Real estate deals offering tax credits see big decline in sales.

Real estate funds investing in low-income housing and offering investors tax credits aren't what they used to be. In part, that's because the tax credits aren't as generous as they once were.

Peter A. Winer, ChFC, with Winer and Jones LLC in Timonium, Md., once recommended low-income housing tax credits, particularly for older clients. He placed a handful of clients in Boston Capital Corp.'s tax credit limited partnership real estate funds to get them.

No more.

Boston Capital Corp. funds invest in low- and moderate-income housing programs to take advantage of housing tax credits. The credits, available through the Low Income Housing Tax Credit Program, enacted by Congress in 1986, provide a client with a dollar-for-dollar write-off on federal income taxes. Credits are a much better deal than tax deductions, which solely reduce taxable income.

Winer lost his taste for those Boston Capital Corp. funds when a client, who had invested $49,000 in the Boston Capital Tax Credit Fund IV, Series 4, Number 43, died in November 2003. "One of the things I was told is that shares are easily transferable to heirs," Winer says. The client left two children, both with limited resources. Neither needed tax credits. They preferred cash.

Winer tried to sell the shares of the limited partnership fund on the secondary market, because his client's estate was small and the heirs needed money. The quotes ranged from 60% to 70% of value. Laurie Miller, a broker with Alliance Partnership Service in Pleasanton, Calif., encouraged him to hold out. Thanks to her limited partnership/REIT matching service, he says, he finally sold the investment at some 82% of value in April 2004.

Nevertheless, "that's totally unacceptable!" Winer maintains. He now shuns Boston Capital Corp. funds entirely. Boston Capital Corp. officials did not return phone calls for this story.

Others are avoiding these low-income housing tax credit funds for clients as well. MONY Group, which recently merged with AXA Financial, halted sales of Boston Capital's tax credit fund, as well as Wells Real Estate Investment Trust, in August. "We have determined that these offerings, which were sold by only a small segment of our producers, currently do not fit within our overall business strategy," says MONY Group spokeswoman Mary Taylor. The decision, she says, "involves only the nonpublicly traded REIT limited partnerships."

Observers say MONY is not alone-at least when it comes to the sale of low-income housing limited partnership tax credit funds to individuals. What was a large industry ten years ago has become very limited. "The only guys I see doing these right now are Boston Capital and WNC (& Associates, Irvine, Calif.)," says Keith Allaire, managing director of Robert A. Stanger & Co., Shrewsbury, N.J. Boston Capital, he says, has done $1.5 billion in public deals, while WNC has done $200 million.

Annual sales of publicly registered real estate low-income housing partnerships, as high as $342.3 million in 1990, dropped to $113.3 million in 2003, Stanger & Co. reports. As of the third quarter in 2004, there were just $77.5 million in public deals. Allaire attributes the decline to the advent of new, more attractive real estate products being sold by financial advisors.

David Fred, vice-president in charge of due diligence for ING Advisors Network in El Segundo, Calif., says sales of the low-income housing tax credit funds through his broker-dealer network are now about one one-hundredth of what they were about a decade ago. "The primary driver is the cost of credits," Fred says. Prior to 1990, an investor buying into a tax credit program could expect to get 160% of the investment in tax credits.

In 2004, he says, the investor was getting just 95% to about 105% of his or her investment in those tax credits. There simply is more competition for tax credits than when they first were enacted, he says.
If you assume the investor does not get any principal back from the funds, "at today's tax credit rates, that's an internal rate of return of about 1%," Fred says. That return, he stresses, figures the time value of money. "That's a very low return for 15 years."

Fred notes that the secondary market is very thin. "Our firm policy is not to participate in the secondary market for these vehicles," he adds. "Typically, they're not sold with a current prospectus. We don't want to run afoul of
securities laws."

Fred's network still offers these low-income housing tax credit funds through ING broker-dealers Multi-Financial Securities, Financial Network Investment Corp., PrimeVest and ING Financial Partners. ING offers Boston Capital and WNC low-income housing tax credits, he says, due to the firms' very stringent policies and procedures. 

