Negotiating the Perils of Tax Increment Financing
By Richard L. Treptow, Senior Associate

Tax Increment Financing ("TIF") for a new single development usually involves financing today and paying later with an uncertain stream of property tax revenue generated from a development not yet constructed or assessed.  The potential risks inherent in a TIF transaction either must have a remedy or a party willing to bear that risk. 

The risks:

• The development may not occur, be late or be smaller than anticipated;
• The developer or company may cease operations, become tax delinquent, file for bankruptcy or appeal for lower property taxes;
• Tax rates may decrease;
• Parcel combinations and splits may be missed; or
• State law changes may affect tax rates or assessment practices (e.g., "Circuit Breaker").

Although this list seems daunting, Indiana TIF bonds are commonly sold. 

There are remedies available to address the above risks such as: 

• Local Development Agreements may address timing and scope risks;
• The developer or parent company may guarantee performance;
• The developer, company or their banker may purchase the bonds or provide a letter of credit (LOC);
• High debt coverage ratios and/or debt service reserves may be established;
• Other security may be pledged (e.g., EDIT, COIT, property taxes); or
• TIF revenue may be monitored on a parcel-by-parcel basis.

It may be desirable not to fully remedy all risks.  Sometimes it is more important to ensure the right parties bear the risks and are fairly compensated for doing so.  For example, a developer with the potential to create hundreds of jobs may want a flexible construction timetable to respond to market conditions.  This makes TIF revenue uncertain, but if the developer accepts a smaller TIF-funded project and purchases bonds without requiring the unit's tax backing, the community will attract a potential major employer with less TIF commitment and without the risk of levying taxes.

Managing the allocation of risk is a critical part of the TIF process.  Only three entities can assume the risks or provide remedies: the developer, the bond issuer and the bondholder.  Since most bond buyers are risk averse, most of the risk must be borne by the developer and bond issuer.  The outcome of risk/security negotiations will impact bond marketability, interest rates and the amount that can be funded. 

To read previous articles in this series, please contact us at umbaugh@umbaugh.com.

Umbaugh assists Indiana communities with an entire range of services to support, attract, and retain high quality developers and projects.  For additional information, contact us at footnotes@umbaugh.com.