Industry Insights

Once credit markets start to recover, it is unlikely that we will see a return to the easy credit terms in place during the early part of this decade. As a result, many projects will require more creative funding sources.

State and local governments have long realized that as an area prospers economically, tax revenues generated from that area—be it from property taxes, sales taxes or other taxes—also increase. Governments use that growth to induce businesses to relocate to or redevelop economically blighted areas. Some even contribute land and property or provide financial assistance to solicit new business and industry. One such inducement that should be of particular interest to developers is Tax Incremental Financing (TIF).

The TIF concept is relatively simple. Though TIF structures vary from state to state, a local government advances cash—typically in the form of a loan—to a business to develop or rehabilitate an area designated as economically blighted. In general, tax revenues generated from the economically blighted area in the year before the TIF project is completed are measured. Once TIF is in place, any tax revenue generated over and above that measured base in subsequent years is used to pay down the loan.

As previously mentioned, TIF monies are available for businesses looking to relocate to or redevelop economically blighted areas. For an area to be considered economically blighted, state laws usually require a multifactor test; these factors may include an assessment of the area’s sanitary conditions, the amount of structural deterioration in the area (or building), whether conditions exist that endanger life or property and the level of environmental contamination.

TIF monies can be raised in myriad ways. Municipal bonds are often issued, and the bond proceeds are loaned to developers to assist with their capital requirements. In this case, incremental tax revenues generated by the project are used to make principal and interest payments on the bonds. Alternatively, TIF money can be given to developers incrementally over time, as they are received by the local taxing authority. In this case, the TIF money alleviates the development’s debt burden as the project pays off its long-term debt borrowed from other sources.

From a developer’s standpoint, TIF provides multiple benefits. First, it allows them to bridge any capital shortfall they may have (Note: TIF cannot be used to finance an entire project). Second, since TIF funds are repaid either in whole or in part by taxes, the project’s debt burden is reduced, which can significantly enhance a project’s financial viability. Third, under certain conditions, TIF monies may qualify as nontaxable receipts. Finally, generally speaking, TIF projects enjoy broad-based support from local governments and area residents.

In general, contributions from a government entity without a repayment obligation create a tax burden for a profit-motivated developer. Several strategies can be employed to mitigate this situation. Since each development project is unique with its own set of financing and tax considerations, it is best to consult your BKD tax professional to ensure the optimal structure.

The TIF concept has been around for numerous years, and many prominent development properties have included TIF in their financial structure.

If you are contemplating a rehabilitation or new development project, consider TIF. If properly structured, this unique financing mechanism can provide a win-win-win situation for the municipality, developer and community. Since laws vary by state, please consult your BKD advisor for specifics about your state’s approach to TIF.