Colorado Real Estate Journal - January 6, 2016
Public-private partnerships are all the rage and for good reason: Even in a strong market as we currently enjoy, putting together a large real estate project is becoming more difficult and certainly more complicated than ever. With high land costs, continued increases in fee structures and escalating construction costs, a long-term project is challenging – and that is without consideration to the substantial market risk that comes with such projects. Throw in issues related to large-scale infrastructure requirements, environmental issues or below-market rate components and a developer typically cannot make a deal pencil without some government help. As a result, public-private partnerships have become a permanent fixture for most projects of any scale. Those arrangements can take many forms, from bonds issues supported by additional taxes or special district taxes and fees to outright grants of funds from governmental authorities. The transfer of benefits from the public side of the equation to the private side also can take many forms: use of special districts to allow the developer to act as a quasi-governmental entity to assess taxes to fund infrastructure, relief from zoning rules to allow more density, or direct transfers of public property and tax increment financing to allow the developer to claim a portion of tax revenues from the developed property to help fund the development, to name a few. If the private side of the equation is receiving measurable benefit from the arrangement, the question of the income tax treatment must be addressed. Some arrangements may take the form of debt (a borrowing with a required repayment), but if the benefit comes without substantial strings attached, it would be, on its face, income to the developer. That is, the Internal Revenue Code defines income by exception; anything received is income unless some provision of the statute says it is not. A loan (albeit cash received) would be an exception since it has to be repaid; a reward of increased density or use of public lands may be excepted because the public good offsets any value received, but a receipt of cash that will be used to create assets that will be owned by the private partner would generally be considered income without some explicit exception. Some examples for consideration are receipt of some kind of TIF payment directly to the developer for its use in building assets that the developer will own or a transfer of property directly to the developer by a governmental entity (either public lands or private land acquired through eminent domain). These types of situations provide an obvious example where the developer has received a direct benefit that would be taxable under the normal tax rules, which read, “gross income means all income from whatever source derived.” There are a multitude of exceptions to this draconian concept, with one particularly important one for the matter at hand: A contribution to a corporation by a non-shareholder can be excluded from income. That means simply that a corporate structure (yes, S corporations qualify) should be used if the developer receives direct benefit, at least with respect to the entity receiving the benefit. There are specific rules around qualifying for this corporate exception, so do your homework, but most typical arrangements should qualify. The takeaway, however, is that partnerships cannot qualify for this general exception from reporting income; no similar exception is available for non-partner contributions to a partnership. This matter has been batted around quite a bit and at one time, the IRS had given its blessing to a partnership qualifying under the same exception as a corporation. However, the IRS subsequently reversed its field on the issue (this goes back to 2011) and the courts have consistently confirmed that only corporations can take advantage of the relief of income for non-owner contributions, noting that it is clear in the statue that it is a corporation-only exception. If you do use the corporate exception to opt out of reporting the benefit as income, the taxpayer is also not allowed basis in the asset. So no depreciation if a built asset (with non-shareholder funds) and no reduction for gain calculations upon sale (likely not a bad bargain since you push off the tax event until a later year). If you are compelled to use a partnership structure, a possible out is to try to qualify the receipt of the benefit as a loan; proceeds from a loan, as noted above, are an exception from the general “everything is income” requirement in the statute. This approach could be applicable where TIF bonds are created and will be repaid, but the “debt” under this approach must be treated as real debt with all that entails and any failure to repay could just defer the taxable income event to a later year. Public-private partnerships are a critical tool in any developer’s toolbox, but don’t forget the appropriate tax planning if you go down that path, particularly if you are new to that world. I would also note that the status of tax-exempt bonds as such can be put at risk if not structured properly. Direct private use of assets funded by tax-exempt bonds is tricky at best and careful planning pre- and post-issuance of the bonds is critical to maintaining tax-exempt status of the bonds. That is, not just at the issuance of the bonds, but for the term that the bonds are outstanding as well. It is important to note that new regulations released in October provide some guidance and relief to the issues discussed above. A careful review of the new regulations, which will take effect in early 2016, will provide a great assist in structuring transactions that meet the needs of the developer and the public, helping to close the gap between what is currently permitted under the tax rules and the reality of the marketplace.