By Samantha Hoyte, CPA, MBA, CFE, Withum
State and local governments, based on volume caps established by the federal government, are able to issue tax-exempt housing bonds. The proceeds of these bonds are used to finance mortgages for, among other uses, the production of affordable housing. Tax-exempt bonds are those where the interest paid to the bondholders is exempt from federal income tax and, in certain situations, state and local taxes as well. This tax benefit tends to result in a higher market price for the bonds, ultimately resulting in lower interest rates for the mortgages financed by these bonds.
The proceeds of these bonds can be used to finance one mortgage or many project mortgages. Issuance of this tax-exempt financing allows the project to apply for 4% low-income housing tax credits (LIHTC) on an “as-of-right basis” and does not preclude the project from receiving other government subsidies that are allowed for qualified projects.
There are costs a property will incur for the mortgage including, but not limited to, bond counsel fees, trustee fees, issuer’s fees, underwriting fees, etc. These costs vary depending on the specific transaction and normally are a percentage of the mortgage loan. Just as with any financing, there are multiple steps to close on tax-exempt mortgages. The most important first steps are:
1. A preliminary sources-and-uses schedule determining how much financing is needed for the project and how much will be supplied by tax-exempt financing; and
2. Securing the right development team to assist with the process. It is always important to ensure there is an efficient team for the process as well as ensuring requirements for applying for and closing tax-exempt bond financing are met.
There are also a variety of tax-exempt bonds such as private activity bonds, exempt facilities bonds and other government programs that allow for tax-exempt bond financing. Each bond has a specific set of requirements in order to not only apply for the bond, but also maintain the bond as well. It is key to understand these requirements when deciding step 1 noted above.
The issuance of municipal government bonds is governed by state law, which results in varying processes and requirements depending on the location of the property.
For the State of New Jersey
Most tax-exempt bond financing for housing is issued by the New Jersey Housing and Mortgage Finance Agency (“NJHMFA”). Projects financed through the sale of tax-exempt bonds must comply with Section 142(d) of the Internal Revenue Code and the applicable U.S. Department of Treasury regulations. These bonds are also subject to a statewide volume cap for the funding of housing projects. Information for the financing of multifamily projects for the State of New Jersey is located on the NJHMFA’s website.
For the State of New York
Housing investment bonds for New York are done through the New York State Housing Finance Agency (“NYSHFA”), a department of the New York State Homes and Community Renewal. The NYSHFA “provides tax-exempt bond financing that generates ‘as-of-right’ 4% federal Low-Income Housing Tax Credits for multifamily rental housing projects developed by private for-profit and not-for-profit owners.” NYSHFA is authorized to allocate “as-of-right” credits to projects that also receive benefits from other state agencies, but the project would still be subject to monitoring by the NYSHFA. Information on bond financing of multifamily projects in New York is located on the Homes and Community Renewal’s website.
For Other States
Visit the website of the State Agency that is responsible for issuing the bonds.
Common Requirements for Tax-Exempt Bonds
• Qualified project
• Low-income set aside
• Rent restrictions
• Subject to the terms of a regulatory agreement
• At least 95% of the bond funds must be used for eligible costs
• Must pass the 50% test
95% Test
Under IRC Section 142, tax-exempt financing requires that 95% or more of the net proceeds be used to provide an exempt facility. In some cases, if the issuer fails to meet these spending requirements, it may remedy that failure by taking certain remedial actions. Only eligible costs are taken into consideration when determining costs expended for the exempt facility.
50% Test
Under IRC Section 42(h)(4)(B), “if 50% or more of the aggregate basis of any buildings and the land on which the buildings are located is financed by tax-exempt bonds, then the credit is based on the entire eligible basis of the qualified low-income buildings, regardless of the source of funds used to finance the qualifying costs. If less than 50% of the aggregate basis of the building and land are financed with tax-exempt bonds, then only the eligible basis actually financed with the tax-exempt bonds is includable in eligible basis.”
Samantha Hoyte, CPA, MBA, CFE, Withum.