The tax equity market is awaiting new guidelines that could affect how some deals are structured.

The Internal Revenue Service is working on a revenue procedure that will explain what it wants to see in tax equity transactions involving tax credits for renovating historic buildings. The tax credits work like the investment tax credit in renewable energy projects. They are claimed in the year a project is completed. They are 20% of the amount spent on renovations. Developers form partnerships with tax equity investors and allocate the credits disproportionately to the tax equity investors.

The IRS feels that some such partnership transactions have become too aggressive.

A US appeals court struck down one such transaction in August 2012. The case, called Historic Boardwalk LLC v. Commissioner, involved renovation of a sports arena and exhibition hall in Atlantic City that was originally built in the 1920s and was the site of the Miss America pageant starting in 1933. The state of New Jersey, which did the renovation and had no use for the federal tax credits on the project, entered into a complicated transaction to transfer the tax credits to Pitney Bowes. The transaction had a number of features that apparently are common in the historic and affordable housing tax equity markets, but that would be viewed as aggressive in the renewable energy market. (See earlier coverage in the September 2012 NewsWire starting on page 7.)

An IRS associate area counsel in Detroit said in an internal memo made public in March 2013 that another transaction was nothing more than a “circular flow of contracts” with no real partnership formed. (See the April 2013 NewsWire starting on page 27.)

The court decision and IRS memo have caused some tax equity investors to defer making further investments in transactions involving historic tax credits until there is more guidance from the IRS.

Senior IRS officials say it is easy to structure transactions to transfer historic tax credits so that the transactions pass muster, but that the market appears to be walking too close to the line in some cases to bare sales of tax credits. Broker presentations that pitch the transactions as tax credit sales do not help the situation.

The guidance is on a “fast track,” according to Craig Gerson, an attorney-adviser in the office of tax policy at the US Treasury.

The goal is to create a zone in which the deals can be done. The IRS is expected to say it wants a meaningful upfront investment by the tax equity investor. Many investors put in a small amount of money shortly before the end of the renovation project and then invest the rest after the project has been completed. The agency also wants to see “entrepreneurial downside risk” and a potential upside for the investor.

An historic tax credit coalition submitted eight fact patterns that it asked the IRS to be sure to address. Two of the fact patterns describe “fixed-flip” partnerships, where the tax equity investor takes a small share of the cash as preferred cash distributions and virtually all the tax benefits until a fixed date in the future, and “overlapping” inverted leases that strip tax credits by having the developer lease the project to a tax equity investor to whom the developer elects to pass through the tax credits and the tax equity investor also takes an interest in the lessor. The fact patterns do not mention some of the more aggressive features that are typical of such transaction structures. Another fact pattern asks the IRS for its view if the investor buys tax credit insurance from a third party.

The guidelines are expected to be patterned after guidelines the IRS issued in 2007 for partnership flip transactions involving wind farms. Any new rules for historic tax credit transactions will be read with interest by the broader tax equity community.

The US Supreme Court declined in late May to review the US appeals court decision in the Historic Boardwalk case.