12, 2010, Council approved the nomination of the Category 2 Roth Building to the
National Register of Historic Places and transmittal of letter of support to the State Historical
Resources Commission. The Roth Building was recently listed on the National Register of
Historic Places, joining several other listed Palo Alto structures such as the Norris House, the
University Avenue CalTrain station and the United States Post office on Hamilton Avenue.
On March 21, 2011, in compliance with conditions of the Option Agreement and the Palo Alto
Municipal Code (PAMC) Section 18, development plans for the Museum’s proposed project
were conditionally approved for Architectural Review, Minor Exceptions, and a Conditional Use
Permit (CUP). The proposed project includes the rehabilitation of the 19,182 square foot Roth
Building and a 1,462 square foot addition for use as a museum including gallery space, office
space for museum staff, and offices for future subtenants, a community meeting room, a gift
shop, café, restrooms, archive storage space, and mechanical/ utility spaces. Minimal exterior
modifications on the east side will accommodate a public restroom and a code-required second
stairway.
On March 29, 2011, final approval of the CUP for the project was appealed in accordance with
Title 18 of the Palo Alto Municipal Code. This appeal focused on parking concerns. A public
hearing on the appeal was held on June 8, 2011 before the Planning and Transportation
Commission (PTC), which recommended that Council deny the appeal. Subsequently, the
Council accepted the PTC recommendation and denied the appeal.
Discussion
To obtain additional financing for capital improvements to the Roth Building, the Palo Alto
History Museum (Museum) has solicited the services of Christine Fedukowski Consulting (CFC).
In describing its services CFC states that it,
“works with developers, governmental agencies, community redevelopment agencies,
and investors involved in redevelopment of urban and rural communities that focus on
urban infill projects, including new construction and adaptive reuse of historic
properties. CFC works with its clients to find financing solutions for these complex
projects. Guided by the client’s strategic vision, it manages the financing process from
beginning to end, to identify sources, structure the capital transaction, and close
financing that includes federal and state historic tax credits, new markets tax credits,
other state and local government incentives, as well as conventional financing”
CFC is proposing that the Museum participate in the Federal Historic Preservation Tax
Incentives program and utilize the Historic Tax Credit (HTC) to obtain additional funds to reuse
and rehabilitate the Roth Building.
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CFC, the Museum’s Board President, and staff from Administrative Services and the Attorney’s
Office have met on several occasions to understand the HTC, its requirements, and the legal
structures necessary to fulfill all obligations. This program is complex in that numerous federal
and IRS criteria must be followed carefully and in that several different “ownership” structures
could be utilized.
The fundamental principle of the HTC program is that it provides federal tax credits to
encourage the private rehabilitation of historic structures. Under the HTC an “Investor” (such as
a bank or corporation) invests funds in an historic building rehabilitation project in exchange for
a federal tax credit. The amount and timing of such an investment is dependent on an
investor’s need for a tax credit. Per CFC, HTCs have been utilized as part of an overall financing
program for historic rehabilitation of the Fox Tucson Theater in Tucson, Arizona; the Arctic Club
Hotel in Seattle, Washington; and Mayo Building in Tulsa, Oklahoma (see response to Question
9 below for HTC use in California).
There are an array of requirements to obtain the tax credits and investor financing. The
following represent a sampling of the most important provisions (a detailed “Program
Overview” and preliminary “Proposed Roth Building Rehabilitation” can be found in Attachment
A) follows:
·The HTC can only be used by a taxpayer that owns and rehabilitates a historic
building
·Qualified buildings must by “certified historic structures” (Roth Building qualifies)
·HTC is limited to 20 percent of “qualified rehabilitation expenditures”
·The IRS requires that the project include:
o substantial rehabilitation
o qualified rehabilitation expenditures
o building must be depreciable, so it must be income producing or used in
a business
o tax exempt entities cannot lease more than 50 percent of the rentable
area…
o “economic substance” on a pre-tax basis whereby project must
demonstrate over a projected holding period of 32 years a 3 percent
return on the investor equity investment. Project must have economic
purpose beyond tax benefit by generating profits
o HTC is generally claimed in year building is placed in service
o Claimer of HTC must retain ownership for the property for at least five
years after occupancy or tax credits are subject to recapture
o HTC can be recaptured or returned to federal government if the project is
sold before the end of the minimum 5 year holding period or if the
property ceases to be income-producing
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Based on the above, intricate criteria it appears that the Museum would have to work closely
with a consultant as well as its partners or investors to comply with federal regulations. In
addition, the Museum would need to secure the legal, financial and administrative expertise
necessary to fulfill federal requirements.
In addition to the challenge of complying with all federal regulations, CFC states that “a
recurring challenge in using the tax credits is identifying an entity that can use the credits and
forming a partnership that includes that entity.” Since non-profits such as the Museum cannot
make use of the HTC, it is necessary to partner with an entity that can. The typical partner is
one that makes an equity investment in the project in return for the tax credits. CFC refers to
this as “syndication” of the tax credit. This syndication has 2 basic structures that can be
developed into different ownership arrangements. These are the “Single-Entity” and “Master
Tenant Lease” structures. In both structures a limited liability company (LLC) must be formed.
CFC states that ‘in the Single Entity, the Project Sponsor is the managing member and the tax
credit investor is the Investor Member of the LLC that owns and operates the building. Each is
allocated, according to their percentage member interest, the tax credits, and other benefits
and obligations of the project, including: 1) profits and losses; 2) depreciation; and 3) cash
flow.”
In the Master Tenant Lease arrangement, the LLC that owns the building enters into a long-
term lease with a master tenant entity. The LLC landlord would own the property (via fee
simple title or long-term leasehold interest) and passes through the HTC to the Master Tenant
entity. CFC is recommending the Master Tenant entity structure.
For more detailed information on the substance of the HTC program, please see Attachment A.
In addition, CFC has provided the following WEB sites that describe the program:
National Park Service -Technical Preservation Services: Historic Preservation Tax
Incentives. http://www.nps.gov/history/hps/tps/tax/.
Within that site: Program Summary: Click on "About the Tax Incentives" -PDF format is
in the left hand column. For more Detailed IRS Matters: Click on "IRS Connection:"
http://www.nps.gov/history/hps/tps/tax/IRS.htm (in the left hand column)
California Office of Historic Preservation:
Mills Act Property Tax Abatement Program:http://ohp.parks.ca.gov/?page_id=21412.
Based on the multifaceted aspects of the HTC program and staff’s unfamiliarity with it, several
key questions were posed to CFC. It is important to note that this would be the first transaction
involving the HTC for the City. Also based on staff’s limited research this program appears to be
more widely used in privately-owned, rather than publicly-owned buildings. It appears that in
California, the publicly-owned scenarios involve redevelopment agencies. The questions and
responses follow:
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Question 1
Recognizing the potential for additional funding for the Museum to rehabilitate the Roth
building, City staff views the tax incentive model as outlined by CFC as extremely complex.
There are numerous and strict regulations that must be followed; partnerships to be
developed; and legal questions to be resolved.At a minimum, expert consultant and legal
advice will be required to guide the Museum through the historic tax credit process and to
demonstrate to the IRS that it is compliant with the terms of for obtaining the tax credit. It
appears that consultant expertise will be required on an ongoing basis and that the Museum
will incur an ongoing cost.
Response 1
CFC has been engaged by Palo Alto History Museum ("PAHM") and continues to work on the
required materials, anticipating submitting investor proposals once there is approval of this
concept from the city staff and Finance Committee of their willingness to consider this
structure. Also, the consultant expertise is required only through closing the transaction, to
negotiate and finalize the transaction and to help put in place accounting processes and
procedures to follow after construction completion. And, most of the consultant fee is earned
and payable, if and when the transaction closes, so no significant monies are owed unless an
HTC investment is obtained.
Please note also, that using the HTC benefits does not preclude seeking other alternative
financing options -whether grants or gifts (public and private). As a matter of fact, many
organizations use the HTC investment to leverage other monies.
Although complex, with the help of the consultant, as well as the investors themselves, many
smaller, non-profit organizations in California and across the country have done this. For
example, with respect to a small group being able to successfully complete an investor
syndication,CFC has worked with, two such groups -one, a small parish in Washington, D.C.
that did a $3 million rehabilitation of 2 townhouses for use as a senior center; and the second, a
small San Antonio nonprofit in San Antonio providing early childcare that did a $6 million
rehabilitation.
Question 2
Is the Museum prepared to take on the responsibilities described above and as discussed by the
consultant?
Response 2
Yes, the museum is prepared to do this, as evidenced by engaging the consultant and bringing
capacity to its board that includes a CPA.
Question 3
Does PAHM want to pursue the HTC program or, given its complexities, pursue alternative
financing options?
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Response 3
Yes, it has analyzed the options, and concluded it wants to pursue the HTC, and also will
continue to pursue all other alternative financing options. Furthermore, PAHM has structured
its consultant agreement so that no significant costs will be incurred prior to receipt of a term
sheet, which will detail the investment terms, from a bona-fide, third-party, established Historic
Tax Credit Investor.
Question 4:
From CFC’s materials, the federal HTC program’s goals are twofold: 1) to
rehabilitate an historic building and 2) to house an ongoing enterprise capable of generating an
annual return of 2% to 3% of the amount invested in the project.This return is payable from
cash flow at the end of the year.Also, CFC states that there is a “requirement that the tax
credit investor demonstrate that the Project has ‘economic substance’ or profit motive above
and beyond the tax credit….” Has the Museum and consultant performed the financial analysis
to demonstrate that the 2% to 3% rate of return is feasible and ongoing?
Response 4
That analysis is in process, and based on preliminary projections, the project should meet these
requirements --however, the assumptions and analysis will be revised based on the final
project construction budget and post-construction operating projections, such to include lease
agreements, event rental fees, admissions (suggested donation), building operating costs, etc.
Note also that this “profit motive” is typically determined using a projected holding period of at
least 30 to 50 years, with project cash flow increasing significantly in later years (years 25 and
on).
Finally, to put this concept of “profit motive” in context, it is helpful to understand that a key
purpose of the economic substance requirement of the Internal Revenue Code,is not
necessarily to limit this tax benefit to only highly profitable ventures, but rather to preclude so-
called "sham transactions," that became prevalent prior to the 1986 Tax Reform Act, and
purposely created money-losing ventures solely as tax shelters.
Question 5
Is PAHM prepared to take steps necessary to create and follow a business model that will meet
the profile of an enterprise as described in the consultant’s discussion of the tax credit
program?
Response 5
Yes, PAHM recognizes the need to retain the business skills on staff and board necessary for
this business model. And, to specifically address the “profit-motive” IRS requirement, prior to
closing the transaction, the tax credit investor will require an opinion from tax counsel and tax
accountant that the transaction complies with all rules and regulations.
Question 6
CFC has generated a number of potential ownership structures the Museum can use to
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facilitate the HTC financing.It is unclear to staff which model is optimal and which protects the
City’s ultimate ownership of the Roth property.It appears that either the Single Entity or
Master Tenant ownership structures will maintain a to-be-created “PAHM Rehab, LLC” as the
property owner, but the question remains as to who will own the property should there be a
recapture of the tax credit or if the LLC fails to meet the IRS requirements?
Response 6
The Master Tenant structure will be used. As to the second question, the transaction structure
contemplates that City of Palo Alto is fee simple owner and enters into a long-term lease (at
least 50 years) with the LLC, the Lessee. So, that leads to the question, “what happens if the
PAHM affiliate, that controls the LLC, fails to meet its obligations to the HTC investor”? In that
event, the HTC investor could seek to remove PAHM-affiliate as controlling member, which, if
successful, would result in the HTC investor taking control of the project. However, PAHM
would take steps to mitigate possible adverse effects even if such were to occur, by providing
language in the transaction documents to insure rights and remedies with respect to potential
removal of the PAHM-affiliate as general partner, such as:
1.The HTC investor would still be bound by the terms and conditions of the lease agreement, as
well as all city requirements with respect to zoning, parking, use, etc., that are imposed on all
property owners and users.
2.While the HTC investor would require that it have the right to take control, the conditions
under which such could happen would be specifically defined, and such right could be exercised
only if PAHM-affiliate (A) were grossly negligent;and (B) such negligence had a material
adverse affect on the HTC investor. In other words, simply failing to meet attendance goals, or
generate sufficient cash flow to pay the annual return, would likely not be sufficient grounds to
remove PAHM-affiliate.
3.Typically, the HTC investment is made by a financial institution's community development
corporation, which requires that such investments be made only for projects that provide
tangible community and public benefit and/or serve the public welfare. As such, for both
business and regulatory reasons, the HTC investor’s and City’s project goals are aligned: (a)
maintaining the structure in a manner consistent with the Secretary Standards of
Rehabilitation; (b) using the building to provide space for a museum, and supporting amenities
–or similar activity –that provides community benefit, including accessibility to low-to
moderate income persons; and (c) having an overall operating strategy that supports the City’s
economic development objectives.
Question 7
CFC estimates that an equity investment of $1.08 million from an outside institution is possible.
From prior information, it appears that $4.75 million in donations has been pledged.Together
these sources total $5.85 million.The project apparently needs $6.3 million so an additional
$0.45 million is yet to be identified. Staff’s understanding is that the Museum has been asked
to identify a complete financing plan before approaching Council.What is the Museum’s plan
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for raising the additional financing?
Response 7
Additional financing will come from philanthropic contributions from major gifts from
corporations, foundations, and/or individuals. A broad-based community campaign will be
launched shortly to target approximately $250,000.
Question 8
In the current economic environment, what is the likelihood of finding a bank or corporation
willing to invest in the project for the tax credit?
Response 8
Right now, there continues to be HTC investors active in the market. And, it is this upfront work
we are doing that takes the longest. Once there is an understanding with the city as to the
required structure, we would be able to obtain a detailed proposal from the investor before the
city had to move to the next step of its approval process.
