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LP Purchase Program

Customized Individual Investment Program Providing Tax Savings and Investment Opportunities for High AGI Taxpayers

Designed by:

Housing & Tax Consultants, LLC

PO Box 701738

Tulsa, OK 74170

918-720-0142

Website:

Caution – Disclaimer

The information provided herein represents general concepts only. The Reader’s specific circumstances will necessitate personalized tax and legal planning. Before implementing or taking action of any kind, the Reader should consult with competent tax and legal counsel. The following is not meant to replace the Reader’s professional counsel and is not to be considered tax or legal advice to the Reader.

The following is designed to provide accurate and authoritative information with regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. The Reader should consult with his/her own tax advisors to determine the suitability of this program and whether the reader is qualified to utilize this program.

Cost-Benefit Summary

Benefits:

For the qualified investor, participation in the LP Purchase Program may significantly reduce income tax. For example, a one-time investment of $100,000 would purchase a loss stream of about $100,000 per year or $1,000,000 over ten years. These reportable losses would reduce “qualified” taxable income dollar for dollar. Based on a combined state and federal tax rate of 40%, this program is designed to produce a return of at least four times the investment over the first 10 years.

Qualifications:

The taxpayer must havesufficient passive income or be a rental real estate professionalto utilize the losses. The IRS defines a rental real estate professional as someone who devotes more than 50% of work-related time and more than 750 hours per year to rental real estate activities.

On a joint return, only one of the spouses needs to qualify. A non-rental real estate professional without passive income may qualify by restructuring his/her holdings to produce passive income as opposed to some other type of income.

Capital Contributions:

Capital contributions are based on the amount of annual deductions required. If the investor desires deductions of $100,000 per year for 10 years, then their capital contribution would be about $100,000.

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Investments:

The LP Purchase Program consists of the acquisition of limited-partner interests in various tax-qualified partnerships, which own multi-family affordable housing projects subsidized by the U.S. Government. Acquisition is accomplishedwith anagreement for a specific investor. These projects have Government mortgage financing and receive Government rental-assistance payments and other subsidies.

Management:

Multi-family housing projects owned by lower-tier limited partnerships are managed by professional managers under strict monetary budgets,approved,and controlled by the Government. These managers must operate within the confines of Civil Federal Regulations under the USDA RD or HUD programs.

The LP Purchase Program is managed by Affordable Housing For America, Inc., an IRS qualified public charitable organization (501(c)(3)) supervised by real estate professionals. The charity’s involvement provides beneficial tax advantages to the investor. Sufficient cash incentives are built into the program to insure stable management.

Risks:

Risks may include the following:

  • Bankruptcy or foreclosure of lower-tier partnership(s)
  • Early termination of the program or sale, which could produce recapture of tax losses
  • Changes to the Tax Code, which may limit deductibility or render the deductions worthless

Although these are minimal, our attorneys have structured the program to minimize any risks to the investor.

LP Purchase Program Overview

Under the LP Purchase Program, the investor enters into anagreementwith Housing & Tax Consultants, LLC (HTC) to acquire limited-partner interests for his/her portfolio in established partnerships that own multi-family affordable housing projects subsidized by the Government. These projects operate under programs administered primarily by two Government Agencies: Housing and Urban Development (HUD) and U.S.D.A. Rural Development (RD). Projects under the RD program are the primary source of investment assets; however, we occasionally use certain types of HUD projects.

Program Benefits:

The largest benefit is tax reduction; however, there are several other areas that can add to the investor’s long-term return. Those include possible appreciation and potential cash flow. The following is a brief description of each area of return:

  • Tax Reduction: Since the mortgages are significantly longer than the depreciation schedule, the projects tend to produce losses in the earlier years. These losses are the greatest in the first fifteen years of the program. Subsequent loans used to rehabilitate the property will increase the depreciation deductions at no cost to the investor.
  • Appreciation: Historically,real estate tends to hold its value over time and as the mortgage is paid down, this creates equity. Another source of equity is from appreciation of the property. Neither of these should be used as a basis for investment in the LP PURCHASE program as the purpose of this program is to produce deductible losses. Appreciation should be looked at as a potential windfall.
  • Cash Flow: Although cash flow is limited by government regulations, and by contract, there is a possibility ofreceiving some cash flow. Another source of cash flow is from re-syndication of a project. Although this may create a recapture event, the cash received can be substantial and allow the investor to replace the project for deduction purposes while receiving a cash payout.

The pricing of the limited partnership interests is based on the value of the estimated annual losses, as this is the most predictable element,but is also dependent on acquisition costs. Due to the inherent risks involved with long-term programs, the program is priced to produce substantial returns based only on the tax savings provided by annual project losses over the first ten years. Losses continue after the first ten years, but are not used in computing the purchase price.

