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Real Estate Advisor July 2014

By William H. Jennings, 07/29/2014


In late 2013, the IRS released Revenue Procedure 2014-12, which established a safe harbor clarifying how the agency will treat allocations of Section 47 rehabilitation tax credits among partners. The procedure specifies the requirements necessary so that the IRS won’t challenge a partnership’s allocation of Section 47 credits to an investor/partner.

Eligible Partnerships

The safe harbor is available to two types of partnerships:

  1. A “developer partnership” that owns and restores a qualified rehabilitation building or certified historic structure.
  2. A “master tenant partnership” that leases a building from a developer partnership and elects to treat itself as having acquired the building for purposes of the rehabilitation tax credit.

These two types of partnerships will generally be eligible for the safe harbor if they satisfy the following requirements:

Minimum partnership interests. The principal in the partnership (the developer) must hold at least a 1% interest for the entire partnership term. The investor (the recipient of the tax credit) must hold at least a 5% interest for the taxable year in which the investor’s percentage share is the largest.

Bona fide equity investment. The investor’s interest in the partnership must be a bona fide equity investment with a reasonably anticipated value commensurate with the investor’s overall interest in the partnership. An investor’s interest is a bona fide equity investment only if the reasonably anticipated value is contingent on the partnership’s net income — gain and loss — and it isn’t substantially fixed in amount. In addition, the investor must not be substantially protected from losses from partnership activities and must participate in the profits in a manner not limited to a preferred return.

Arrangements to reduce value of partnership interest. The value of the investor’s interest can’t be reduced through arrangements (for example, management fees or lease terms) that don’t reflect arm’s-length charges in other projects that don’t qualify for credits. It also can’t be reduced by disproportionate rights to distributions or issuances of partnership interests for less than fair market value.

Minimum contributions. Before a building is placed in service, the investor must contribute at least 20% of its total expected capital contributions relating to the partnership as of the date the building is placed in service. That minimum contribution must be maintained throughout the duration of the investment and generally may not be protected against loss through a guarantee or insurance arrangement with any person involved in the project.

Contingency consideration. Before the building is placed in service, at least 75% of the investor’s total expected capital contributions must be fixed in amount. The investor should reasonably expect to meet its funding obligations as they arise.

Guarantees/loans. The safe-harbor qualification procedure limits the types of guarantees that may be provided to the investor by parties involved in the project. (See the sidebar “Is that guarantee permissible or impermissible?”) Plus, the investor can’t get loans from the partnership or the principal, and the partnership and the principal can’t guarantee or insure any indebtedness the investor incurs to acquire its interest.

Purchase and sale rights. Neither the partnership nor the principal can have a call option or other right to buy or redeem the investor’s interest in the future. The investor may not have a right to require anyone involved in the project to buy or liquidate its interest at a future date at a price exceeding its fair market value.

Intent to abandon. The investor must not have acquired its partnership interest with the intent of abandoning it after the qualified rehabilitation is complete. Such intention is presumed if the investor abandons its interest at any time.

Note that simply complying with these requirements won’t ensure the validity of the tax credits. The credits must also derive from qualified rehabilitation expenditures and such allocations must possess “economic effect” as provided within the 704(b) regulations. The regulations generally requires credits to be allocated to the partners in the same ratio that the partners share the partnership’s taxable income for the year the property is placed in service, although future changes in income allocations are permitted.

Follow the rules

Revenue Procedure 2014-12 is effective for allocations of rehabilitation tax credits made after December 29, 2013. However, if a building was placed in service before December 30, 2013, and the safe harbor requirements were met at that time, the IRS won’t challenge the allocation.

As you can see, claiming rehabilitation tax credits is hardly simple. Make sure you work with your tax and real estate advisor to ensure the best results.

Is that guarantee permissible or impermissible?

The new IRS safe harbor for Section 47 rehabilitation credits isn’t available if anyone in the rehabilitation project has entered into certain guarantee or insurance arrangements to protect the investor’s minimum contribution against losses.