Since a key piece of PAHM’s financing plan rests on a complicated, but viable tax credit
program, PAHM staff recommend that an option extension be approved and that the Finance
Committee and the full Council have additional time to review, raise questions,and provide
input on the funding plan.
Question 9
This tax credit program is geared toward incentivizing private sector investment in historic
renovation. Can you please identify three public sector projects in California where this funding
approach has been utilized?It would also be helpful to have a specific city staff
contact/reference.
Response 9
Please see the following California projects and contacts/references:
Fox Oakland Theater, rehabilitation of historic theater and adjacent new construction using
federal historic and new markets tax credits. The Oakland Redevelopment Agency (ORA) owns
the building and entered into a long-term lease with a non-profit sponsor. ORA also provided
bond financing for a significant part of the project.
Contact: Patrick Lane, Oakland Redevelopment Agency: 510-238-7362
pslane@oakland.net.com.
Ferry Building (and adjacent Piers 1, 3, 5). Rehabilitation of piers and buildings in San Francisco
using Federal historic tax credits.
Contact: Kathleen Diehep -415-274-0536 kathleen.diohep@sfport.com
October 18, 2011 Page 9 of 10
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REA Building, Sacramento. Rehabilitation using Federal Historic Tax Credits. The rehabilitation
was done through an Owner Participation Agreement with the redevelopment agency, which
also provided financing for the project.
Contact: Roberta Deering, Preservation Director, City of Sacramento: 916-808-8259
rdeering@cityofsacramento.org
Question 10
a) This transaction appears to be more complicated than even a city-sponsored bond
financing/COPs transaction or a private-sponsored “TEFRA” bond transaction.
b) In these types of transactions, the City typically engages bond counsel and a financial advisor
with significant expertise. Will these types of consultants be involved in preparing the
documentation or is tax counsel only used to issue an opinion letter?
c) Who will pay for legal counsel?
Response 10
a) There is complexity to the HTC transaction, especially when public and/or private non-profit
organizations are involved, but it is assured that as the transaction moves forward, with the
support of the investor and project sponsor tax counsel, the City will better understand and
become more comfortable with it. This is especially true since you are familiar with bond and
COP financing. CTC believes the City will find the HTC quite simple by comparison. Moreover,
there is no financial liability on the part of the city.
b) Since there is no bond or financing provided by the City, CTC does not expect such counsel or
advisors will be necessary for the City, unless the City decides to hire such expertise. As to the
transaction documents,the investor’s tax counsel will prepare almost all documentation,
except for the PAHM-affiliate entity documents and the lease agreement between the city and
PAHM. For your approval, investor or PAHM counsel will make revisions to the lease
agreement required to comply with IRC. The investor counsel will issue the opinion letter on
behalf of the investor. Also, if you would like to engage tax counsel with HTC expertise, we can
provide referrals.
c) There is no set procedure, everything is a negotiation. Our aim, however, would be to
provide as much counsel as possible to the City, so that the City or outside counsel are
reviewing rather than creating documentation. While I've seen costs for bond counsel at
around $100,000 for the City's specific HTC aspects of this transaction (if a city chooses to
engage outside counsel), CTC expects such cost to be minimal for Palo Alto since outside
counsel would be reviewing, rather than preparing documents. The City’s counsel would focus
primarily on the city's lease agreement and its consent to assignment.
Conclusion and Recommendation
As stated above, the HTC program is new to City staff, although the program has been used in
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(ID # 2197)
other California jurisdictions and the CFC and the History Museum have been responsive to
staff questions. At this time, it appears prudent for the Finance Committee to become familiar
with the HTC program, ask questions, and request additional information where needed. Staff
would then return to the Finance Committee for its recommendation on whether or not to
move the History Museum’s financing proposal on to the full Council.
Resource Impact
All costs associated with CFC are being paid by PAHM. In its current financing proposal, there
are no requests for financing from the City. The City may incur, however, costs for outside
experts (e.g., financial advisor and legal to advise staff and to review documents should PAHM’s
historical tax credit financing plan move forward.
Policy Implications
The City’s goal of preserving the historical Roth structure would be achieved by PHM financing,
especially since the HTC program is, by design, meant for such purpose. Although the
ownership structure proposed by CFC preserves ownership of the land through a long-term
lease, it is possible that tenants could change should PHM not be able to fulfill its
commitments. In this situation, it is the investor and not the City that would determine the
new tenant. The Finance Committee and Council should discuss this possible scenario.
Attachments:
·Attachment A: Public Private Partnership, The City of Palo Alto and Palo Alto History
Museum, Tax Incentives for Adaptive Reuse….(PDF)
Prepared By:Joe Saccio, Assistant Director of Administrative Services
Department Head:Lalo Perez, Director
City Manager Approval: James Keene, City Manager
CFC
DISTINCTIVE SUSTAINABLE DEVELOPMENT
Public -Private Partnership
The City of Palo Alto and Palo Alto History Museum, Project Sponsor
of
The Adaptive -Reuse and Rehabilitation
of the
Roth Building
300 Homer Street
Palo Alto, CA
Tax Incentives for Adaptive Reuse:
Historic Tax Credit and New Markets Tax Credits
Program Basics and Syndication Market
August 3, 2011
FINANCING STRATEGIES FOR HISTORIC PROPERTIES AND URBAN INFIL,L,
601 E. DEL MAR BLVD, #408
PASADENA, CA 91101
PHONE: 626-792-6246
EMAIL: CEEDUKOWSKiaGMAIL.COM
441068
CFC
PROGRAM OVERVIEW
Since 1976, the Federal Historic Preservation Tax Incentives program has played a major role in real estate
development involving historic properties. The IRS Code, Sections 38 and 47, includes provisions for the
"rehabilitation tax credit" which can be utilized in connection with "qualified rehabilitation expenses" for
rehabilitations of "certified historic structures".
Referred to as the Historic Tax Credit ("HTC"), according to the National Park Service 2010 Annual Report, this
program has leveraged reinvestment into more than 37,000 historic properties, which had a total development cost
of more than $58 billion and provided approximately$10.5 billion in tax credits for investors,
HTC has been used for historic rehabilitation projects by both, private and public, non-profit sponsors, as well as by
for-profit developers. However, as is further explained in following sections, the HTC can only be used by a
taxpayer that owns and rehabilitates a historic building. Therefore, structures, in order use HTC financing, all
public -private projects require that if the building is owned by the public entity, the building's ownership ultimately
be transferred to a for-profit entity. while there are a number of transaction structures (specific alternatives are
attached), all require either a long-term lease (minimum 50 or more years) or a sale of the fee simple title, to the for-
profit entity, such that ownership be in place prior to construction completion and remains in place for not less than
five years from the date of construction completion. Projects that have done this include:
➢ Fox Oakland Theater, Oakland, CA: $11MM Historic and New Markets Equity Investment
Public -Private Partnership between Oakland Redevelopment Agency and Private Non -Profit.
➢ Adler Theater, Davenport, IA: $4.5MM Historic and New Markets Equity Investment Public -Private
Partnership between the City, Non -Profit Arts Organizations and For -Profit Theater Manager.
➢ Fox Tucson Theatre, Tucson, AZ $3.1MM Historic and New Markets Equity Investment.
Public -Private Partnership between Rio Nuevo Multipurpose Facilities District (TIF Financing and
grant) and Private Non -Profit Organization.
A. What is the Historic Tax Credits Program? This program administered jointly by the U.S. Department of the
Interior (through the National Park Service) and by the Department of the Treasury (through the IRS), makes tax
credits available to developers that rehabilitate qualified historic buildings. As set forth in Internal Revenue Code
(IRC) § 47(c)(3)(A), qualifying buildings must be "certified historic structures" defined as: (a) buildings listed on the
National Register of Historic Places; or (b) buildings that contribute to a National Register Historic District or
another qualifying local historic district. Treas. Reg. § 1.48-12(d).
The HTC is equal to 20 percent of the "qualified rehabilitation expenditures" incurred in the certified rehabilitations
of certified historic buildings. So if a developer spends $5 million on for a project, there could be $1 million in tax
credits available to directly offset income taxes owed by that entity or one or more of its members/partners.
B. Who Uses the Tax Credits? The Historic Tax Credit is used by owners of certified historic structures who
complete certified rehabilitations. It can be used by developers and individuals, though such use is very limited,
primarily due to the passive activity rules introduced in the Tax Reform Act of 1986.
However, widely -held corporations (i.e. banks, utility companies, oil companies) regularly use the credits to reduce
their income tax liabilities. So, typically, developers partner with a corporate tax credit investor. A limited
partnership is formed, with the developer as general partner and corporation as limited partner. The tax credits are
allocated to that investor and in exchange for the credits, the investor makes cash contribution to the partnership.
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C. NPS Basics: What is a "Certified Rehabilitation" of a Historic Structure? A key eligibility requirement is that
the rehabilitation work must be certified by the Secretary of the Interior as being in conformance with the Secretary
of the Interior's standards for rehabilitation. See IRS § 47 (c)(2)(B) & (C); Treas. Reg. § 1.48-12(d). This certification
and review is administered through the National Park Service (NPS), in conjunction with the State Historic
Preservation Officer (SHPO) in each State. Application for certification is made to the NPS through the SIIPO. The
SHPO reviews the applications and forwards its recommendations to the NPS for approvals. To be certified, the
rehabilitation must be consistent with the historic character of the structure and/or historic district. The defining
historic features and character must be maintained and not destroyed or compromised by the rehabilitation work.
D. IRS Tax Basics.
1. Substantial Rehabilitation: The project must be "substantial." "Substantial
rehabilitation" is defined in Treas. Reg. section 1.48-12(b)(2)(i) as projects that incur
qualified costs in excess of the larger of: (a) the adjusted basis of all owners of the building;
or (b] $5,000. The adjusted basis is generally equal to the property purchase price, less the
costs of the land, less any depreciation taken to date, plus the cost of any improvements
made since the purchase. These costs must be expended within any 24 -month period
ending with or within the tax year that the Historic Tax Credits are claimed.
2. Qualified Rehabilitation Expenditures ("QREs"): are defined in Treas. Reg. § 1.48-12
(c) and IRC § 47 (c) (2) (B) and include certain hard and soft costs associated with the
existing historic building. QREs include hard construction costs, as well as costs of
architecture, engineering, legal (zoning, entitlement), property insurance and utilities, and
financing (closing costs, construction -period interest). Costs not included include
acquisition costs, new additions to the historic structure or other new buildings, parking
and landscaping costs. The total dollar value of the qualified expenditures is critical,
because the total amount of tax credits is calculated as 20% of this amount.
3. Building Uses: To qualify for the Historic Tax Credits, the building must be depreciable,
so it must be income producing or used in a business. Rental housing, retail, commercial
and industrial uses all qualify.
4. Building Tenants: There are also limitations on the types of users and tenants that
occupy the building after construction completion. Tax-exempt entities cannot lease more
than 50% of the rentable area, unless the lease terms do not trigger a "disqualified lease".
The tax exempt user rules must be analyzed on a project by project basis, however, key
events that trigger a disqualified lease are:
a) Use of tax-exempt bonds or other tax-exempt financing for construction; or
b) Under the lease there is a fixed or determinable purchase price or an option to
buy; or
c) The lease term is in excess of 20 years, or
d) Sale - leaseback, i.e. the lease occurs after a sale or lease of the property and the
tax-exempt tenant used the property before the sale or lease.
5. When is the HTC Claimed? The HTCs are generally claimed in the taxable year that the
rehabilitated building is "placed in service," i.e. when a certificate of occupancy has been
issu ed.
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6. Who Claims the HTC? If the developer (or general partner) cannot use the HTC, then
the HTC may be allocated to one or more other partners of the ownership entity.
7. How Long Must the Tax Credit User Own the Property? A taxpayer that claims the
HTC must retain ownership of the property for at least five years after the date the project
was placed in service, or the tax credits will be subject to recapture.
8. Recapture of the Credits. HTCs can be recaptured if the project is sold before the end of
the minimum five-year holding period or if the property ceases to be income -producing.
These recapture rules are laid out in IRC section 50(a). Recapture can also take place if the
project ceases to comply with other transfer or leasing restrictions imposed under the
program or if the project is physically altered such that it no longer complies with the
approved rehabilitation improvements. SEE Treas. Reg. § 1.48-12(f)(3). The amount of the
credit recapture is calculated on a sliding scale based on how much of the minimum five
year holding period has elapsed at the time of noncompliance.
Challenges/Opportunities in Using the Credits:
A recurring challenge in using the tax credits is identifying an entity that can use the credits and forming a
partnership that includes that entity. Also, the rules are complex, and require expert analysis to insure compliance
with all rules and regulations, and to meet business objectives of the developer and investor.
But this is a challenge that can also present real opportunities. Over the years, attorneys, accountants, and investors,
and preservation consultants have developed deep expertise in all areas related to the tax credit. As a result, the
HTC is now one of the most important sources of financing for the rehabilitation of historic properties and has been
successfully used by both for-profit and non-profit developers, for projects large and small.