The added value of appreciation and cash flow cannot be calculated easily, but can represent potential future value to the investor. Therefore, we have not included these items in the valuation or cost of the limited-partnership interests.

Investor Qualifications:

The LP PurchaseProgram provides significant tax benefits to a very limited scope of investors, which generally includes only two groups of taxpayers: those with large amounts of passive income and rental real estate professionals (see tax information section for details). To qualify as a rental real estate professional, the taxpayer must initially meet two tests: over 50% of activities in rental real estate; and more than 750 hours per year.

In some cases, an investor may be able to restructure holdings to produce passive income. We can present ideas regarding restructuring that the taxpayer can review with his/her CPA to determine validity for your situation.

Projected Returns:

HTC provides calculations for the investor to share with their advisors to help determine the potential returns available. HTC reviews and analyzesthe project’s tax returns over the previous three years and then averages them. HTC also reviews the project’s annual Audits, Budgets, and Statement of Loan accounts to determine the viability of the project.

Description of Assets:

The limited-partner interests acquired typically represent 25% to 99% of the lower-tier partnership interest. This lower-tier partnership owns and operates a multi-family apartment building called a project. The following are some of the primary aspects of these projects:

  • Projects are limited disbursement projects where the distributable cash flow is limited by a formula and regulated through the budgetary process.
  • The average size of RD projects is 25 units – HUD projects are generally much larger.
  • RD projects are located in predominantly rural areas; HUD projects are located predominantly in urban areas.
  • Many RD projects are projects for the elderly as opposed to family projects.
  • Both HUD and RD projects generally have some form of rental assistance, and RD projects typically have interest-rate subsidies that effectively reduce the mortgage interest rate to 1%.
  • Projects are professionally managed.
  • Projects are generally fifteen to twenty years old at time of acquisition.
  • Virtually all projects will need renovationover the term of the remaining loan.
  • Most of these projects were previously syndicated through tax-credit funds.

Program Design andStructure:

The investor forms a general partnership or other entity to hold the limited partnership interests. The managing general partneris Affordable Housing for America, Inc.(AHFA) (see Managing General Partner) with a 1% economic interest. The investor general partnerhas a 99% economic interest. We usea general partnership format to avoid the problems associated with limited partnerships including tax shelters, private placement registration and the showing of active participation for tax purposes (see Acquisition Process for more detail).

Payment:

Investors typically make a capital contribution at the time of purchase. If the Investors’ needs change and they need more deductions, they can purchase additional projects and add them to their general partnership.

Managing General Partner:

Affordable Housing For America, Inc. (AHFA) is the managing generalpartner. AHFA is a public non-profit 501(c)(3) organization formed in 2001. Its sole mission is preservation of affordable housing. The directors of AHFA are real estate professionals and interested parties in the affordable housing industry.

Asset Management Services:

AHFA as the managing generalpartner is responsible for the asset management services of the LP Purchase Program. These services consist of the following:

  • Gather annual financial information from the lower-tier partnerships including: complete tax returns, annual project Budget (Form RD 3560-7), annualStatement of Loan Account (Form RD 3560-54), and annual audit reports if applicable.
  • Prepare Tax Returns for the upper-tier general partnership.
  • Review information to isolate problem areas, create solutions, and implement remedies.
  • Assist lower-tier GP in securing funds for project rehabilitation and rental assistance. This includes applying for grants, tax credits, subsequent loans, and debt restructuring.
  • Determine the status of equity returns and collect funds.

As compensation for its services, AHFA receives the first $1,000 per project of equity return collected from eachof the lower-tier partnerships. AHFA also receives 50% of any additional equity return collected. Since the equity return can only be received if the project is financially in compliance, it creates an economic incentive for the managing GP to help solve any problems with the projects.

Acquisition Process:

The following is a brief overview of the LP Purchase Strategy. It is accompanied by four charts. A review of these charts should help the Reader understand the acquisition process as well as the underlying product.

Chart One:

Chart One is a depiction of a syndicated project. The lower-tier partnership is typically structured as a limited partnership. The lower-tier general partner (LTGP) operates the project for the limited partners. Normally LTGP either owns or is affiliated with a professional management company.

The limited partner (LP) in a syndicated project is generally another limited partnership. The general partner of the upper-tier limited partnership (UTGP) is the syndicator or one of its affiliates. The limited partners of the upper-tier are generally investors in the tax credits provided through the syndication. The blue arrows show the flow of losses, income, and taxcredits to the investor partners.

