Understanding the New Safe Harbor for Historic Rehabilitation Tax Credit Allocations

By Keiter CPAs

Understanding the New Safe Harbor for Historic Rehabilitation Tax Credit Allocations

In August 2012, the Court of Appeals for the Third Circuit reversed a previous Tax Court decision in the Historic Boardwalk Hall LLC v. Commissioner case by ruling that an investor in an LLC formed to rehabilitate a historic property was not a bona fide partner because the investor had no “meaningful stake” in the entity’s failure or success. They ruled the transaction was, in substance, a prohibited sale of historic rehabilitation tax credits. The appellate court concluded that the investor did not truly join the entity with the intent of carrying on a business and sharing the profits and losses from entity’s activity. Because the investor was not a bona fide partner in the entity, the IRS disallowed the allocation of the historic rehabilitation tax credits to the investor.

In response to the ruling described above, which caused immense uncertainty within the historic tax credit community, the IRS issued Rev. Proc. 2014-12 on December 30th, 2013. Rev. Proc. 2014-12 provides a safe harbor under which the IRS will not challenge partnership allocations of historic rehabilitation tax credits by a partnership to its partners. By following these safe harbors, partnerships and their partners can breathe a sigh of relief that they will not lose their tax credits because of a future IRS ruling.

Safe Harbor

The Revenue Procedure outlines several requirements that must be met for IRC Sec. 47 rehabilitation tax credit allocations to be respected:

  • Investors Defined: An investor may be an initial partner in the partnership, or they may be a person who later becomes an investor by purchasing their partnership interest. The investor may be a member in either a developer partnership or a master tenant partnership, but they cannot receive allocations of credit from both.
  • Partners’ Partnership Interests:
    • The principal partner must have a minimum one percent interest in each material item of partnership income, gain, loss, deduction, and credit at all times during the existence of the partnership.
    • The investor partner(s) must have at all times during the period it owns an interest in the partnership, a minimum interest in each material item of partnership income, gain, loss, deduction, and credit equal to at least five percent of the investor’s percentage interest in each such item for the taxable year for which the investor’s percentage share of that item is the largest. This is referred to as the investor’s minimum partnership interest.
    • The investor’s partnership interest must constitute a bona fide   equity investment with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership, separate from any Federal, state, and local tax deductions, allowances, credit, and other tax attributes to be allocated by the partnership to the investor. An investor’s partnership interest is a bona fide equity investment only if that reasonably anticipated value is contingent upon the partnership’s net income, gain, and loss, and is not substantially fixed in amount. The investor cannot be protected from losses, and they must participate in profits in a manner not limited to a preferred return that is in the nature of a payment for capital.
    • The value of the investor’s partnership interest cannot be reduced by fees, lease terms, or other arrangements that are unreasonable as compared to fees, lease terms, or other arrangements for a real estate development project that does not qualify for rehabilitation credits. The value also may not be reduced by disproportionate rights to distributions or by issuances of interest in the partnership for less than fair market value consideration.
  • Investor’s Minimum Unconditional Contribution (IMC): The investor must contribute a minimum unconditional amount before the date the building is placed in service equal to 20 percent of the investor’s total expected capital contributions required by the partnership agreement. The investor must maintain the IMC as long as they own their partnership interest, and the IMC cannot be protected against losses. Contributions of promissory notes or other obligations made by the investor are not included in determining whether the investor satisfied the IMC.
  • Contingent Consideration: At least 75 percent of the investor’s total expected capital contributions must be fixed in amount before the date the building is placed in service. The investor must reasonably expect to meet its funding obligations as they arise.
  • Guarantees and Loans: Certain guarantees are permissible while some are not.
    • Permissible guarantees: The partnership may provide unfunded guarantees to the investor for the performance of   any acts necessary to claim the rehabilitation credits, and for the avoidance of any act that would cause the partnership to fail to qualify for the rehabilitation credits or that would result in the recapture of the credits. The guarantees must be unfunded, meaning no money or property can be set aside to fund any portion of the guarantees. Neither the guarantor nor any person under the control of the guarantor can agree to maintain a minimum net worth in connection with the guarantee. Examples of unfunded guarantees permitted include completion guarantees, operating deficit guarantees, environmental indemnities, and financial covenants.
    • Impermissible guarantees: No person involved in any part of the rehabilitation transaction may directly or indirectly guarantee or otherwise ensure the investor’s ability to claim the rehabilitation credits, the cash equivalent of the credits, or the repayment of any portion of the investor’s contribution due to inability to claim the credits in the event the IRS challenges all or a portion of the transactional structure of the partnership. Additionally, no person involved in any part of the rehabilitation transaction may guarantee that the investor will receive partnership distributions or consideration in exchange for their partnership interest. No person involved in any part of the transaction may pay the investor’s costs or indemnify the investor for   the investor’s costs if the Service challenges the investor’s claim of the rehabilitation credits.
    • Loans: A developer partnership, a master tenant partnership, or the principal partner of either partnership may not lend any investor the funds to acquire any part of the investor’s interest in the partnership or guarantee any indebtedness incurred with the investor’s acquisition of their partnership interest.
  • Purchase Rights and Sale Rights: Neither the principal partner nor the partnership may have a call option or other contractual right or agreement to purchase or redeem the investor’s interest at a future date. The investor may not have a contractual right or other agreement to require any person involved in any part of the rehabilitation transaction to purchase or liquidate the investor’s interest in the partnership at a future date at a price that is more than its fair market value determined at the time of exercise of the contractual right to sell. A determination of the fair market value of the investor’s interest in the partnership may take into account only those contracts or other arrangements creating rights or obligations that are entered into in the ordinary course of business and negotiated at arm’s length with unrelated parties. An investor cannot acquire their interest in the partnership with the intent of abandoning the interest after the partnership complete the qualified rehabilitation.
  • Allocation of Rehabilitation Credits: Allocations under the partnership agreement must satisfy the requirements of IRC Sec. 704(b) and its regulations. The rehabilitation credits must be allocated in accordance with Reg. 1.704-1(b)(4)(ii).
  • Related Parties: For the purposes of the safe harbor, the terms principal partner, partnership, investor, and person include any related persons. Relationships are analyzed under the related party rules under IRC Sec. 267(b) or IRC Sec. 707(b)(1).


The ultimate reasoning behind this new safe harbor procedure is to ensure that partnerships engaging in historic rehabilitation transactions maintain a minimum level of economic substance for each partner involved. These guidelines provide helpful boundaries for businesses to properly and effectively structure rehabilitation transactions and allocate the tax credits among partners. Any companies who may have been sitting on the sidelines due to the uncertainty surrounding the rehabilitation credit industry can now enter into transaction with faith and assurance their desired outcome will hold true provided they follow the safe harbor guidance outlined above.

Questions? Contact your Keiter representative or information@keitercpa.com | 804.747.0000

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Keiter CPAs

Keiter CPAs

Keiter CPAs is a certified public accounting firm serving the audittax, accounting and consulting needs of businesses and their owners located in Richmond and across Virginia. We focus on serving emerging growth businesses and companies in the financial servicesconstructionreal estatemanufacturingretail & distribution industries and nonprofits. We also provide business valuations and forensic accounting servicesfamily office services, and inbound international services.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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