Resources
The National Park Service web site at www,nps.gov includes numerous links to sites that include information on the
various stages of the National Register process and Historic Tax Credits program. The IRS web site at yvww.irs,gov
also has links to sites that focus specifically on tax aspects of the program. Some specific links:
a) National Park Service Technical Services: Federal Historic Preservation Tax Incentives.
http://www.nps.gov/histoay/hps/tps/tax/incentivesjindex.htm.
b) Internal Revenue Service: Rehabilitation Tax Credit - Real Estate Tax Tips
http://www.irs.gov/businesses/small/industries/article/0,.id=97599,00.html
Roth Building — Historic Tax Credit Financing Page 4 of 23
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EXECUTIVE SUMMARY
Proposed Roth Building Rehabilitation
A summary of the HTC, IiTC syndication (and NMTCs basics) is provided in the attached Exhibit A, with HTC and HTC
syndication discussed in more detail below:
Federal Historic Tax Credit: Equity Investment and Investor Market:
Based on current market conditions and representative projects, investment terms and conditions that the
Project can reasonably expect are as follows:
• The tax credit amount would be approximately $1,200,000, and generate an
equity investment of $1,080,000, assuming a "price" of $.90. A
development cost of approximately $6 Million is assumed to determine the tax
credit amount (20% x $6,000,000 x $.90 = $1,080,000);
The equity investment would be paid in 3 installments: (1) a minimal
amount a construction start, (2) 85% at construction completion, and (3) the
remaining amount upon receipt of NPS Part 3 Approval;
• Investors require an annual return of 2% to 3% while they remain in the
partnership (typically 5 years from construction completion), with a potential
buyout of investor interest at that time, at a price negotiated prior to closing,
typically 5% to 20% of the investment amount.
To maximize the tax credit amount, further review would look at all costs, already, or that will be, incurred,
that could potentially be considered in the tax credit amount (and equity amount) calculation, such as:
• Soft Costs: Architectural fees; Engineering fees; plumbing, Legal fees for
zoning and entitlements; Utilities, Insurance, Janitorial and Security;
• Equipment - certain kitchen equipment not considered FF&E;
• Other: Certain costs already incurred by the City or others, and "special
purpose" items, such as the murals, antique light fixtures; and/or
• Developer Fee: Depending on the final 10 -year operating projections, it may
be possible to include a developer fee up to 20% of development costs.
Regulatory Requirements:
National Park Service
With respect to HTC regulatory requirements of the National Park Service ("NPS"), given that the building
is individually listed on the National Register of Historic Places, for this analysis, it is assumed that it will
receive NPS Approval of Part 1 and Part 2 of the Historic Preservation Certification Application. However,
such Application is to be prepared and submitted by the preservation consultant, with the final
determination to be made by the NPS.
Internal Revenue Service
With respect to regulatory requirements of the internal Revenue Service, given that the Project Sponsor is
a non-profit organization, it must create an ownership structure whereby a for-profit entity will own the
building (as described below). With this ownership structure in place, the Project potentially can meet the
Roth Building - Historic Tax Credit Financing Page 5 of 23
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following threshold requirements as set forth in Section 47 of the Internal Revenue Code ("IRC"):
1. The building is depreciable;
2. The Project will be a "substantial rehabilitation;"
3. The Project will not include a "disqualified lease;" i.e. not more than 50% of the building leases
tax-exempt entities; and
4. The Project will have "economic substance," i.e. the Project must demonstrate "economic
substance" on a pre-tax basis, over a projected holding period of 32 years, generally demonstrated
by showing a 3% return on the investor equity investment.
While ownership of the building will be transferred to a to -be -formed for-profit entity, given that the
building is currently owned by a non-profit organization, which was formed for the purpose of acquiring
and rehabilitating the building as a certified historic structure, it may be of value to explore its continued
participation in the Project. Such may permit use of grants and charitable contributions received from
corporations, foundations, and individuals, for construction and/or operations.
Ownership Structure
The HTC is earned by an entity that (1) pays federal income tax, (2) owns a certified historic structure, and (3)
completes a certified rehabilitation of that structure. Often, a property owner is not able to use the credit, and
therefore, enters into a partnership with an entity, such as a bank or other corporation, that can use the credit.
In a syndication, a for-profit entity is formed, a limited liability company, to own the building, either by holding fee
simple title to the property or by entering into a long-term (50 or more years) lease agreement. The tax credit
investor is a member investor and the Project Sponsor (for-profit) affiliate serves as the managing member. The
managing member and the investor member each agree to receive certain benefits expected to be generated by the
Project, in exchange for fulfilling certain obligations required to complete and operate the Project.
INVESTOR MARKET AND PROGRAM FUNDAMENTALS
HTC INVESTOR MARKET:
1. Credit and Equity Investment Amount: Investors still have interest in the historic tax credit, and a $2,000,000
tax credit is considered attractive, with pricing generally a minimum of $0.90 up to $1.10. However, hotel use is
considered to be higher risk, so the investment terms will look to mitigate perceived market risk, by a "staged"
pay -in; strong guarantor, non -foreclosable debt, reserves and/or combination. .
2. Potential Tax Credit Investors: Tax credit investors that would be solicited include:
a) Banks, which make tax credit investments to satisfy regulatory requirements to make loans
and investments in underserved communities and/or mission -oriented projects with strong
community benefits, such as USBanc, Wells Fargo, Bank of America, Chase, and PNC;
b) "Non -bank" corporations, Chevron for example;
c) Syndicators, such as CityScape Capital Group, and Tax Credit Capital, and NTCIC, (subsidiary
of the National Trust for Historic Preservation);
d) Individuals, while initial due diligence and closing may be easier, pricing may be less and
other services to assist Project Sponsor after closing may not be available.
3. Investor Market: Overall, as a result of the significant losses that most banks incurred over the past few years,
while the investor market for historic tax credits is not as strong as it was a few years ago, there is still demand
for "good" projects.
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a) Investment Terms: Terms typically include:
i) Tax Credit Amount: Generally, a minimum of $1.0 million (project size of approximately
$5 million);
ii) Tax Credit Equity Amount: Currently approximately $0.90 to $1.05 per tax credit.
Generally, the larger deals attract better pricing, as there is more demand for larger deals.
Hi) Annual Return on Investment: Generally 2% to 3% of amount invested, payable from
cashflow at the end of the calendar year. This is required partly due to the requirement
that the tax credit investor demonstrate that the Project has "economic substance" or
"profit motive," above and beyond the tax credit, and partly due to required business
return;
iv) Exit from partnership: To comply with IRC requirements, the investors remain in the
partnership for 5 years from the date of certificate of occupancy. They exit the
partnership in exchange for a payment, which is negotiated prior to closing. This
payment, the "Put Price," is typically S% to 20% of the total investment amount.
v) Other: investors will require a guarantee of the tax credits and possible reserves for
operating deficits and replacement reserves
b) What Makes a Project "good" - What Investors Look For: Generally, in addition to meeting all legal and
regulatory requirements, investors look at the same things a lender or charitable foundation would,
including:
i) Sponsor Capacity: Does the sponsor have the skills and financial strength to complete
the project and to generate sustainable revenues to keep the project going;
ii) Project Readiness:
(1) Construction Financing: are there sufficient sources to pay for all costs, what is
the status of financing commitments;
(2) Permits and Entitlements: are all requirements of state and local governmental
agencies in place; and
(3) Construction and Management Team - Is there a qualified team in place to
begin construction and complete construction on budget and on schedule, and to
operate property after completion; and
iii) Project Timing - construction start, construction completion (Le. when credits will be
delivered), timing of NPS Part 3 Approval (investors typically requires NPS approved
Part 2 before beginning the closing process).
(1)
"Credit Delivery:" Investors' returns are driven in large part by the date they
can earn the credit, f.e. the date of construction completion. An investor's
projected tax liability for any given year, will influence whether, and on what
terms, it would be interested in making a tax credit investment, depending on
when construction completion is projected. In the current market, many
investors who previously had "unlimited appetite" now are looking only for
investments scheduled to complete construction in 2013.
(2) Closing Date: "Syndicators" typically earn their fees upon closing, so are driven
by the Project Sponsor's ability to close within a reasonable timeframe (2 to 4
months).
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C)
HTC REGULATORY REQUIREMENTS:
The regulatory requirements are outlined in Section 47 of the internal revenue code and other tax law. The
threshold requirements are:
1. Depreciable Property: The building must be used in a trade or business, or held for the production of income.
2. Substantial Rehabilitation: A substantial rehabilitation means that the rehabilitation expenditures during a 24 -
month, or in certain instances, 60 -month, measuring period must exceed the "adjusted basis" of the building.
Provided that the construction is expected to be completed within a 24 -month period, the 24 -month measuring
test is usually used, with a 60 -month measuring period for particularly large, complex projects.
a) The adjusted basis is generally defined as the purchase price, minus the value (or cost) of the
land, plus the value of any capital improvements made since the building acquisition, minus any
depreciation already claimed.
b) For the project where there is no purchase price or the purchase price does not represent a
market value, it may necessary to obtain a valuation of the property (with a value each for land
and building), to determine the Project's adjusted basis. Rather than a full appraisal, the
valuation might be obtained by review of assessor records, the most recent "market' purchase
price, and/or a letter from an appraiser.
3. Disqualified Lease and Tax -Exempt Use Property: Internal Revenue Code Section 168(h) contains a
comprehensive set of rules dealing with leases of property to "tax-exempt entities". Under these rules, real
property, which is leased to a tax-exempt entity in a "disqualified lease," is treated as "tax-exempt use property"
and not eligible for the historic tax credit. A "disqualified lease" is defined in Internal Revenue Code Section
168(h)(1)(B)(ii) as a lease to a tax-exempt entity where:
a) Part or all of the property was financed directly or indirectly by an obligation in which the
interest is tax-exempt under Internal Revenue Code Section 103(a) and such entity (or related
entity) participated in the financing, or
b] Under the lease there is a fixed or determinable purchase price or an option to buy, or
c) Lease term is in excess of 20 years, or
d) Lease occurs after sale or lease of property and lessee used the property before the sale or lease.
4. Economic Substance: Generally, tax law provides that to comply with LAC rules and regulations, that a
transaction cannot be undertaken solely to avoid federal income tax liability, otherwise the transaction could be
considered a "sham transaction" and disregarded for federal income tax purposes. As a result, tax practitioners
require that investments using historic tax credits demonstrate "economic substance," i.e. in addition to tax
benefits there is a reasonable expectation of other benefits that will result in profits and that the investment was
motivated by a business purpose other than obtaining the tax benefit. While there is no specific definition of
what is "economic substance," tax practitioners agree that a 2% to 3% annual return on investment achieved
during the holding period is deemed to demonstrate "profit motive," and that the investment is not a "sham
transaction." For historic tax credit transactions, this might be achieved from the aggregate of the investor's
annual preferred return in early years of the partnership, and beginning in later years, additional benefits from
annual cashflow distributions and share of proceeds from property sale.
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OWNERSHIP STRUCTURE
INCOME TAX CREDITS ARE AN IMPORTANT WAY THROUGH WHICH the UNITED STATES CONGRESS CREATES
INCENTIVE for activities that it deems will bring benefits to society that an organization relying solely on private
investment likely would not. The historic tax credit is one of these incentive programs and was created by Congress
in 1976. Current incentives under this program were established by the Tax Reform Act of 2986, and are referred to
as the "Rehabilitation Tax Credit" described in Section 47 and Section 50(d) of the Internal Revenue Code.
Tax credits are available for many activities (the HTC is actually one of the smallest programs), however, for many of
these activities, no taxable income will be earned for a number of years, and often, for various reasons, the activities
are undertaken by entities for whom the tax credits are not beneficial at all. As a result, organizations that cannot
benefit from tax credits, seek out others that do have a need for tax credits, to participate in their projects. This is
referred to as "syndication" of the tax credit.
To syndicate a project, a limited liability company (LLC) is formed to own the property, with each organization (or
affiliate) being a member of the LLC and having a specific ownership interest in the project. Through an agreement,
the benefits and obligations of the project are "allocated" to each member, such that the tax credit investor is
allocated, among other benefits, the tax credits. In return for their allocation of tax credits, the tax credit investor
typically makes an equity contribution to the project.
Within this general concept, there are a number of ownership structures, with two basic structures that are used by
most investors: a single -entity structure or a master tenant ]ease structure.
Single -Entity Structure: In the single -entity transaction structure, the Project Sponsor is the
Managing Member and the tax credit investor is the Investor Member of the LLC that owns and
operates the building. Each is allocated, according to their percentage member interest, the tax
credits, and other benefits and obligations of the project, including: (1) Profits and Losses; (2)
Depreciation; and (3) Cashflow.
Master Tenant Lease -Structure: In the master tenant lease structure, the LLC that owns the
building enters into a long-term lease with a master tenant entity. Per Section 50(d) of the IRC, LLC
that owns the building will "pass -through" the tax credit to the master tenant entity. The master
tenant entity is a separate LLC, but again, with both the Project Sponsor and the Investor Member
having ownership interests, and as in the single -entity, each allocated its share of benefits of the
project -- tax credits; profits and losses; depreciation; and cashflow.
On the following pages are ownership transaction structure diagrams representative of typical single -entity and
master tenant -lease structures, each with a detailed step-by-step description of how the transaction works.
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C.)
SINGLE -ENTITY OWNERSHIP TRANSACTION STRUCTURE: In a Single Entity structure, the tax credit investor is
admitted as a non -managing member to the entity owning the property and makes a capital contribution in an
amount equal to an agreed upon percentage of the historic tax credits delivered. In exchange for its capital
contribution, the investor is allocated its share of the tax credits.
General Partner
Managing Member
• ,01% P&L Allocation
* Operator of Property
The Project
Building
Ownership Entity
• LP o>; LLC
• Single Asset Entity
• Performs Rehab Work
Tenant
Leases
Tenant
Leases
Limited Partner
Investor Member
• 99.99% P&L Allocation
• 3% Priority Return
Tenant
Leases
1. Member ownership interests: As tax credits follow profits allocation,, the tax credit investor holds
a 99.99% investor member ownership interest, and receives 99.99% of the following Tax Credits,
Profits and Losses, and Cashflow
2. Cashflow is an amount remaining after payment of the certain items, which may include:
a] Property operating expenses;
b] Debt service on all loans (including any loans made by the Project Sponsor);
c) Investor priority return; and/or
d) Developer Fee, if any, (potentially equal to up to 20% of eligible expenditures), in which the
developer may be the Project Sponsor, or an affiliate.
The specific benefits that the Managing Member and Investor Member receive, and when they are
received, are described in the terms and conditions of an operating agreement.
