The Internal Revenue Service (IRS) has released guidance that creates a “safe harbor” for exempt organizations that participate in low-income housing tax credit (LIHTC) transactions and specifies the guarantee and control provisions that can be included in the documentation of the transaction. Though the guidance, which was outlined in an April 25 memo, is applicable to newly formed entities that are seeking a determination of tax-exempt status, it also establishes standards for all tax-exempt organizations that participate in LIHTC transactions.

The two areas of concern for the IRS regarding tax-exempt participation in LIHTC projects have been certain industry-standard guarantees made by these organizations to investors, and the limited ability of the tax-exempt organization to control the LIHTC entity. To comply with the safe harbor provision, LIHTC entities must now enter into a fixed-price construction contract with a bonded contractor or a contractor that provides a performance letter of credit or adequate personal guarantee. Tax-exempt general partners are required to protect themselves from environmental liability by obtaining an independent Phase I environmental report on the proposed project.

If the tax-exempt entity provides an operating deficit guarantee, its liability must be limited to a period not more than five years from the date the project achieves break-even operations or the amount of the guarantee should not exceed six months of operating expenses. Tax credit guarantees provided by a tax-exempt entity must be limited. The limitation may be adopted through either of the following approaches: First, if the limited partnership agreement includes separate tax credit adjuster provisions, the guarantee would be limited under each separate adjuster provision to an amount that does not exceed the aggregate amount of developer and other fees (both payable and deferred) that the tax-exempt entity, or any affiliate, is entitled to receive in connection with the project. Alternatively, any adjuster payments would be treated as a capital contribution or loan to the limited partnership, and repayment must take priority over any other distribution of residual assets to partners upon sale or refinancing. Payments under the second method may be unlimited in amount. Tax credit adjuster provisions that combine these two approaches would be permissible.

Right of first refusal

Tax-exempt general partners must also secure a right of first refusal to acquire the project at the end of the LIHTC compliance period under Sec. 42(i)(7) of the Internal Revenue Code and include a right to purchase the property at fair market value if such value is less than the Sec. 42(i)(7) price. Though the requirement provides that the right of first refusal price is the lesser of the minimum Sec. 42(i)(7) price or fair market value, this does not violate Sec. 42(i)(7). Under general tax principles, the owner of property may grant a right to another party to purchase the property for fair market value without jeopardizing ownership of the property.

If the tax-exempt entity must guarantee to repurchase the investors’ interest in the limited partnership in case of a failure to meet certain fundamental requirements relating to project viability, the repurchase price may not exceed the amount of capital contributions. Under this requirement, “mark up” of the repurchase amount to cover syndication costs would not be permitted, regardless of whether the syndicator is a for-profit or a tax-exempt entity.

While the tax-exempt entity must manage the partnership in accordance with its charitable purposes, the exercise of enumerated consent rights by the investor fits within the safe harbor provision. Consent to proposed actions, however, may not be unreasonably withheld. Additional consent rights may be included in the agreement, but if the additional non-enumerated consent rights become too extensive, the IRS may object to their inclusion.

Documents governing limited partnerships or limited liability companies must provide that rights of limited partners or other members to remove a tax-exempt entity as general partner may only be for “cause,” and notice must be provided to the tax-exempt which states the cause for the action and allows the tax-exempt a reasonable period to cure any deficiencies. The definition of “cause” may be tailored to the specific facts of a transaction.


We are pleased that the IRS has released guidance in the form of a safe harbor for nonprofit organizations that serve as general partners of LIHTC partnerships. Though the safe harbor provision is more restrictive than many LIHTC partnership agreements, investors may adequately protect their interests under the new standards. Representatives of the IRS have cautioned that when the executed documents do not comply with the guidelines, tax-exempt organizations should identify the alternative provisions in the documents that provide equivalent protection for the nonprofit and identify the reasons why the guidelines were not followed.

At this time, we do not recommend that tax-exempt organizations apply these standards retroactively or attempt to renegotiate specific provisions in previously executed documents, but documents entered into after the issuance of the guidelines should comply with the safe harbor provision.

Michael I. Sanders is chair of the Tax Practice Group at Powell Goldstein, LLP. He has a significant practice in the area of exempt organizations and regularly counsels clients on low-income housing projects. He can be reached at msanders@ or (202) 624-7308. Jerome A. Breed is a partner in the Housing and Tax Practice Groups at Powell Goldstein, LLP. He regularly advises investors on issues related to the structuring of the low-income housing tax credit. He can be reached at or (202) 624-7221.