Revenue Procedure 2014-12 specifically prohibits developers from providing guarantees of the investor’s ability to claim Section 47 tax credits or guarantees that the investor will receive distributions or consideration for its partnership interest. It also prohibits developers from indemnifying the investor for its costs if the IRS challenges the investor’s claim of the credits.

However, the procedure does allow “unfunded permissible guarantees,” which can include guarantees of or for the following items:

  • Performing any acts required to claim the Section 47 credits;
  • Avoiding an act or omission that would result in the recapture of credits by the IRS because the partnership doesn’t qualify;
  • Completion of the project;
  • Operating deficit guarantees;
  • Environmental indemnities, and
  • Financial covenants.

The procedure doesn’t prohibit third-party guarantees or insurance from parties not involved in the project.


The IRS has issued new guidance that will, in certain circumstances, exclude from gross income any discharged debt that’s secured by the ownership interest in a disregarded entity. Revenue Procedure 2014-20 should help taxpayers with mezzanine financing in workouts and similar arrangements.

How the issue arises

Gross income usually includes income from the discharge of debt. But such income is excluded if, for any taxpayer but a C corporation, the debt is qualified real property business indebtedness (QRPBI). A requirement to qualify as QRPBI is that the indebtedness must be incurred or assumed by the taxpayer in connection with real property used in a trade or business, and it must be secured by such real property.

The term “secured by such real property” isn’t defined by the relevant law. While lenders commonly use mortgages to secure an interest in real estate, mortgages aren’t the only form of security allowed.

For example, in some instances, real property is owned by the borrower in an entity that’s wholly owned - such as a single-member limited liabitlity company ("SMLLC") - which is disregarded for federal tax purposes but respected under state law as a separate and distinct entity. The mezzanine financing in such cases may be secured by the borrower’s ownership interest in the SMLLC. The IRS has recently noted that mezzanine debt secured by an interest in a wholly owned entity is also considered QRPBI so long as certain conditions are met.

How to qualify for the exclusion

Under the new IRS guidance, a safe harbor exclusion is available if:

  • The taxpayer or a wholly owned disregarded entity incurs debt;
  • The borrower owns 100% of the ownership interest in a separate disregarded entity owning real property (the property owner), and isn’t the same entity as the property owner;
  • The borrower pledges to the lender a first priority security interest in the borrower’s ownership interest in the property owner / disregarded entity;
  • At least 90% of the fair market value of the total assets directly owned by the property owner / disregarded entity is real property used in a trade or business, and any other assets held by the property owner / disregarded entity are incidental to the property owner / disregarded entity’s acquisition, ownership and operation of the real property, and
  • Upon default and foreclosure on the debt, the lender will replace the borrower as the sole member of the property owner / disregarded entity.

Notably, if a taxpayer fails to meet these requirements, it’s not precluded from arguing, based on facts and circumstances, that its debt nonetheless satisfies the “secured by” requirement.

The amount that may be excluded from gross income is limited to the amount by which the outstanding principal amount of the QRPBI immediately before the discharge exceeds the fair market value of the real property. It’s reduced by the outstanding principal amount of any other QRPBI secured by the property at the time of discharge.

Applying the exclusion

The exclusion is effective for taxpayers that make the required election regarding discharged debt on or after February 5, 2014. Please contact your financial advisor if you would like to discuss further.


Section 1031 exchanges have been around for quite some time. They offer participants a way to dispose of property and subsequently acquire one or more other “like-kind” replacement properties as part of a nonrecognition taxable transaction. The simplest type of exchange is a simultaneous swap of one property for another. Deferred exchanges are more complex but allow for additional flexibility. Here’s how they work.

Exchanging property

Sec. 1031 exchanges allow you to exchange business or investment property (the relinquished property) for business or investment property of a like kind (the replacement property) without recognizing any gain or loss until the disposition or liquidation of the replacement property occurs.

The provision also allows a deferred, or “forward,” exchange whereby the relinquished property is transferred before the acquisition of the “replacement property.” The replacement property must be identified within 45 days of when the relinquished property is transferred. The replacement property also must be acquired within 180 days of the transfer or by the due date of the applicable tax return (including extensions) for the year in which the relinquished property is transferred, if sooner (the exchange period).