1 The tax credits must follow the "profits allocation," i.e. lax eredils are allocated to members according to their share of profits. As "profits"
are not specifically defined in the IRC, the investor share is cashflow is generally used to determine "profits allocation." As such to maximize the
tux credit amount allocated to the investor member, the investor member holds a 99.99% interest in a single -entity ownership transaction
structure.
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MASTER TENANT LEASE OWNERSHIP TRANSACTION STRUCTURE: A Master Tenant pass -through structure
(Per 1RC Sec 47 and Section 50 (d)) is typically used to enhance the overall tax credit benefit and to keep underlying
real estate economic benefits and obligations consistent with the investor and developer return requirements.
The Landlord entity owns the property (via fee simple title or long-term leasehold interest) and passes through the
historic tax credit to a Master Tenant entity. Both the Landlord and Master Tenant are managed and controlled by
affiliates of the developer.
Building Ownership Enlily
• For -Profit Taxpaying Entity
• PerffrnurRehab Work
Long -Tenn Motet Lease
Genet -al Partner
Managing Member
• ,o Ri P&L Allocation
• Operator of Property
Leasing Company
• LP oT LLC
• -Managing Member - Building Owner (.01'4 P&L)
• investor;Member - Tax Credit inveator(99,99%P&L)
Sub-Laase(s)
Tenant
Erases
Tenant
Leaps
Team
Leers
Limited Partner
investor Member
+ 99,99% P&L Allocation
• 3:e Priority Return
The Landlord Entity: LLC Manager holds 90% controlling interest and the Master Tenant holds 10%
non -manager member interest. Landlord responsibilities and benefits include:
a. Earns the historic tax credit and passes through to the Master Tenant
b. Owns the building either via fee simple title or a long-term leasehold interest
(typically 40 years or longer) and is responsible for:
1 Purchase and rehabilitation of the building;
ii. Securing Construction and Permanent Financing, including
tax credit equity which is contributed by the Master Tenant;
iii. Construction Completion and Part 3;
iv. Enters into a lease agreement with the Master Tenant:
v. Paying debt service on construction and permanent financing; and
vi. Receives tax benefits of mortgage interest deduction and
depreciation and other benefits of building ownership.
Master Tenant Entity: LLC Manager holds a .01% controlling interest and the Investor
holds a 99.99% non -manager member interest.
a. Claims the historic tax credit (per the pass -through from the Landlord)
b. Holds a 32 -year lease -hold interest in the property and is responsible for:
i. Leasing and Management of property operations;
ii. Lease payments to Landlord in an amount not less than
Landlord's expenses, including mortgage debt service;
iii. Payment of annual return to the investor; and
iv. Payment of Deferred Development Fee
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EXHIBIT A
20% FEDERAL HISTORIC TAX CREDIT
AND
HISTORIC TAX CREDIT SYNDICATION
20% FEDERAL HISTORIC TAX CREDIT BASICS
Internal Revenue Code (Section 47) and National Park Service Requirements
1. Tax CreditAmount;
20% of Qualified Rehabilitation Expenditures (QREs) incurred in rehabilitating a building:
a. Includes: Hard and soft costs, including a developer fee in an amount up to 20% of
QREs.
b. Excludes: Acquisition costs, landscaping -paving, FF&E, new construction (defined as
a structure adjacent to or above the existing structure).
2. Building;
Building must be a certified historic structure or contributing to a national register historic
district and rehabilitated per the Secretary of Interior Standards for Rehabilitation as detailed
in Part 1, 2 and 3 of the Historic Preservation Certification Application
3. Who Can Use Tax Credits?
Earned by taxpayer(s) owning the Building, provided such ownership:
a. Occurs before placement in service;
b. Continues for not less than 5 years (credits vest 20% per year) - transfer of
ownership prior to end of 5 years triggers recapture;
c. Provides substantial economic benefit excluding tax benefits (Though not specifically
stated in the IRC, review and interpretation by tax attorneys of rules and regulations
has determined that a return on investment of approximately 3% is deemed to
demonstrate such benefit.)
4. When Can Credits be Claimed?
a. Claimed in the tax year of placement in service and receipt of NPS approval of Part 3;
b. Credits can be carried forward 20 years and carried back one year;
c. Taxpayers other than widely -held corporations may be subject to Passive Activity
rules and At -Risk rules.
5. The program is jointly administered by:
a. U.S. Department of Treasury - IRS
b. U.S. Department of the Interior through State Historic Preservation Office and
National Park Service that approve Part 1, 2 and 3 of the Application
Roth Building - Historic Tax Credit Financing Page 12 of 23
DRAFT - FOR DISCUSSION
CFC
HISTORIC TAX CREDIT SYNDICATION
While the tax credit can be earned by taxpayers meeting the above requirements, due to relatively limited
income tax liability and certain other considerations, a taxpayer may not be able to use the tax credit. In such
cases, the taxpayer will partner with a tax credit investor that can use the credit and will contribute equity to the
project in exchange for the tax credit and other project benefits. This is referred to as syndicating the project,
with the following key considerations:
1. Ownership Structure:
• Single -entity structure vs. credit pass -through (also known as lease pass -through)
• LLC or LP
• Minimum term of investment is through end of 5 -year credit compliance period
2. Equity Contribution:
• Price based on timing of equity payments and delivery of credits
• Payments tied to performance benchmarks (e.g. closing, certificate of occupancy, Part 3, full
operations and permanent conversion)
• Some investors offer an "upward adjuster" to provide additional capital if the project delivers more
credits than projected.
3. Ongoing Operations:
• Investors require an annual "priority return" on their investment, usually on the order of 2% to 3%
of equity investment plus any tax liabilities
• Investors usually require an annual asset management fee (nominal) to cover their costs of
monitoring project operations and compliance with tax law.
4. Investor buyout:
• Investor "put" option: usually in first 6 months after end of compliance period; usually greater of
exit taxes or 5%-20% of capital contribution
• Developer "call" option: usually after end of put period; usually greater of exit taxes or fair market
value of investor ownership share
• Issue: developer needs to be confident investor will exercise their put, otherwise cost of exiting
transaction will be at higher call option amount.
S. Other Considerations:
• Investor closing costs
• Terms of guaranties and adjusters
• Investors underwriting standards, reserve requirements, etc.
• Tax implications of project structure
Roth Building — Historic Tax Credit Financing Page 13 of 23
DRAFT — FOR DISCUSSION
CFC
39% FEDERAL NEW MARKETS TAX CREDIT
1. Tax Credit Amount;
• 39% of Qualified Equity Investment [QEI] contributed to a Community Development
Entity ("CDE") that invests in a qualified low-income comm unity business ("QALCB").
• NMTC is claimed over a 7 -year period:
o 5% in each of the first 3 years
o 6% in each of the next 4 years
2. Allocation and Investment Amount:
• Assuming a $10,000,000 "allocation, and "pricing" of $0.60 (current market is $0.60
to $0.73), total investment amount (the QLICI) is $10MM, structured as follows:
o "A" Loan - $7,660,000, interest only, at market -rate, 7 -year term
o "B" Loan - $2,340,000, interest only, at 50 to 100 bps, 40 year term.
o (CDE "sponsor fee" would have to be paid to NMTC investor and could be
approximately $500,000, payable at various benchmarks.)
NMTC allocation may come from one or more CDEs. CDEs typically provide
allocation of not more than $8 million, and not less $5 million to a single project.
3. The Program:
• Investment in businesses and real estate to benefit low-income communities.
• Administered by the IRS (Section 45D) and Community development Financial
Institution Fund ("CDFI"), a department of the U.S. Treasury.
• The CDFI annually awards NMTC allocations (approximately $3.5 billion) to CDEs
based on a competitive allocation process. Awards range from $10MM to small CDEs
up to $150MM to large financial institutions and syndicators.
4. What is a CDE?
• Domestic corporation or partnership that provides loans, equity investment or
financial counseling in "low-income communities"
• Community Development Corporation of major financial institutions typically are
CDEs, for instance.
• A financial institution that serves as the HTC investor, often is the NMTC investor.
5. What is a QEI:
• Equity investment into a CDE, with a NMTC allocation;
• Equity Investment must remain invested in the same CDE for at least 7 years; and
• QEI must be used to make a QLICI within 12 months.
6. What is a QLICI?
• Equity Investment or Loan to a QALICB.
7. What is a QALICB?
• Real estate development projects located in qualified census tracts ("QCTs);
• Businesses located in QCTS or that serve low-income communities.
8. CDE and NMTC Investor Requirements
• Community Benefits:
o Must demonstrate direct benefit to low-income persons. Specific
requirements are in an Allocation Agreement between CDE and CDFI;
• Must meet the "but -for" test, i.e. "but for" the NMTC investment, the project
)
Roth Building - Historic Tax Credit Financing Page 14 of 23
DRAFT - FOR DISCUSSION
CFC
would not be possible.
EXHIBIT B
Disqualified Lease Rules and Examples
Excerpt from IRS Publication
www.cr.nns.gov/hps/tps/tax/IRStaxexempt.htm.
HRTC vs.
LI I -ITC
IRS
Horne Page
Questions/
Answers
IRS Code &
Treasury
Regulations
Facade
Easements
Late
Submission
Lessee use
of Tax Credit
Tax Credit
Recapture
IRS
PROPERTY LEASED TO A
TAX-EXEMPT ENTITY
Prepared by: Mark Primoli and Tom Gavin, internal Revenue
Service
Here we review how the provisions set forth under Internal
Revenue Code Section 47(c)(2)(B)(v), dealing with property leased
to a tax-exempt entity, may impact the use of the rehabilitation tax
credit. These rules apply for both the 10% non -historic tax credit
and the 20% historic tax credit.
Disqualified Lease Rules
When a property owner leases their building or a portion of their
building to a tax-exempt entity, i.e. governmental unit, a tax-exempt
organization, or a foreign person/entity, it is important that they are
familiar with the "disqualified lease" rules that may prevent them
from claiming an otherwise eligible rehabilitation tax credit.
Internal Revenue Code Section 168(h) contains a comprehensive
set of rules dealing with leases of property to "tax-exempt entities".
Under these rules, real property, which is leased to a tax-exempt
entity in a "disqualified lease", is treated as "tax-exempt use
property". Qualified rehabilitation expenditures associated with tax-
exempt use property are not eligible for the rehabilitation tax credit,
A "disqualified lease" is defined in Internal Revenue Code Section
168(h)(1)(B)(ii) as a lease to a tax-exempt entity where:
Roth Building - Historic Tax Credit Financing Page 15 of 23
DRAFT - FOR DISCUSSION
CFC
(1
locations
Tax
edits
x Effect
Grant
ney
(1) Part or all of the property was financed directly or
indirectly by an obligation in which the interest is tax-exempt
under Internal Revenue Code Section 103(a) and such
entity (or related entity) participated in the financing, or
(2) Under the lease there is a fixed or determinable
purchase price or an option to buy, or
(3) The lease term is in excess of 20 years, or
(4) The lease occurs after a sale or lease of the property and
the lessee used the property before the sale or lease. See
Internal Revenue Code Section 168(h)(1)(B)(ii).
Lease Term
When determining whether a lease has a term in excess of 20
years, term of the lease is deemed to begin when the property is
first made available to the lessee under the lease. Treasury
Regulation 1.168(j) -1T Q17 states that lease term includes not only
the stated duration, but also any additional period of time within the
realistic contemplation of the parties at the time the property is first
put into service. The Treasury Regulations cite Hokanson v.
Commissioner 730 F.2nd 1245, 1248 (9th Circuit 1984).
The Treasury Regulations also provide that the term of the lease
includes all periods for which the tax-exempt lessee or a related
party has a legally enforceable option to renew the lease, or the
lessor has a legally enforceable option to compel its renewal by the
tax-exempt entity or a related party, unless the option to renew is at
fair market value determined at the time of renewal.
In other words, a lessor is allowed to renew a tax-exempt entity's
original "under 20 year lease" as long as the new lease is at fair
market value.
The 50% Threshold Test
An exception under Internal Revenue Code Section 168(h)(1)(B)(iii)
provides that property is treated as tax-exempt use property only if
the portion of such property leased to tax-exempt entities under
disqualified leases is more than 50% of the property.
The phrase "more than 50%" means more than 50% of the net
rentable floor space of the building. The net rentable floor space
would not include the common areas of the building, regardless of
the terms of the lease. See Treasury Regulation 1.168(j) -1T Q-6.
Roth Building - Historic Tax Credit Financing Page 16 of 23
DRAFT - FOR DISCUSSION
CFC
If more than 50% of a building is leased to a tax-exempt entity, a
taxpayer would be able to claim the rehabilitation tax credit on the
expenditures incurred for the portion of the building not rented to a
tax-exempt entity. This is illustrated in the following example:
A taxpayer purchases a building for $50, 000 and spends $100, 000
to rehabilitate the property. Three fourths of the building is leased
to a tax-exempt entity for 25 years making 75% of its net rentable
space tax-exempt use property. No rehabilitation tax credit would
be allowed on the $75,000 of rehabilitation expenditures
attributable to the tax-exempt use portion of the building. However,
the taxpayer would be allowed a rehabilitation tax credit on the
$25, 000 expended on the portion of the building not leased to a
tax-exempt entity.
In situations where an expenditure is not considered to be a
qualified rehabilitation expenditure because it is applicable to a
portion of the building which is tax-exempt use property, the
expenditure can still be included in the computation to determine
whether a building has been "substantially rehabilitated". See
Internal Revenue Code Section 47(c)(2)(B)(v).
Property Owned by Partnerships with Taxable and Tax -
Exempt Partners
Many tax-exempt organizations are affiliated with "for-profit"
entities. In these situations, tax-exempt use property would not
include property which is predominantly used by a tax-exempt
entity in an unrelated trade or business (directly or through a
partnership in which such entity is a partner) on which it pays
taxes. See Internal Revenue Code Section 168(h)(1)(D).
