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Since writing the story that revealed a tax snafu at a burgeoning arts and culture district in March, I’ve been asked a frequent question: What’s the deal with the nonprofit NTC Foundation forming for-profit sub-companies, anyway?
To refresh our memories: The nonprofit foundation is trying to turn 26 buildings in NTC into the city’s next arts, culture and nonprofit district. The foundation ran into trouble after unexpectedly triggering property taxes by creating a for-profit company to help finance the rehabilitation of historic buildings. In February, city officials agreed to pick up the $1.25 million tab for unexpected taxes, back taxes and penalties for the NTC Foundation.
But a lot of people have asked me why the NTC would set up those companies to begin with.
It’s actually a common financing structure used by nonprofits developing historic buildings. Here are the basics on why:
The federal government has a historic tax credit program to incentivize the rehabilitation of historic buildings without putting cash on the table upfront itself.
When a regular for-profit developer or business redevelops a certified historic building, it can apply to for a 20 percent rebate on the money it spent developing the project. The rebate comes in the form of a reduction in the company’s tax liability for several years afterward.
“It’s an example of social engineering through the federal tax code, as opposed to direct intervention from the federal government,” said Paul Hoffman of City Scape Capital Group, an investment banking firm that works on tax credit development deals. Hoffman has worked with the NTC Foundation, but he spoke to me in general about the way the tax credit programs work.
But a nonprofit or a public agency doesn’t have such a tax liability to lessen — it is by nature tax-exempt.
So the government allows nonprofits to sell its tax credits to for-profit companies that would be looking to reduce their tax liability. The nonprofit and the for-profit enter a limited partnership or limited liability corporation, and the for-profit investor becomes a technical part-owner of the project, and invests money into the project.
The nonprofit is the managing partner, overseeing all of the development.
Here’s where the structure got NTC into trouble: The for-profit limited partnership — made up of the nonprofit and the for-profit investor — becomes the technical owner of the project for seven years. The seven years are up in 2013. But that still technically means the buildings are owned and operated by a for-profit company, which is why the county assessor’s review in 2010 triggered a slew of property tax bills and back penalties.
(The structure wasn’t only to take advantage of historic tax credits. The foundation also applied for and got another batch of tax credits from a program meant to incentivize development in low-income communities, for which the shuttered base qualified.)
The foundation’s executive director, Alan Ziter, said the County Assessor’s Office had told them that because the city’s redevelopment agency owned the property, they wouldn’t have to pay taxes.
The NTC Foundation isn’t the only organization to use this structure, but it does seem to be the only one surprised by the obligation to pay property taxes. Other organizations, like the Jacobs Center for Neighborhood Innovation, and the Exploratorium arts and science museum in San Francisco, anticipated the taxes in setting up their deals. They say they just pay the taxes. And it’s worth it.
“It’s a financial decision to choose which financing structure you want,” said Laura Zander, chief operating officer for the Exploratorium. “The whole cost structure was on our radar and it made sense.”
The NTC Foundation now says it was still a good deal for it to form these structures. Even faced with the $1 million-plus bill for back taxes and property taxes through 2013, the more than $12 million netted in the tax credit structure still outweighed the cost.
It hasn’t been such a great thing for tenants who’ve seen their rents rise suddenly and unexpectedly, though the foundation has been working with some of them to lessen their share of the extra burden.
In NTC, for the eight buildings the foundation is about to open in its second phase, it went after the tax credits again, securing this time about $11 million, said Pam Hamilton Lester, the foundation’s CEO. This time, the foundation knows the county will charge property taxes and is building that knowledge into the rents for the new tenants, rather than come back with surprise extra bills as it did to its original tenants earlier this year.