Anyone considering a tax credit deal will quickly come to realize that your benefit comes in a stream of cash flows. The key to using the cash in your project is to convert the tax credits to a lump sum.
Do you remember the commercials from daytime TV about structured settlements? They promised “cash now” to assume your steam of future payments.
That advertisement targets less sophisticated people on medical leave watching daytime TV. However, the investment strategy was born in high finance.
I’ll give a primer on how to get your “cash now” when you convert tax credits to a lump sum.
Model the Cash Flows
Businesses and investors buy tax credits from deal sponsors for many reasons. Mostly, they’re interested in a discounted way to offset future tax liabilities. Consider the following example.
A big company, like ExxonMobil or Amazon, has major operations in all states. They also have a big team of accountants working hard to reduce tax liabilities in each state and at the federal level. You receive a low-income housing tax credit (LIHTC) annually based on maintaining a certain rental affordability standard. The big companies want that tax credit because it allows them to take you out in a lump sum at a lower rate than what they owe Uncle Sam.
The first step in this process is to model the cash flows. A tax credit buyer needs to see the gross amount paid over time.
This is strictly a financial transaction after all. The tax credit buyer’s only interest in your project is that you obtain the tax credit and maintain compliance with on-going obligations. Beyond that, they could care less if you lose money on the deal.
Establish Net Present Value
Today’s value of a future cash flow stream is known, appropriately, as the present value. You get to this point by applying an interest rate to future cash flows based on competing investment opportunities. That interest rate is known as the discount rate.
Your cash flow model is essential to establish present value. Tax credits usually come in fixed amounts for a defined time period. Simply, plug the dollar amount along with timing and discount rate into a spreadsheet or financial calculator to get the present value.
Let’s assume the going rate is 5.0% on a 30-year fixed payment of $1,000 per month.
The Excel formula to get the present value would be PV(5%, 30*12, 1000). This results in a present value of $20,000 to convert the tax credit to a lump sum.
Approach the Market
You probably wouldn’t be reading this if you had enough tax credit experience to go it alone. More than likely, you’ll want to lean on a tax credit expert to help you along the way.
A tax credit expert is part consultant and part intermediary. She helps you structure the deal, line up the appropriate third-parties, and finally shops the deal to investors. This person is a critical part of your team, and you probably won’t find much success without her.
Each tax credit type has different compliance requirements and regulatory frameworks. You may know enough to get started, but doing this without an experienced guide can be dangerous.
Look through recent deals in your market for the consultants that were involved. They may not be associated with big firms. For example, one of the leading historic tax credit consultants in New Orleans is an architect. Think outside the big consulting firms to find the right person for your situation.