When property is owned by a partnership that consists of both
taxable and tax-exempt partners, Internal Revenue Code Section
168(h)(6) sets forth a number of specific rules intended to prevent
the use of tiered arrangements or partnerships and other pass -
through entities to allocate in a disproportionate manner the tax
benefits and burdens of property owned by tax-exempt entities. In
general, if any property that is not otherwise treated as tax-exempt
use property is owned by a partnership that has both tax-exempt
and taxable partners, the proportionate share of the property
allocated to the tax-exempt partners will be treated as tax-exempt
use property.
Any allocation to the tax-exempt entity of partnership items must be
Roth Building - Historic Tax Credit Financing Page 17 of 23
DRAFT - FOR DISCUSSION
CFC
a "qualified allocation" (meaning equal distribution of income, gain,
loss, credit and basis) and must have "substantial economic effect"
(the Treasury Regulations provide that the economic effect of an
allocation is substantial if there is a reasonable possibility that the
allocation will affect substantially amounts to be received by the
partners from the partnership, independent of tax consequences)
Disqualified Lease Rule Examples:
Example 1: A taxpayer rehabilitates an historic structure and
leases the building to the City of Pleasantville. The taxpayer
financed the rehabilitation with tax-exempt bonds issued by the City
of Pleasantville. Even if the lease term is less than 20 years, the
fact that the rehabilitation was financed (directly or indirectly) with
bonds exempt from tax under Internal Revenue Code Section
103(a), the agreement between the city and the taxpayer will'result
in a disqualified lease.
Example 2: A taxpayer rehabilitates an historic structure and
leases the building to the Willow Theater, a non-profit community
theater group. If the taxpayer includes in the lease agreement an
option for the Willow Theater to purchase the building after 15
years, the agreement will result in a disqualified lease.
Example 3: A taxpayer rehabilitates an historic structure and
leases the building to a foreign owned corporation. The lease
agreement contains a provision where the lease term is equal to 15
years with a legally enforceable option to renew the lease for an
additional 10 years at a fixed, non-negotiable price. Since lease
term is in excess of 20 years, the agreement creates a disqualified
lease. If, in this example, the lease agreement contained a 15 year
option to renew at the fair market value that will be determined at
the time of renewal, the agreement would not result in a
disqualified lease.
Example 4: The historic St. Johns School was in dire need of a
substantial rehabilitation. The school sold the building to a XYZ
Limited Partnership for $500,000. The Partnership spent
$1,000,000 rehabilitating the property. The Partnership leased the
property back to St. Johns School. The resulting agreement would
be a disqualified lease because Internal Revenue Code Section
168(h)(1)(B)(iv) specifically states a disqualified lease occurs after
a sale (or other transfer) of property by, or lease of the property
from, the tax-exempt entity and the property has been used by the
entity before the sale (or other transfer) or lease.
Roth Building - Historic Tax Credit Financing Page 18 of 23
DRAFT - FOR DISCUSSION
C F C
EXHIBIT C
Tax Effect of Grant Money
Excerpt from IRS Publication
www.cr.nps.govihns/tps/tax/IRStaxexempt.htm.
Heritage
Preservation
Seat;ces
IRS
Home Page
Questions)
Answers
IRS Code &
Treasury
Regulations
Late
Submission
Tax-exempt
Entity
Lessee use
of Tax Credit
Tax Credit
Recapture
Federal Historic Preservation
TAX INCENTIVES National Park Servico19
"Revitalizing America's Older Communities Through Private Westmont"
IRS
THE TAX EFFECT OF GRANT MONEY IN REHABILITATION TAX CREDIT PROJECTS
Prepared by: Mark Primoli, Internal Revenue Service
This tax brief offers guidance with respect to the tax treatment of
grant proceeds in rehabilitation tax credit projects, and discusses
whether or not the expenditures made with grant proceeds would be
eligible for the 10% or 20% rehabilitation tax credit.
There are various forms of monetary incentives offered by
governmental and tax-exempt entities to help defray the cost of
rehabilitating many of our nation's historic structures. The recipient
of grant money must first consider several factors before determining
whether or not to include the proceeds in income. Two primary
factors include whether the recipient is a corporate or non -corporate
taxpayer and whether the entity receiving the money has dominion
and control over the proceeds. The taxpayer must then determine if
the expenditures made with grant proceeds should be included in its
computation of qualified rehabilitation expenditures.
Unfortunately, our current tax law does not offer specific guidelines
with respect to the issue of taxability, nor does it specifically convey
rules regarding whether or not expenditures made with these grant
proceeds are allowed to be included in one's computation of qualified
rehabilitation expenditures. However, between various decisions
rendered by our courts, actions taken through legislation, and
Roth Building - Historic Tax Credit Financing Page 19 of 23
DRAFT - FOR DISCUSSION
CFC
HRTC vs.
LI1-ITC
locations
Tax
edits
opinions offered through various rulings by the Office of Chief
Counsel, the Internal Revenue Service can offer some guidance in this
area.
Grants Received by Non -Corporate Taxpayers
Section 61(a) of the Internal Revenue Code provides generally that
gross income means all income from whatever source derived. In
Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), the United
States Supreme Curt held that the concept of gross income
encompassed accessions to wealth, clearly realized, over which
taxpayers have complete dominion.
If a grant is given to a non -corporate taxpayer (individual or
partnership) and that taxpayer has dominion and control over the
proceeds, the grant will generally be taxable to the recipient. An
example of this type of general purpose grant would be one where the
taxpayer can use the funds for any purpose, such as operating
subsidies or a general improvement grant.
In Bailey v. Commissioner, 88 T.C. 1293 (1987), the court held that
the recipient of a facade grant lacked complete dominion and control
over the facade because the city's urban renewal agency chose the
contractors and paid them directly. Accordingly, the cost of the new
facade was not included in the recipient's income and was excluded
from the property's basis.
One can draw from this ruling that if the taxpayer had dominion and
control over the grant proceeds, the amount would be taxable.
On the other hand, if a taxpayer had dominion and control over grant
proceeds, but these funds were given to promote the general welfare
of the community, the grant proceeds would be tax exempt under the
general welfare doctrine. The Internal Revenue Service has
consistently held that payments made under legislatively provided
social benefit programs for the promotion of general welfare are not
included in an individual's gross income. Examples of general welfare
grants include flood relief grants and disaster relocation grants. See
Revenue Ruling 76-395 and TAM 200016019
Urban Revitalization Grants used to fund improvements to business
property are normally considered taxable income. Federal grants
given to business owners who suffered flood damage to help them
Roth Building - Historic Tax Credit Financing Page 20 of 23
DRAFT -- FOR DISCUSSION
CFC
recover and improve exterior facades and street level interiors of
commercial buildings were determined to be taxable. See TAM
199919020, Doc 1999-17630.
A grant will also generally be included in gross income if the
contributor expected or received something in return (quid pro quo).
An example of this type of grant would be one where the contributor
receives goods, services, or other direct and quantifiable benefit in
exchange for the grant.
Grants Received by Corporate Taxpayers
Generally, grant proceeds received by corporations are excludible
from gross income. Grant proceeds received by a corporation are
considered to be a capital contribution made by a non -shareholder.
Internal Revenue Code Section 118 was enacted in 1954 to codify and
to rationalize a line of court decisions. This code section provides, in
part, that capital contributions made by non -shareholders are exempt
from income. Internal Revenue Code Section 362 (c) further provides
that these contributions will have no basis.
Non -Taxable Grants
As discussed above, the Internal Revenue Service has consistently
held that payments made under legislatively provided social benefit
programs for the promotion of general welfare are not included in an
individual's gross income.
In addition to general welfare grants, Revenue Ruling 82-195
provides that payments (grants) received by taxpayers under the
National Historic Preservation Act, 16 U.S.C. 470, are not included in
the taxpayer's gross income. The Act of 1966 was amended by section
202 (b) in 1980 and provides that "effective December 12, 1980, no
grant made pursuant to this Act shall be treated as taxable income for
purposes of the Internal Revenue Code.
Effect of Grant Proceeds on Basis
Taxable Grants
If a grant is deemed taxable, the taxpayer will have basis and the
rehabilitation tax credit can be taken on any qualified rehabilitation
expenditures incurred with the grant proceeds.
Roth Building - Historic Tax Credit Financing Page 21 of 23
DRAFT - FOR DISCUSSION
CFC
Non-taxable Grants
If the grant is deemed non-taxable, basis has not been established and
the taxpayer will not be eligible to claim the rehabilitation tax credit
on the expenditures made with the proceeds.
This position is fully supported in Bailey v. Commissioner, 88 T.C.
1293 (1987). In that case, the court ruled that when a grant recipient
incurs no cost attributable to the improvements made to property,
the amount of the grant would not be includible in the basis of that
property. The only instance where the Internal Revenue Service ruled
that a non-taxable grant could also establish basis was in Revenue
Ruling 74-205. This ruling concluded that replacement housing
payments were not only excluded from income, but increased the
recipient's basis in the replacement home. It is important to note,
however, that this ruling was criticized by the Tax Court in Henry L.
Wolfers, 69 T.C. 975 (1978).
Consequently, the general rule disallowing inclusion of tax-free grant
proceeds in basis is set forth in Bailey, while Revenue Ruling 74-205
is an exception to this general rule.
Internal Revenue Code Section 362 (c) clearly states that non -
shareholder contributions of capital to a corporation would not
establish basis in property acquired with the money or property
contributed by the non -shareholder.
Conclusion
Taxpayers who receive grants must first determine if the proceeds
are taxable or non-taxable. If the grant money is taxable, the taxpayer
has basis and the rehabilitation tax credit will be allowed on
expenditures made with this money.
If the grant money is not taxable, taxpayers will have no basis and the
rehabilitation tax credit can not be claimed on the expenditures
incurred with these proceeds.
Grants received by corporate taxpayers fall under the auspices of
sections 118 and 362 (c) and would be considered tax-exempt
contributions of capital by a non -shareholder. Consequently, no
rehabilitation tax credit would be allowed for the expenditures made
with these proceeds.
Roth Building - Historic Tax Credit Financing Page 22 of 23
DRAFT - FOR DISCUSSION
CFC
Grants received by non -corporate taxpayers, such as partnerships and
individuals, will include the proceeds in income if they have dominion
and control over the funds, unless the proceeds are provided as a
general welfare grant or a National Historic Preservation Act grant.
Resources
Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955
Bailey v. Commissioner, 88 T.C. 1293 (1987).
Henry L. Wolters, 69 T.C. 975 (1978).
Graff v. Commissioner, 673 Fed 2nd 784, 5th Circuit 1982
Internal Revenue Code Sections 118 and 362(c)
Revenue Ruling 74-205
Revenue Ruling 82-195
Revenue Ruling 76-395.
Revenue Ruling 76-75
Revenue Ruling 98-19
TAM 199919020, Doc 1999-17630
TAM 200016019
Article: "The Taxability of Capital Subsidies and Other Targeted
Incentives," by Kimberly S. Blanchard, Tory Haythe, New York,
November 5, 1999
Download a chart showing the tax effect of grant proceeds on the
Rehabilitation Tax Credit. (MS WORD format - use the "Save As"
option to download)
Roth Building - Historic Tax Credit Financing Page 23 of 23
DRAFT - FOR DISCUSSION
Historic Tax Credit Syndication
Sample Single Entity Structure
Augu st 2, 2011
PAHM Ma nag er LLC
("PAHM Manager')
Al % Credits, Profits &
Losses and Cash Row
Manager Equity $$
and Building
Historic Ve ntures SPE 1, LLC
("HTC In vestor")
99 .99 %
Credits,
Profits & Lossees,
Casfflow
PAHM Landl ord, LLC
Building Owner
.01 % Man ag er - PAHM Man ag er
99.99% Member,- HTC in vestor
Loan
Proceeds
Debt Service
Payments
Lender(s)
Lease
Agreements
Lease
Payments
Tenants
Historic Tax Credit Syndication
Sampl e Master Tenant Lease Structur e with F or -Profit Developer
August 2, 2011 - F or Discussion Only
Manager
Equity $$
Landlord, LLC
Buildin g Owne r
90% Manager - Developer Manager
10% Member - Master Tenant
Loan
Proceeds
De bt Service
Payme nts
Len der(s )
For -Profit Developer Manager LLC
( "Developer Manager ")
1% Manager: Dev eloper
99%: Developer Equity Partner
.01%
Credits,
Pr ofits, Losses,
Cash Flow
Adminstrativ e
Fee
Tax Credits (1), Profits,
Losses & Cash Flow
Tax Credit Equity $
32 -year Lease Agreement
Lese Payments
Adminstrative
Services
ti
Hist oric Ve ntures 1, LLC
("HTC Investor")
Tax Credit
Equity $$
1
99.99%
Credits, Profits,
Lossees, Casfflow
Mast er Tenant, LLC
(" Master Tenant")
.01 % Manager - Developer Manager
99 .99 % Member - HTC Investor
Lease Agreements
and Paym ents
Sub -T enant
(1) Pe r Se ction 50 (d) of the Interna l R evenue C ode, a taxpayer e ntitle to the HTC may pass -
through HtC to a lessee, provide d lease is at least 80% of depre ciable life.
1
Sub -Tenant
S ub Tenant
Historic Tax Credit Syndication
Sample Master Tenant Lease Structure with N on -Profit Developer
August 2, 2011 - For Discussion Only
Corporations,
Foundations,
Govern men tal
A gencies,
Individuals
(Note 1)
City of Palo A lto
(the "City")
No tes:
—Donatio ns
Tra nsfer of Land and
Building via Sale or
Lo ng-te rm (50+
years) Lease
(Note 2)
Palo Alto History Museum, Inc .