Chart Two:

A new entity is created for the acquiring investors. The entity is normally formed as a general partnership, but may beanother form of entity organized by the investor. This is indicated by the green oval. The managing general partneris a non-profit organization, Affordable Housing for America, Inc. (AHFA). The new investor will also be a general partnerif a general partnership is used and will provide the capital to acquire the limited partnership interests from the syndicated partnership.

The new entity will assume and become responsible for its portion of the non-recoursegovernment-insured or directly-issued mortgage. Our research has concluded that the new investor may be able to show active participation through their status as a GP, since the general partnership will be providing financial services to the lower-tier partnership through the activities of the managing GP. This would allow an investor that qualifies as a rental real estate professional to use the losses against ordinary income.

Although the new investor(s) has potential liability from his/her interest in a general partnership, the only asset in the partnership will be limited partner interests in lower-tier limited partnerships. Since the debt that the general partnership is assuming is non-recourse, the partners of the general partnership are protected from default risk. The mortgagor cannot look past the property to satisfy its claims.

If the investor cannot qualify as a rental real estate professional or only wants to receive passive losses as opposed to non-passive, they can choose to operate the program through an LLC. The LLC structure can also be used if there is more than one investor in a program and the investors have different needs. This is fairly common with families where one of the family members is active in rental real estate and the rest are passive.

Chart Three:

The new entity will purchase limited partner interests acquired from the syndicator under agreementwith Housing & Tax Consultants, LLC (HTC). The investorin the new entityaccepts these limited partner interests under the condition that the losses produced by the lower-tier partnership can be fully utilized. This transaction is highlighted by the dashed red line and circle.

The price paid to HTC by the new general partnership for the syndicated limited partner interests is determined through a formulafollowing a review of the financial and physical data of each project. Individual project analysis is performed by Housing & Tax Consultants, LLC (HTC). Information necessary for quality and risk analysis is gathered from the lower-tier GPand reviewed by HTC prior to closing.

Chart Four:

Chart Four shows the completed program. The blue arrows show the flow of project losses from depreciation. The losses produced by the lower-tier partnership indicated by the green oval are primarily from depreciation expenses of the project.

Tax Issues:

The tax treatment of a taxpayer’s income is largely determined by two factors: how the operating business is owned and how it is operated. Making changes to either of these factors can alter the tax treatment of the income. In this section, we will attempt to outline several tax issues regarding the LP Purchase Program.

Alternative Minimum Tax (AMT):

AMT is an alternative tax computation that adds back several tax preference items to the taxpayer’s adjusted gross income (AGI) and applies a rate of 25% to the result. The taxpayer must pay the greater amount of either the tax calculated by Form 1040 or the AMT.

Passive Income:

Passive income is defined in IRC Section 469 as income whereby the taxpayer has no material participation in the operations in the activity that produces the income. Typically, investor holdings in limited partnerships and LLCs produce passive income.

Non-Passive Income:

This is income in which the taxpayer materially participates in the operation of the activity that produces the income. Non-passive income also includes portfolio income such as interest and capital gains.

Rental Income / Losses:

According to IRC Section 469(c)(2), passive activity includes any rental activity. However, certain qualified real estate professionals may be able to treat rental real estate activities as non-passive as described in IRC 469(c)(7). A qualified real estate professional may use losses from rental activities to offset any taxable income for the years they meet the qualifications.

Ordinary Income:

Ordinary income is income from a trade or business and includes salaries and bonuses.

Using rental losses against passive income:

Passive lossesmay be used dollar for dollar to the extent of passive income.

Using rental losses against non-passive income:

If the taxpayer qualifies as a rental real estate professional, they may use rental losses against non-passive income if they can show active participation in the activity that produces the losses.

Qualifying as a rental real estate professional:

In order to qualify, the taxpayer must meet two tests:

  1. The taxpayer would have to perform more than one-half of his/her personal services in rental real estate activities in which the taxpayer materially participates.
  2. The taxpayer must perform more than 750 hours of service during the tax year in rental real estate activities.

The taxpayer may also aggregate all of his/her rental activities in various properties to meet the qualifications of these two tests. In addition, employees whose services are in rental real estate may use the time spent on these services to qualify if they own 5% or more of the business in which they are employed.

The burden is on the taxpayer to prove that they meet the two tests in order to qualify for the special treatment of rental activity income or losses from rental activities. The best way to document time spent on rental activities is by keeping a log of the time spent on each activity. It may be well worth the hassle of keeping the logs if the potential tax savings are substantial.

A married couple filing jointly may qualify if one or both of the taxpayers meet the two tests. The taxpayers may also reorganize their business affairs so that one or both spouses would qualify. This may provide significant tax benefits to married couples.