However, he cites a number of issues with low-income housing tax credits. For one thing, the 1986 tax code change limited deductibility of passive losses for the individual investor.
The programs continue to generate passive losses, but a current investor can't use them unless they can offset specific passive income. This rule does not apply to corporations. "Typically, we advise [individual] clients that at some point, the assets are going to be disposed of, which may lead to a capital gain," Fred says. "In that case, suspended passive losses can be used to offset income at that time."

The low-income housing real estate limited partnership programs, he says, still are attractive, say, for someone who has entered into an installment sales contract to sell a business. Each year, he notes, the tax credit could wipe out the tax liability.

Fred says they may be perfect vehicles for new retirees making substantial withdrawals from large qualified plans to slash their tax bills. "If you have a known series of taxable gain items coming in your future, this is a way to partially offset some of this liability," he says. "Too often, an advisor will put a client into this for a current-year tax issue, without looking at the longer term."

There are other issues with these funds, Fred says. Based on the formula at this writing, the maximum tax credit an individual can get is just $9,900 a year. Meanwhile the ultrawealthy, thanks to the widening tentacles of the alternative minimum tax, may not be eligible to use tax credits.

Getting a client's principal returned from an original investment in these funds is questionable, says Fred. "They (Boston Capital) actually go after the senior market and target retirees," he says. "They position tax credits as a way to offset the tax costs of minimum required distributions for qualifying accounts. They show year-by-year payouts beginning in 1989 through 2002."

In an example of one program, someone who invested $10,000 in December 1988 would have received $14,510 in tax credit returns through 2002, he notes. Two objectives were hyped. First, a 97.5% to 102.5% return on your money over ten to 12 years in the form of tax credits. "They've always hit that objective," Winer acknowledges.
The second objective, however, was preservation of principal and repayment after about 15 years. That's where the funds fall short, Winer says-particularly for senior citizen clients who may have a remaining lifespan not much greater than that. "You'd think the properties in the tax credit series started in the 1980s would have been sold or refinanced by now and principal would be returned to investors," Winer says. "The reality is it's not really happening that way. It's going very slowly."

Sy Garban, senior vice president at WNC & Associates Inc., another sponsor of public low-income housing real estate limited partnerships funds, stresses that clients need to assume they won't get their principal back. However, he says, WNC definitely has sold properties within its partnerships, and already has returned some proceeds to investors.

After the 15-year contractual period, he says, investors could lose their tax credits, but they still get a tax deduction. "In the 16th year going forward, we continually monitor the marketplace and work looking for opportunities-for refinancing, liquidation, or providing additional tax benefits on each of the properties in the fund."

The portfolio is not going to sell intact, he emphasized. "There are 14 or 15 properties within a fund. Unlike most investments, it's important to realize in the beginning that the tax credit alone is a return of capital, and a return on capital. They (investors) will be whole and profitable just from the tax credit. If they want to invest in real estate directly, they should be making another investment."

WNC's Garban acknowledges that the programs were more attractive in the late 1980s and early 1990s because they were new and priced more advantageously. "Whenever you have a new program, the market isn't as efficient as when it matures," he contends

These programs can be tough to sell for several other reasons, ING's Fred says. Prior to 1990, most of the property loans issued under these programs were Farmers Home Administration loans, at low interest rates hovering around 1%. Now, Fred says, most loans are at market rates. "There's a much higher risk for a mortgage default these days than in the old days." At the same time, the low-income property operator is limited from raising rents.

Low-income housing tax credits, provided by the U.S. Treasury Department, are phased in, and assigned on a property-by-property basis. Investors can't use them until the construction is completed and the lease-up takes place.

Then the credit is pro-rated. Say the property comes on line July 1; you can get six months of a credit for that year, which marks the beginning of 120 months of tax credit flow. "In reality, you're looking at ten to 12 years of actual tax impact, because of a partial year on the front," WNC's Garban explains. To be safe, and to consider partial years, sponsors report investors need to be willing to tie up their money for 15 years.

In Winer's case, the partnership was only about a year old and had not yet started accruing tax credits.

However, Fred says that investors have no guarantee even of getting tax credits that are promised. An investment partnership receives Tax Form 8609, allotting the tax credits, Fred says. One misstep, and those tax credits not only can be yanked, but they also can be recaptured. Boston Capital and WNC follow stringent polices and procedures, and their entire staff checks and monitors them. "That's probably why they've survived," Fred says.