("PAH M")
a501 (c)3,
Califomia nonprofit corporation
("Project Sponsor")
PAHM makes 168 (h) Election
Capit al C ontributions
of —,
Building and Cash
(Note 1)
PAHM Manager LLC
("P AHM Manag er, LLC")
S ole Member: PAH M
LLC m akes C Corp 8832 Election
Tax ID#
J
.01 %
Manager/ .01%
Equity $$ / Profits, Losses,
f Cash Flow
L andlord Rehab, LLC
Building Owner
90% Manager - PAHM Manager, LLC
10% Member - Master Tenant
Loan
Proceeds
Debt Service
Payments
(
Lender(s)
Adminstrative
Fee
Tax Credits (3), Profits,
Losses & Cash Flow - "-`
T ax Cr edit Equity S
32 -year (or 19.5 yr Net Le ase)
Leas e Agree ment
Lese Payments
(1) PAHM makes capital contributions, to PAHM Manage r, LLC, as needed for construction or operations after construction
c ompletion , with pro ceeds from charitable do nations, grants, andlo r lo ans received from financia l institutions, gove rnmental
age ncies, individua ls . PAHM Man ager, LLC will then make a capita l contribu tion to the Landlord or Ma ster Tenant.
(2) Landlo rd Rehab, LLC will take ownership of the property via (1) a le asehold interest pursu an to a lon g-term groun d leas e (at
least 50 ye ars) and deve lopmen t agreement be twee n the City and the Landlord, or (2) transfer of fee simple title to land and
improvemen ts pu rsu rant to a pu rc hase and sale a greemen t (or Disposition and Dev elo pment Agreeme nt) between the City and
the Lan dlord. This exa mple assu mes a sa le from the City to the Lan dlord Re ha b. LLC
(3) Per Section 50 (d) of the Internal Rev enu e Code, a ta xpayer entitle to the HTC may pass -through HtC to a lessee, prov ided
lease is at (east 80% of depreciable life. The term will be eithe r at least 32 years or a 19. 5 year net le ase (as defined in IRC).
(4) To a void en terin g in to a 'Dis qua lified Lease," the leas e to a rty n on -profit will be for a term of less than 20 yea rs, an d in some
instance s may have to be less than 3 -years.
Ad minstrative
Services
ti
Historic Venture s 1, LLC
("HTC Investor")
T ax Credit 99
Eq uity $$ Cr edits, Pro1lt s,
Losse es, Castil e*.
Mast er Ten ant, LLC
("Master Tenant")
.01% Manager - P AHM Manag er,
LLC
99 .99 % Member - HTC Investor
Sub -T enant 2:
Sub -Tenant 1:
C afe Bookstore
Lease Agreeme nts (4)
and
Le ase Payments
PAH M
Sub -Tenant 3:
Revenue and c ash from:
1. Memberships
2. Admissions
3. Facility Rentals f or Ev ents
4. PAHM Manager LLC Capital Contributi ons
10 18 2011 Finance 1
FINANCE COMMITTEE
Special Meeting
October 18, 2011
Chairperson Scharff called the meeting to order at 5:10 p.m. in the Council Conference
Room, 250 Hamilton Avenue, Palo Alto, California.
Present: Scharff (Chair), Schmid, Shepherd, Yeh (arrived at 6:43 p.m.)
Absent:
Oral Communications
None
Agenda Items
1. Palo Alto Historic Museum’s Proposal to Use Federal Historic Tax Credit Program for
Adaptive Reuse of Roth Building
Assistant Director of Administrative Services, Joe Saccio gave a brief introduction to
familiarize the Finance Committee with the Federal Historic Tax Credit Program which
the museum was proposing to receive partial funding to restore the Roth Building. He
expressed that City Staff had met with Museum Executive Board Members and a
consultant with Christine Fedukowski Consulting (CFC) to achieve a better
understanding of the program.
Christine Fedukowski, Consultant for CFC, announced her role was to bring tax credit
equity to the project and structure a financial package for the City. She noted although
the program was new to Palo Alto it was established in 1976 and reformed in 1986 to
correlate with the tax reforms. She noted prior to requesting a formal approval, her
firm would provide specific investors, terms, and structure. She stated the Council
would have seen a number of reiterations of the documentation. In order to take
advantage of the tax credit program the entity, the Palo Alto History Museum, would
need to be made into a Limited Liability Company (LLC), because to participate in the
10 18 2011 Finance 2
program they needed to be a taxpaying entity. The tax credit amount was equal to the
20 percent of the qualified costs which were costs associated with the building,
landscaping and new construction would not be qualified costs. The property owner
could claim the tax credit, they were required to own the property prior to the start of
the construction and for 5 years. She explained if the taxpayer claimed a credit but
the tax liability was less than the tax credit they could carry the credit forward for up
to 20 years and it could be carried back for one year.
Council Member Shepherd said the tax laws with the Internal Revenue Service (IRS)
were currently in flux and asked where the information was. She asked where the
responsibility towards the new LLC would be in the event things shift again as they had
previously.
Ms. Fedukowski said there were 1,037 federal tax credits and tax deductions on the
books and there were no indications of the Historic Tax Credit presently.
Council Member Shepherd asked what would happen if the laws changed.
Ms. Fedukowski said if the laws were to change the responsibility would be on the
investor. Within the document there was a section explaining, in the event there was a
recapture of some kind and the tax credit was not available because of a change in the
law, the firm would seek to put the burden on the shoulders of the investors.
Council Member Shepherd asked whether that information would be a part of the LLC
agreement.
Ms. Fedukowski confirmed it would be.
Council Member Shepherd said with respect to the rehabilitation costs, the
conversation was restricted to the building and not the land acquisition.
Ms. Fedukowski stated yes.
Chair Scharff said the Palo Alto Historic Museum was leasing the building for a term of
40 years so therefore they would be receiving the tax credit, not the City of Palo Alto.
Ms. Fedukowski agreed.
Chair Scharff asked how the City had an interest.
Ms. Fedukowski clarified the City had a role as the landlord.
10 18 2011 Finance 3
Chair Scharff asked for clarification that the Master Leasing Agreement required a
minimum of 50 years.
Ms. Fedukowski confirmed that 50 years was a typical minimum. She said for federal
income tax purposes the owner of the property needed to be deemed the taxpayer. It
had been generally agreed that a lessee who held a long-term lease holding interest
would be deemed to have ownership for federal income tax purposes. She noted there
was a threshold of a 50 year lease so if the lease was only 40 years there would be a
change and the federal government would be looking for a 50 year lease. She
mentioned the investors and the firm would be having discussions regarding who the
project sponsor was going to be, their capacity to build the museum, the ability to
complete the project on time and budget, who was on the project teams, and on a
global basis what were the community benefits.
Council Member Shepherd understood the Chamber of Commerce was planning on
becoming a tenant and asked whether they would then become a tenant of the LLC.
Ms. Fedukowski said they would.
Chair Scharff asked if the firm would be returning to the Council to inform them
whether or not the Palo Alto History Museum met the investor criteria.
Ms. Fedukowski said she could.
Chair Scharff asked for an understanding as to why the firm took over the project.
Ms. Fedukowski said because with all of the work the Palo Alto History Museum Staff
and Board Members had accomplishment to date the next step was for assistance with
financing. This was where the tax credit program came in. They needed the firms’
expertise. It was the influence the museum had in Palo Alto, the overall business plan
they had put together, and the funds they had already earned that made it an easy
decision for the firm to participate. They had also taken their plight through the
National Parks Service requirement to get the property listed on the Register which
was a huge step. They put together an eight member team on the construction side
with Vance Brown as the general contractor who was a highly recommended expert in
Historic Preservation. The firm was currently working to refine the operations and the
business plan.
Council Member Shepherd asked for clarification on an example; the cost of renovation
was $10 million and the History Museum had $6 million with a need for $4 million. That
amount came in and the outside investor received 20 percent of the $4 million as a tax
credit.
10 18 2011 Finance 4
Ms. Fedukowski corrected the statement saying if the project was $10 million the
investor would receive a tax credit on $2 million as the aggregate.
Council Member Shepherd said the investor received a tax credit on the project as a
whole even though their portion of it was $4 million.
Ms. Fedukowski said it was a significant dollar amount which was about 20 percent of
the total construction amount excluding acquisition.
Council Member Shepherd said it was approximately a $10 million investment based on
the City’s investment and the renovation costs.
Ms. Fedukowski explored the basic partnership structure of the LLC; the property seller
was at the top, the property was sold into an LLC, the managing member the investor
member, and then the tenants that leased from the LLC. The investor member would
be looking to contribute the historic tax credit equity, to receive the tax credits, and in
addition they would receive a return of two to three percent annually. At the
beginning of the partnership there would be an option that would provide each partner,
the developer and the investor, to buyout their interests at a specified period.
Chair Scharff asked for clarification regarding the investor’s right to buyout the non-
profit.
Ms. Fedukowski said the investor had the right to put its interest to the non-profit. The
investor had the right to force the non-profit to buy them out, not the other way
around.
Chair Scharff asked under what terms that would occur.
Ms. Fedukowski explained it was a negotiated price, in a typical real estate deal which
was anywhere between five to fifteen percent of the equity invested; for a non-profit
deal it could range from $5,000 to $10,000.
Chair Scharff confirmed the buyout could occur after the first five years.
Ms. Fedukowski said one of the requirements of the tax credit was the taxpayer must
own the property for five years. She noted the museum would have the right to buyout
the investor at the five year timeframe. If for some reason the investor did not
exercise their option after the five year term, the museum had the same buyout rights.
Council Member Shepherd said there would be two investors, the History Museum and
10 18 2011 Finance 5
a for-profit industry.
Ms. Fedukowski confirmed yes, that would be the structure.
Council Member Shepherd said in the agreement the two investors would own 99.99
percent of the LLC.
Ms. Fedukowski clarified the manager, which would be the museum affiliate, would
own .01 percent interest.
Council Member Shepherd said the History Museum would be a .01 percent interest
holder and the investor would come up with all of the cash.
Ms. Fedukowski said no, the investor’s cash would be equal to the 20 percent of the
tax credit allowance.
Council Member Shepherd asked how the manager member integrated their
fundraising dollars into the rehabilitation. If the managing member raised ample funds
and the property was in the tax credit arena for the required five year term, could they
then not convert back to a non-profit and out of the LLC.
Ms. Fedukowski said that was correct.
Council Member Shepherd said the tax credit was just for five years.
Ms. Fedukowski agreed and noted there was to be an option agreement so that each
partner had a mechanism to cause the investor to exit the partnership.
Council Member Shepherd confirmed that would occur only after the five year term had
extended.
Ms. Fedukowski said that was correct, the usual time was five years and two months
by the time of completion.
Council Member Shepherd said the for-profit entity would leave the project and invest
in another project elsewhere.
Ms. Fedukowski said the institutions had well established programs through their
Community Development Corporations and had regulatory obligations to make
investments in those types of private/public partnerships.
Council Member Shepherd asked how the investments were captured.
10 18 2011 Finance 6
Ms. Fedukowski said through the Community Revitalization Act. She discussed the
single entity ownership. She hoped to show how the tax credit investor and the project
sponsor, the City of Palo Alto and the Palo Alto History Museum, came together in the
newly formed Roth Building Rehabilitation LLC. The City as one of the project sponsors
was the landlord, while the Palo Alto History Museum as the other project sponsor was
the property owner or lessee who was responsible for fundraising. The funds collected
through the contributions would likely make a loan or an equity project contribution.
Between the landlord and the property owner was the property manager which was the
Palo Alto History Museum as the sole owner of the 5013C was the sole member of the
manager LLC.
Chair Scharff asked for clarification on following the money. When the LLC was formed,
he asked how would the Palo Alto History Museum get its equity contributions into the
LLC so the work could be completed.
Ms. Fedukowski said the Palo Alto History Museum would make an equity contribution
into the Rehabilitation LLC.
Chair Scharff asked how they held an equity contribution of .01 percent and yet were
able to make a contribution of $4.5 million while the star venture equity made a
contribution of $2 million, and one person received 99.99 percent and the other .01
percent.
Ms. Fedukowski understood it was a difficult scenario to consider but this project was
not typical for an LLC.
Chair Scharff asked if the IRS was satisfied with the situation of the manner in which
the LLC was set-up.
Ms. Fedukowski said yes.
Council Member Shepherd asked if this type of LLC was specifically spelled out in the
IRS code.
Ms. Fedukowski said no, but in a partnership interest it was an allocation of various
economic benefits.
Council Member Shepherd said if a donor made a contribution of $1 million to the
History Museum, the donor received a tax deduction, while the museum took the funds
to create a loan to the manager LLC.
10 18 2011 Finance 7
Ms. Fedukowski clarified there would probably be an equity contribution involved.
Council Member Shepherd said an equity contribution of .01 percent in a taxable
contribution meant they would receive deductions based on their sizable equity
contribution.
Ms. Fedukowski said as in any property statement there were revenue and operating
expenses and income. If it appeared as though there would be cash flow, there would
be other fees such as an administration fee or developer fee and those would be
distributed to the other partner to pay them for their obligation.
Council Member Shepherd asked if the obligation was to manage the property.
Ms. Fedukowski said that was correct. She said with this specific project the cash flow
would not be much to speak of.
Council Member Shepherd stated her confusion on how she could make a taxable
exempt donation that transitioned itself into an LLC.
Ms. Fedukowski said the donor’s charitable contribution was tax exempt and was going
to a non-profit organization for the purpose of rehabilitation.
Council Member Shepherd agreed but the non-profit transitioned their $5 million into
the manager LLC as an equity investment. That money would be used and mingled
with other funds.
Ms. Fedukowski said that was correct. She said this type of LLC had been practice with
both large and small groups and it was done under a corporate charter, in this case the
Palo Alto History Museum. They could not take the funds and enter into a joint
ventures partnership to develop retail outlets; the money needed to follow its purpose.
Chair Scharff asked the relevance of the Chamber of Commerce.