The same time limits apply to “reverse” exchanges. In a reverse exchange, the replacement property is acquired first and then “parked” with an exchange accommodation titleholder (the accommodator) before the relinquished property is transferred.

Unwrapping the law

In a memo from the Office of Chief Counsel (Memo No. 200836024), the IRS considered a scenario in which a taxpayer structured two separate exchanges. In the first, a reverse exchange, the replacement property was acquired and parked with the accommodator, and the taxpayer identified the relinquished property in a timely manner (within 45 days).

The relinquished property had a much higher value than the replacement property, so the taxpayer planned to engage in a second exchange — a deferred exchange — to defer the gain that remained after the relinquished property was exchanged for the replacement property.

A qualified intermediary (QI) was retained to execute the transfers of the properties in both exchanges. The QI followed all guidelines to ensure the taxpayer wasn’t in constructive receipt of any of the exchange funds during the two 180-day exchange periods.

The IRS memo concluded that, as long as the various guidelines are followed, the same relinquished property can be used in both forward and reverse exchanges — even though allowing this structure could result in up to 360 days between the day on which replacement property is parked at the beginning of the reverse exchange and the day the deferred exchange is completed.

It’s important to note that a memo from the Office of Chief Counsel is specific to the particular facts that it addresses and has no precedential value. That said, it does provide a guideline for how to structure such a transaction.

Executing an example

Imagine you decide to take advantage of property values and buy a property in California for $450,000 in January 2014. You park it with an accommodator so you can determine which property you’d like to sell in order to reap the benefits of a reverse exchange.

Within 45 days, you identify a property in New Jersey. In July 2014 — within 180 days of parking the California “replacement” property — you sell the New Jersey “relinquished” property for $1 million, completing the reverse exchange.

You begin executing a deferred exchange within 45 days, identifying additional like-kind replacement properties to buy with the remaining $550,000 of proceeds from the relinquished New Jersey property. And you have 180 days from the close on the New Jersey property to close on one or more identified replacement properties.

So you don’t have to close on those properties and complete the deferred exchange until January 2015 — nearly a year after you bought the California property.

Getting help

To be certain, Sec. 1031 exchanges can be a great way to defer payment of income taxes. But it’s not a cakewalk. So work with your tax and real estate advisors to ensure you structure your next deal properly.



Find out on July 31.  The results of our latest Gotham Commercial Real Estate Monitor survey, which tracks the concerns, opinions, outlook and forecasts of New York’s commercial real estate executives and decisions makers, will be emailed directly to you. 

Marks Paneth Sponsors Crain’s Real Estate Conference

Marks Paneth is one of the leading firms serving the New York real estate market. In June, we were one of the sponsors of the Crain’s Real Estate Conference entitled “What"s Really Driving the Market?” The conference explored the growth opportunities in commercial and residential real estate from midtown to downtown Manhattan to Flushing and downtown Brooklyn.


For commercial real estate investors, the boom mentality continues, and those seeking opportunities continue to flock to New York City. That can spell trouble if your clients are not prepared for the consequences real estate investment can bring, including results that are hard to foresee. To learn more, please read the article authored by Real Estate Partner Abe Schlisselfeld, originally published in The Metropolitan Corporate Counsel in April

NYC Real Estate Expo

Marks Paneth will be participating in the 6th Annual NYC Real Estate Expo, which will be held at the Hilton Hotel on November 6.


If you have any questions, please contact William Jennings, Partner-in-Charge of the Real Estate Group at 212.503.8958 or or any of the other partners in the Marks Paneth Real Estate Group:

  • Timothy Andrews


  • Vincent Barra


  • Susan Nadler


  • Dawn Rhodes


  • Bradley Eckstein


  • Michael Hurwitz


  • Kurt Kiess


  • Vivian Martinez


  • Harry Moehringer



  • Abe Schlisselfeld


  • Michael Siino


  • Richard Simon


  • Howard Warshaw



Additional information about the Marks Paneth Real Estate Group can be found at


Treasury Regulations require us to inform you that any Federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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