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• New for 2009

Formulating a Purchase Proposal

NEF, Inc. will seek a purchase proposal from a sponsor or third party seeking to purchase a project at the end of its year 15 compliance period. The proposal should follow the following format in written summary form, with relevant spreadsheets or documentation attached.

1. Intended Ongoing Use of the Project

You should describe your plans for the project’s future operations. More specifically:

• Outline plans for the continued affordability of the project, including the terms of continued low-income use and the targeted rents. Also, indicate whether there are any existing low-income use restrictions that the project must continue to meet.
• List any special targeted populations and whether there are committed or expected operating subsidies.
• Indicate whether you intend to resyndicate the project and your expectations about the proposed trans-action’s timeline.

2. Outstanding Partnership Debt

The sponsor must review the amount and terms of the existing partnership debt, and determine how each component of the debt will be satisfied. Plan to do the following:

• Review documents for each loan, including the promissory note, mortgage, and loan agreement and any regulatory agreements to ascertain maturity dates, interest rates and the extent of required and deferred debt payments. Check to see if the documents permit the sponsor or another specified borrower to assume the loan from the partnership (the original borrower) and if they require the lender’s consent for that assumption or for a change in ownership interest.
• Determine whether there are any regulatory or land-use restrictions associated with the loan.
• Review financial audits prepared by the project accountant, especially the most recent year-end audit. They should provide details about the outstanding debt’s amount, including outstanding principal balances, accrued interest, and partner loans.
• Contact lenders directly if needed.

NEF, Inc. Outstanding Debt Analysis Worksheet 1: This worksheet can help detail a project's outstanding debt. The far right column asks about your initial discussions with your lender regarding assumption of the loan. For many projects with soft secondary loans from government agencies, the loan documents may not specifically address the question of assumability when the sponsor seeks to purchase the project from the limited partnership. However, the lender may agree to such an assumption, if requested. First mortgage loan or loans from conventional lenders, may have balloon balances due at or around the end of year 15. These loans must either be paid off or refinanced, or loan assumptions and extensions must be negotiated. Go to worksheet.

3. Proposed Purchase Price

Generally, NEF, Inc. limited partnership agreements (or corollary documents) contain provisions providing the general partner or sponsor: (a) a purchase option and/or right of first refusal to purchase the property; and (b) a purchase option to purchase the limited partner interest at the end of the compliance period. While the terms of these provisions may vary among agreements, in general, the purchase option price will be based on the greater of fair market value or debt plus taxes, and the right of first refusal will be based upon debt plus taxes.

In cases where the sponsor has determined it will exercise its right of first refusal to purchase at the debt plus taxes price, a full accounting of the partnership indebtedness must be completed, as described previously, and the sponsor must determine how each component of partnership debt will be retired. In addition, the capital gains, or exit tax resulting from the sale must be determined, as further described below. This tax may result regardless of whether there is a sale of the property or of the limited partner interest.

Satisfying Outstanding Partnership Debt: The outstanding partnership debt will be satisfied either by a cash payment (through a refinancing or other cash infusion) or by the purchaser assuming the debt. It might also be possible for the purchaser to negotiate a cancellation or forgiveness of the debt. However, NEF, Inc. must approve any forgiveness of debt that would occur while one of its funds still holds the limited partner interest.

Satisfying Exit Taxes: A sale or transfer of the project or limited part-er interest will result in an exit tax liability in cases where the limited partners’ capital account is negative at the time of transfer. Exit taxes are most simply calculated by multiplying the limited partner's negative capital account by the investor's tax rate; a gross-up factor may then be applied. The Code contains a provision to include a gross-up factor as part of the exit tax calculation.

The method of calculating exit taxes and the gross-up may vary among investors and syndicators. One distinction is whether the infinite calculation will be applied to capture the iterative nature of the gross-up calculation, or whether a specified number of gross-ups will be applied. As shown below, NEF, Inc. is currently applying a one-time gross-up factor rather than using an infinite calculation of the gross-up factor. The NEF, Inc. Exit Tax Analysis Worksheet 2 helps estimate current or future years' exit taxes. Go to worksheet.

In cases where the sponsor will not be exercising the right of first refusal to purchase at the debt plus taxes price, the purchase price analysis must be based on the greater of fair market value of the property or debt plus taxes. NEF, Inc. will consider purchase proposals that are based on a reasonable analysis to determine fair market value, although we reserve the right to require an appraisal in all cases.

For rental properties, the income approach is typically the most heavily weighted valuation approach. In preparing an analysis in lieu of submitting an appraisal, the prospective buyer should address the following questions:

--What's the property's current net operating income?

--What are the rent restrictions under applicable regulatory or financing agreements and for how long are these restrictions in place?

--How much could rents be increased over current levels, based on market conditions, and still operate within regulatory constraints?

If possible, include supporting documentation, such as results of a rent survey of comparable properties, advertisements for comparable rental properties from the local press, etc. Also include any other pertinent information that impacts future project operations. To impute a fair market value for the property, NEF, Inc. will evaluate the information provided in the purchase proposal to determine the expected future net operating income, and then apply a capitalization rate appropriate for local market conditions.

Estimating Exit Tax Liability: Exit tax liability may be estimated based on the information provided in the limited partnership's tax return- Form 1065, Schedule K-1 for the Limited Partner. Since the year 15 tax return may not yet be available at the time of the evaluation, the most recent year's tax return can be used and extrapolated thru the end of year 15. The limited partner’s capital account information is located in Section M and titled Analysis of Partner’s Capital Account. If the amount shown for the limited partner's capital account in box J(e) is negative, the following exit tax calculation will be applied:

Negative capital account balance x 0.35 (investor's federal tax rate) x 1.35 (one-time gross-up)

Note: In some cases, NEF, Inc. may require that the project accountant provide a reconciliation between GAAP and tax accounting to determine the tax liability, if there is a question regarding the presentation of capital accounts on partner-ship tax returns.

4. Remaining Cash Assets

Project reserves, typically replacement and operating deficit reserves, are partnership assets. As such, any reserves remaining after the sale of the project, along with any cash proceeds of the sale, are to be distributed according to partnership allocation rules and the limited partnership agreement.

The agreement may contain specific language regarding remaining reserve balances. For instance, it might stipulate that any amount remaining in the operating deficit reserve account would first be applied toward payment of any exit-tax liability. In addition, loan documents may contain limitations on the replacement reserve account in the event a subsequent buyer assumes the loan assumed from the partnership. Sponsors are asked to detail the amount of remaining reserves and any lender controls on reserves as part of the purchase proposed.

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