Ms. Fedukowski said their role would be as a tenant.
Council Member Shepherd said the History Museum itself would be a renter or would
have a lease with the City.
Ms. Fedukowski said that was correct.
Chair Scharff asked if there were real numbers for the Finance Committee to review.
10 18 2011 Finance 8
Ms. Fedukowski said there were not real numbers available yet.
Council Member Shepherd inquired as to the single entity method where there was a
need for a two to three percent return.
Ms. Fedukowski clarified the return was on the equity investment.
Council Member Schmid asked what the scenario would be if the investor and the non-
profit went bankrupt after only two years. He asked what the City’s liability would be in
that circumstance.
Ms. Fedukowski said in any lease there was a built-in clause with details on default or
bankruptcy. The landlord had the right to terminate.
Council Member Schmid asked what would occur if the non-profit closed down, the
investor went into bankruptcy, and the investor held 99.99 percent of controlling
interest in the property while the City held the 50 year lease and was the responsible
party. He asked if the bankruptcy court decide the fate of the property.
Ms. Fedukowski stated she was uncertain of the proper answer for that specific
scenario although said she would research and return with a response. She said if the
investor had the interest in an entity that held the ownership lease, the terms and
conditions of that lease recited that if the tenants went into default the lease holder or
in this case, the City had the right to terminate the lease.
Council Member Schmid asked if the ownership of the property resided with the
investor.
Ms. Fedukowski said the ownership resided with the City.
Council Member Schmid corrected the lease was held by the City and that held a
financial interest which the bankruptcy court was interested in.
Chair Scharff said the lease was of value and it would be assigned to someone else
which would not impact the City because they then would be receiving rent from that
other entity.
Council Member Schmid asked if the ownership of the lease had the ability to control
who resided with the investor, the one who held 99.99 percent of the controlling
interest.
Steve Staiger, Historian, Palo Alto Historical Association clarified if the non-profit was
unable to fulfill their obligation, the City had two interests, 1) they were the ultimate
10 18 2011 Finance 9
landlord and 2) they controlled how the building was used.
Council Member Schmid said there was a financial interest; the non-profit was required
to make a three percent payment per year with a buyout clause written for a later
period. There was no monetary connection to the timeline. He wanted to know if there
was a value placed on the property interest if the City would be financially responsible
to the investor if the non-profit defaulted.
Mr. Staiger said the building had a Use-Permit which determined the type of use that
could occur within the structure. If the investor attempted to alter the use of the
building the City would not allow it and therefore would not be financially responsible
for the investor.
Council Member Schmid asked what the City’s ultimate financial responsibility or
liability for loss was if things went wrong.
Senior Assistant City Attorney, Cara Silver noted that was a concern that had been
explored at the Staff level and it was still being reviewed; although, they felt the City
would be able to build-in certain protections within the lease agreement.
Chair Scharff asked for clarification on which lease agreement.
Ms. Silver clarified between the landlord, the City of Palo Alto and the LLC, which was
the tenant of record on the property. The protections built-in to the lease agreement
would state that the property was required to be used for the 50 years or the term of
the lease as a history museum so in the event the Roth Building non-profit entity lost
control or if a for-profit investor went bankrupt or was bought out of the partnership
their interest would be assigned. Staff felt the protections set forth in the lease
agreement would be suitable to protect the City’s interest.
Council Member Schmid said it would be helpful from a risk point of view to have a
financial prospectus for the history museum and what type of budget they had.
Ms. Fedukowski said pending approval of the matter providing that information would
be the next step. In order to get to a point where all of the numbers and the tax credit
information were in a complete package the firm needed to identify the Finance
Committee and Council’s overall willingness to pursue the project.
Council Member Schmid acknowledged most of the risk with these types of projects
was done with non-profit entities with uncertain cash-flow. He said all of the examples
given were with for-profit entities such as restaurants and caterers.
10 18 2011 Finance 10
Ms. Fedukowski said if an investor participated in the program they recognized the
entity was a non-profit and explained part of the process might be there needed to be
a sum of the equity set aside as a reserve. She noted if there was a partnership and
the revenues were such that were not able to achieve the two to three percent, that in
and of itself would not be a reason for the investor to seek control of the partnership
unless there was gross neglect on the part of the museum.
Council Member Schmid asked if going out of business would be considered gross
negligence.
Ms. Fedukowski conceded that would not be considered negligent.
Council Member Shepherd asked if the firm was looking at partners with corporate
social responsibility dollars where a company had set aside certain pieces of their
corporate status to show they were benefactoring a position in human resource
projects. She said the tax credit was not recognized and yet the corporate entities
contributing through donations were still seeking a two to three percent return on the
cash-flow. She asked if there was a way for the City to be a part of the manager LLC
scenario in order to recapture the lease and re-manage the project in the event there
was a default.
Ms. Fedukowski said even in the manager LLC the sole member would need to make
the election to have the revenues to be treated as taxable but the expenses
depreciation should more than off-set any revenue.
Council Member Shepherd asked for a scenario in selling the Roth Building.
Ms. Fedukowski noted it was ultimately a business decision.
Chair Scharff said he did not see a strong risk to the City as long as the lease was well
drawn. If the history museum did not provide their obligations, the City terminated
their lease and the building belonged to the City again.
Ms. Fedukowski clarified if the tenant defaulted, the City could terminate.
Ms. Silver agreed and added the risk appeared to be during the five year period
because after that the investor had received their tax credit and the history museum
would have the ability to buyout the investor.
Chair Scharff asked if Staff could draft a lease agreement encompassing all suspected
risks to the City.
10 18 2011 Finance 11
Ms. Silver believed so and was going to review the bankruptcy risk mentioned
previously.
Council Member Shepherd said if the City did not notify the bankruptcy court correctly
then typically there were no rights extended for the year.
Council Member Schmid asked for clarification that the funds being expended by the
investor were not considered donations because they were expecting a 36 percent cash
return which placed the City somewhat in the business world so Council could not
assume a well written lease could pull the City out. In the report provided to the
Committee the IRS rules cited it was required the project include a depreciable
building, was income producing, sustained ownership over a period of at least five
years, and supply a regular return on the investment.
Chair Scharff said those were requirements for the museum not the City.
Council Member Schmid said the IRS would only accept the tax credit program if the
project entering into the program was a profit venture on the property.
Ms. Fedukowski said the key concept was depreciable property, property used in a
trade or rental not a personal property and in this incident it would be rental property.
With respect to the return, the IRS were referring to economic self stems which were
really for taxpayer protection to avoid what were called fraud transactions. She noted
the two to three percent was calculated over a projected period of 32 years.
Chair Scharff asked for clarification on the two to three percent return, asking if there
was a certain regulation.
Ms. Fedukowski clarified whether it was a two or three percent return was a negotiated
amount.
Chair Scharff said the IRS did not have a guideline; it was typically what was
negotiated between the parties.
Ms. Fedukowski said that was correct and the typical market was two to three percent.
Chair Scharff was aware the history museum had a Use Permit and asked if the firm
was familiar with the document and what it allowed them to do. He was aware the
museum had plans to lease portions of the building to other tenants and he asked if
that was within their purview.
Ms. Silver said there was office use contemplated by the Use Permit although she did
10 18 2011 Finance 12
not believe there was currently a Café allowed.
Chair Scharff recommended reviewing the terms of the Use Permit during the
renegotiation of the lease. He felt the risk to the City was minimal, but was unclear
about the viability of the deal. He said the history museum in itself would not be
adding additional funding so in order for them to be able to make the lease payment it
came down to the other tenants.
Ms. Fedukowski said that was correct.
Chair Scharff stated he would be supportive of the project; however, there were
concerns with the amount of time the City legal team and Staff was spending without a
business plan or budget in place.
Council Member Shepherd said her perspective was the investments were in the leases
themselves not whether the History Museum collected donations or were able to raise
revenues based on events. It was the fact that they had three leases with cash flowing
to the project at two to three percent; that was the business plan.
Chair Scharff asked Ms. Fedukowski what their next steps were.
Ms. Fedukowski said they would be looking deeper into the City risks and the
bankruptcy concept. She explained there would be some importance to the revenues
collected by the museum which would also include the donations.
Council Member Shepherd said at the end of the five years the museum could
transition the LLC out since the history museum did not need the depreciation. She
asked how the City was being reimbursed for the Staff’s time.
City Manager, James Keene clarified the City would not be reimbursed for the Staff
time because the information being collected was considered part of the Palo Alto
process.
Council Member Shepherd stated her concern for the amount of Staff time being spent
on the project that had not been approved as of yet when there were other projects of
high level importance being pushed aside.
Director of Administrative Services, Lalo Perez noted there had been more time
invested on the project thus far since it was an unfamiliar process. He realized the
importance of the museum to the community so it was felt due diligence was necessary
at the $30,000 level to see what the requirements were but he understood at this point
he and his Staff needed to focus on the detail of investors, financial plan, and other
10 18 2011 Finance 13
processes. According to Ms. Fedukowski before she could move forward they needed to
receive a sense of approval from the governing body.
Council Member Shepherd asked how this project rose to the priority level with so
many other projects not getting the attention they deserved.
Mr. Perez said the nexus was the lease options and how to get to the next step to get
the museum to the long-term lease without realizing the time constraint it would
entail.
Council Member Shepherd felt there needed to be a clear prioritization list and she
recommended it go through the Policy & Services Committee. She said the City
resources were thin and there were losses in the process of budgetary cutbacks.
Mr. Keene said he understood the prior investment of Staff time it had taken to reach
where the project was being brought to the Finance Committee but with that being
said, it had reached the point where there needed to be a decision on whether or not
to move forward with it.
Council Member Shepherd asked if there should be a dollar value placed on the Staff
time being spent from this point forward so the community understood the issues were
brought before the Council and Committees and a value was placed on them.
Chair Scharff shared the concern over Staff time being spent and the concern was
raised when there were discussions of the City paying for outside experts at a premium
cost. If the museum had come before the Committee with the three tenant leases in
hand his comfort level would have been higher.
Council Member Schmid said as you look around the City and see City owned property
on long-term leases for the community good; Avenidas, the Art Center, elder people’s
homes, Little League fields and they came from a point in time when the City made a
commitment to turn property over to a non-profit. The museum was the first in a long
time and he felt it was central to the life of the community and worthwhile that Staff
did what was necessary to ensure success but he agreed there needed to be a business
plan in place to verify viability.
Chair Scharff asked what was needed from the Committee to move the project
forward.
Mr. Perez said Staff could return to the Finance Committee once they received the
business plan and had time to review it.
10 18 2011 Finance 14
Ms. Fedukowski said the Committee had provided the requested information needed to
move forward and build a viable business plan.
MOTION: Council Member Schmid moved, seconded by Chair Scharff that the Finance
Committee 1) Accept the Historic Tax Credit Financing Plan 2) Encourage the History
Museum to return to the Finance Committee with a Business Plan as soon as possible,
and 3) direct Staff to be sensitive to the amount of time spent on the Item.
Mr. Keene understood and appreciated the Council’s sensitivity to Staff’s capacity. He
informed the Finance Committee Staff did not have the resources to take actions that
would be of benefit. The driving force was the building of tremendous City asset that
had fallen on hard times and was in disrepair.
Chair Scharff requested to see signed Letters of Intent (LOI) from the intended tenants
of the building when Staff returned with the Item.
INCORPORATION INTO THE MOTION WITH THE CONSENT OF THE MAKER AND
SECONDER: Track Staff Time Spent on the Item and Present Finance Committee with
a Report of Staffing Costs to the City.
MOTION PASSED: 2-1 Shepherd no, Yeh abstain
'Progrlllll ......... .
Admission Fees
Mernberships
! §p(lciill.t;~~.6.ts ........... .
· Spea~(lr§eries,()ther . ..,
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Sub·Total'
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.. Fa9i1i!x.R(lf)!.a1
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· 6iiic:e$p~~~Xnon~pr()fiil.· i 1000 i
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:9afe§p?ge ..... ····· ..... .... . .. ;2~01
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· Sub·Totall
: b()n?lion~:f6~i\ljduai~ ..... . ... i'
;Grants
0
25,025"
.2,50Q:
3,500'
$31,025,
40,000.
.10,9Qo'
30,000
79,266[
§,QQOj
5,000:
27,666'
$196200'
i
PALO ALTO HISTORY MUSEUM
5-YEAR OPERATING PROFORMA: 2013 -2018
M 12
0' 0
31,795: ~3,385:
2,750 3,025 3,328 3,660
3,850, 4,235 4,659' 5,124
$34,600 $37,255: $39,782, $42,169
42,000 44,100, 46,305' 48,620 .
10,500' 11,025 11,576 12,155
~1,~6Q 33,075 34,729' 36,465
83,160' il7,318' 91,684 96,268
6,666, 7,960; 7,500; 8,666
.. fQoQ' .~,QQO 9,000 j,006;
27,000' 27,000; 27,000: 27,000' ;
$207 160, $217518 $227794; $237508,
: :
. ,
3$,990;50,000: '60,QOO! 65,000'
· Endowment Income
i
125,000 145,000, 160,000: 170,0. 6.0.'
'10 O~~~2~5~,6~bO~!~iil'~"~2~t,@00~-6~ Ii ~~ .. ~35~0~6~61' ~~'ii *+""';~f'<""~""'L,
!Benefits @
; ProfessfonalFees
· A~~2~nt(jrit~1,~gal .......... '
IT, Web Design, Book Store
• Administrative Tel(lp~ori~jll1t~rnet
Organiz(jtion§lIO!Jes .
, Postage~Supplies
Ins -0&0
Sub·TotaL
· Travef and Entertainmeflt
Sub·Total
~<lrkeiin9 .
PR.Il\dvertising ................. .
• Postage, Printing, Design
Sub·TotaL
Utilities
i:iectric, water, gas,etal ........ . .' ...... .. Sub·Totai:
Collection/Exhibits
28%'
IO,oQO;
20,000:
27,600:
117,000:
1,500~
2,000,
3,500'
2,SOO
.. 306:
4,5001
.3,Q90 ;
750'
11,050:
5:000;
t,OO() ,
12,000:
1~,O()():
.. 2,QQoi
6,009)
5,006;
31,000'
30,000
30,000 :
72,100
20,600:
27,810
120,510:
J,5Z§
2,000'
3,575'
... '2,625
500
4.725
3.!.1(i0;
1,000
12,000'
5:09Q;
7,350
12,350:
18,540
2,066
26,o6b.,
5,250:
45,850)
33,000
33,000
:
.. 74,2.§3i
21,218;
28,6441
124,125;
34,755
.. .. 1,§!i4:
2,000;
3,654'
,
2,756:
600:
4,961'
3,307
1,000:
12,624 .
5,500;
7,71'(
13,217:
19,467
?,1??
?7.0QO,
5,512.
54,101 :
3~,300.
36,300'
35,797
.V36
2,000
3,736:
2,894
600:
5,209
3,473
{soD
13,676;
6,60.0;
8,103;
14,103)
39,930
39,930
1,829
;i,oilO:
3,823,
3,639;
. 600
5,470
3,646
1,500'
14,255
6,000
8,508'
14,508,
21,462 .
'2,251'
49:000,
43,923
43,923
10,090 10,000 10,000'
20,000
Cllrator.Col1.sultant 10,000 10,000
20,000 • 20,000 • Exhibit.-.Consultant 20,000 20,000
10% increases
2,500 2,625 2,756:
32,500; 32,625 32,756:
,.!.·ln~s~u~ra;!!.n!Cec:,:e ___ --:::-;--;;:--:--c';-_-;-__ ""'~;-;-__ 2~~ __ 2~:,-_--:",2~,829::;4 ... , __ ~3""0,,,3:;c9~ ____ 5% incre.ases
Sub·Totar: 32,894 33,039
SURPLU§; $118,108 $163,241, $185,180
s
FF
GG
HH
II
PALO ALTO HISTORY MUSEUM PROJECT
Five Year Proforma KEY
A Consistent with Lease Agreement
B Survey of local area museums and historical associations
This calculation demonstrates 500 at an average membership of $50 each.
C Anticipated but, conservatively, not included in budget
D Nearby Woman's Club speaker series, as example
E Survey of local area museums
F The Museum performed survey of other area facilities for both rates and
availability. There is a scarcity of available venues in the area, and,
additionally, the Museum offers unique possibilities.
G The Museum performed survey of other area facilities for both rates and
availability.
H Non-profit office. Dedicated second floor office space (800 sq ft) is supplemented
by shared use of second floor board room, staff break room and staff shower
plus ground floor open office (200 sq ft). Rate is calculated at $2.50 sq ft.
Commercial office realtors indicate inflation rate is low, but demand is high.
3% -5% inflation range is typical.
For-profit office. Dedicated second floor office space is supplemented by shared
use of board room, staff break room and staff shower. Rate is calculated at $5.00
sq. ft.
Commercial office realtors indicate inflation rate is low, but demand in high.
3% -5% inflation range is typical.
Comment: The intention of including only non-profits in leased space is
well meaning. However, non-profits cannot typically pay market rents. The
Museum renting to another non-profit (at $2.50 -$3 sq. ft.) means one non-profit
is subsidizing another non-profit. Higher rental income from for-profit tenants
($5 -6 sq. ft.) makes our project viable for ITC investors.
J Calculated at minimal income based on interviews with local museum cafe
operators
K Calculated at minimal income based on survey of local area museums
L Established and ongoing
M Responses from local museums
N The Museum has successfully received grants, including one for $250,000 in the
fall without having a facility. We believe, based on other museums' experience,
that a functioning museum will help draw more attention and more grant monies
to support our exhibits and programs.
o Year two: $250,000 endowment @ 4% return
Year three: $500,000 endowment @5% return
Year four: $540,000 endowment @ 5% return
Year five: $700,000 endowment @ 5% return
P Full time position. Wage & Benefit Survey of No. California Non-Profit
Organizations and local survey
Q Part time.
PALO ALTO HISTORY MUSEUM PROJECT
R Part time. This has been a steady source of revenue for over 20 years
S 28% based on Wage & Benefit Survey of No. California Non-Profit Organizations
and includes a minimal benefit package
T Based on current and researched future needs
U Based on local research
V Based on current and anticipated need
W Current and anticipated
X Current and researched rates
Y Current and anticipated
Z Minimal allowance
AA Estimated based on materials anticipated
BB Estimates from local service providers
CC Estimates from local service providers
DD Estimates from local service providers
EE Estimates from local providers
FF City of Palo Alto -estimated rate based on approved plans
GG Professional consultant responses based on antiCipated need
HH Professional conSUltant responses based on anticipated need
II Estimates from local service providers
PALO ALTO HISTO Y MUSEUM
HONORARY CHAIRS
DEAN CLARK
HEWLETT LEE
WILLIAM E. ROTH
PROJECT DIRECTOR
KAREN HOLMAN
BOARD OF DIRECTORS
STEVE STAIGER
President
GAIL WOOLLEY
Vice President
DIANA WAHLER
Treasurer
BARIJARA WALLACE
Secretary
SUSAN BEALL
NANCY BJORK
GLORIA BROWN
BETH BUNNENBERG
DEANNA DICKMAN
GARY FAZZINO
MARGARET FEUER
NANCY HUBER
DOUG KREITZ
SHULAMITH RUBINFIEN
TOM WYMAN
BOARD OF ADVISORS
JIM BAER
GWEN BARRY
MARILYN BAURlEDEL
BERN BEECHAM
FAITH BELL
GREG & JULIE BROWN
LOREN BROWN
DAVID BUBENIK
CAROLYN CADDES
WANDA CAVANAUGH
MARGARET CHAI MALONEY
CAROLYN LOUGEE CHAPPELL
VICKY CHING
MALCOLM CLARK
ANNE CRIBBS
ANDY DOTY
SID ESPINOSA
MEGAN SWEZEY FOGARTY
HILLARY FREEMAN
CRYSTAL GAMAGE
DR. JIM GIBBONS
GEORGIE GLEIM
BOB GRIMM
BIRTHARVEY
ANDY HERTZFELD
LAURA JONES
JEANNE D. KENNEDY
DUDLEY KENWORTHY
HaN. LIZ KNISS
PHILLIP LEE, M.D.
MILLIE MARlO
JOYCE MCCWRE
PEGGY McKEE
JIM MITCHELL
PHYLLIS MUNSEY
BEv NELSON
ENID PEARSON
NANCY & STEVE PLAYER
EMILY RENZEL
DICK ROSENBAUM
MICHAEL SANTULLO
HON. 10E SIMITIAN
SUSAN' SWEENEY
LEONARD WARE
SAM & KIM WEBSTER
ROBERTA YEE
CONNIE YOUNG Yu
May 18, 2012
To Members of the Palo Alto Finance Committee,
In the process of creating the Palo Alto History Museum, one of the funding mechanisms
identified was the Historic Investment Tax Credit Although the process to obtain this
benefit is complex, it is worthwhile because the benefit is so large. The Museum hired
Chris Fedukowski, an experienced tax credit consultant, to execute this process. The
Museum Board hopes the following will answer any questions that the Finance
Committee might have as we seek your support for this program.
With any start-up, such as the Museum, it takes considerable effort and time to lay the
groundwork for later success. Once we were granted the Option to Lease in June 2007,
the following steps were taken:
• Work began on researching the Roth Building's history and archi tecture so it migh t be
determined eligibile for the National Register, which in turn would make the project
eligible for Investment Tax Credits. We presented an extensive set of documents and
photographic evidence that determined eligibility and the Roth Building is now listed on
the National Register of Historic Places;
• Planning began with the project architect to develop a restoration plan appropriate for
a museum in a National Register Building;
• A professional Investment Tax Credit advisor was brought on to help navigate the
necessary steps, including developing a 5-year budget as part of a package to secure an
investor;
• Architectural plans were completed, submitted to the City, and have received final
approvals from all City departments.
While the Museum Board has been very conservative in including only $850,000 in our
capital gifts estimate, the Investment Tax Credit is may be as much as $l.2M (20% of
qualified capital improvements) for the restoration of the Roth Building for use as our
local history museum.
Although the process may seem complex, the Museum is paving the way for the City to
potentially use its new understanding of Historical Investment Tax Credits to facilitate
the rehabilitation of the Downtown Post Office or Lucie Stern Community Center and
thus provide the opportunity for millions of dollars of infrastructure funding.
The Museum Board respectfully seeks your support for the Investment Tax Credit
program. It's conservative. It's significant. It can bring money to this and other City
projects.
Respectfully submitted,
PO Box 676 PALO ALTO, CALIFORNIA 94302
650.322.3°89 MUSEUM@PAHISTORYMUSEUM.ORG
Palo Alto History Museum
c/o Steve Staiger
300 Homer Ave.
Palo Alto, CA 94301
Dear Mr. Staiger,
I have prepared the following in response to your request for an estimate of the
potential lease rates for office suites that may be made available at 300 Homer
Avenue Palo Alto, the future location of the Palo Alto History Museum.
Two suites are being considered.
Suite B3
Ii Location: Floor 2 at the Homer/Bryant corner of the building
II Configuration: Five private spaces
.. Window line: Two spaces without windows, one with two small high on wall
windows, and one with one high and one typical height window
.. Entrance: Within the museum staff suite
.. Other: Shared use of break room and conference room
.. Size: Approximately 8805f
Suite B1
.. Location: Floor 2 at Channing/Waverley corner of building
.. Configuration: Open floor plan
Ii Window line: Good windows on both exterior walls
.. Entrance: Off floor 2 lobby
.. Other: Private balcony and shared use of break room and conference room
.. Size: Approximately 1320sf
Potential tenants are as follows:
Ii Suite B3: Non-profit or for-profit business entity
.. Suite B1: For-profit business entity
Non-Profit:
In addition to Suite B3 the non-profit would lease an additional approximately 200sf
on the first floor for interfacing with the public. The space would be well suited for
a non-profit needing space to meet with the public and private space for its staff. It
is estimated that the triple net market value would be in the $5.00/sfto $S.50/sf per
month range. (Under a triple net lease all operating expenses born by the landlord
are passed through to the tenant ona pro rata basis in the form of additional rent).
The total monthly rent would be about $5,400 to $6,000.
For-profit entity:
Suite B3 has identity issues for a private entity. It has a weak entry and is located in
museum not an office building. This and the poor parking would render the rate in
the $4.50/sfto $S.OO/sfrange or $4,000 to $4,400 per month.
Suite B1 would have greater appeal due to the stronger entrance and window line.
In addition, many office users prefer the open landscape configuration. The
estimated value of the spaces is $5.00/sfto $5.50/sf or $6,600 or $7,300 per month.
These are rather rough estimates in today's dollars. As the project progresses, I
would be pleased to update and refine these estimates.
Sincerely,
Steve Pierce
Owner-Broker
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PALO ALTO HISTORY MUSEUM PROJECT
Historic Preservation Investment Tax Credit Program Described
The Federal Historic Preservation Tax Incentives Program began in 1976 as a
way to encourage private investment in America's downtowns at a time when they
were suffering. Strip mall development was diverting business away from core
business districts. Recognizing that downtowns commonly were comprised of historic
buildings, a plan was developed to incentivize the restoration of the business core.
The program was later expanded to allow broader community investment.
One of the federal government's most successful and cost-effective community
revitalization programs, the Preservation Tax Incentives reward private investment in
rehabilitating historic properties such as offices, rental housing, and retail stores.
Abandoned or under-used schools, warehouses, factories, churches, retail stores,
apartments, hotels, houses, and offices in many cities have been restored to life in a
manner that retains their historic character.
The Federal Historic Preservation Tax Incentives program encourages private sector
investment in the rehabilitation and re-use of historic buildings. Each year, approximately
1000 projects qualify for the Credits, leveraging nearly $4 billion annually in private
investment in the rehabilitation of historic buildings across the country. A local example
of a project that utilized tax credits is 520 Ramona Street, former site of Chantilly
Restaurant.
The Tax Credit is calculated at 20% of the project's qualified preservation costs.
6,
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PALO ALTO HOUSING
725 Alma Street· Palo Alto, CA 94501 • (650) 321-9709 • Fax (650) 321·4341
November to, 2011
Mr. Steve Staiger
Palo Alto History Museum
P,O. Box 676
Palo Alto, CA 94302
Re: Letter of Intent to Lease Parking Spaces at 2501270 Homer, Palo Alto to History
Museum/Chamber of Commerce ~.
Dear Mr. Staiger
This Letter ofIntent signifies Palo Alto Housing Corporation's (PAHC) interest in leasing up to
12 parking spaces to the History Museum/Chamber of Commerce. The parking spaces are
located in the underground garage at 2501270 Homer in Palo Alto and are currently assigned as
guest parking for Oak Court Apartments. At this time, Oak Court is sufficiently parked for both
its residents and guests. Hence, we are pleased to be able to share our space with the exciting
museum.
As discussed during preliminary meetings with staff at Palo Alto Housing Corporation (PARC)
and the History Museum, these parking spaces will be leased in the fall of20]2 with the
completion of construction of the History Museum. Parking spaces will be leased for employees
of the History Museum and Chanlber of Commerce at a rate consistent with that charged by the
City of Palo Alto lots. Specifics of the rental agreement, including the indemnification
agreement & insurance requirements, etc, will be finalized prior 10 commencement of the rental
period.
Thank you for your interest in leasing these parking spaces and we look forward to working with
your agency. Should you have any questions or concerns, please contacts do not hesitate to
contact us.
Sincerely,
PALO ALTO HOUSING CORPORATION
~ Candice R. Gonzalez
Executive Director