1031-00004 · Hudson Yards West Mortgage LLC · Deal Analysis

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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL ATTORNEY–CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT

TO: Douglas Fairchild, Partner, Corporate/Real Estate Department Angela Fontaine, Senior Associate, Corporate/Real Estate Department Grace Nakamura, Associate, Corporate/Real Estate Department

FROM: Sylvia Hartwell, Partner, Tax Department

DATE: February 25, 2025

RE: Hudson Yards West — Tax Analysis of SPE Structure, Government Instrumentality Status, Ground Lease Treatment, and State/Local Tax Considerations

Matter No.: 1031-00004

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I. EXECUTIVE SUMMARY

This memorandum analyzes the federal, state, and local tax implications of the proposed dual–special purpose entity ("SPE") financing structure for the Hudson Yards West mixed-use transit-oriented development located at 450 West 34th Street, New York, New York 10001 (Block 729, Lots 1, 5, 12, and 15) (the "Project"). The total estimated Project cost is approximately $920,000,000, to be financed through a combination of (a) a $475,000,000 senior mortgage loan from Ironclad National Bank, N.A. ("Ironclad"), as administrative agent, (b) a $200,000,000 mezzanine loan from Granite Peak Capital Partners, LP ("Granite Peak"), (c) $200,000,000 in equity contributed by Metropolitan Transit Development Corp. ("MTDC"), and (d) a $45,000,000 infrastructure grant from the City of New York through the NYC Transit Infrastructure Grant Program (the "Transit Grant").

The proposed structure contemplates the formation of two Delaware limited liability companies: (i) Hudson Yards West Mortgage LLC (the "Mortgage Borrower"), which will hold the leasehold interest in the Project site and serve as the borrower under the senior mortgage loan, and (ii) Hudson Yards West Mezzanine LLC (the "Mezzanine Borrower"), which will serve as the sole member of the Mortgage Borrower and as the borrower under the mezzanine loan. Each of the Mortgage Borrower and the Mezzanine Borrower will be a single-member LLC, with the Mezzanine Borrower being wholly owned by MTDC directly and the Mortgage Borrower being wholly owned by the Mezzanine Borrower. The two-tier SPE stack is designed to satisfy lender requirements for bankruptcy remoteness, credit separation, and intercreditor separation while preserving MTDC's fundamental tax posture.

Our principal conclusions are as follows:

(a) MTDC's tax-exempt status as an Illinois government instrumentality is preserved through the SPE structure under Section 115 of the Internal Revenue Code of 1986, as amended (the "Code"), and applicable administrative and judicial authority. The interposition of the SPEs does not compromise this status, provided the conditions discussed herein are satisfied and maintained.

(b) Single-member LLC treatment as disregarded entities for federal income tax purposes is available under the default classification rules of Treasury Regulations Section 301.7701-3(b) and is recommended. No Form 8832 elections should be filed. Both SPEs will be treated as transparent for federal income tax purposes, with all items of income, deduction, gain, loss, and credit flowing through to MTDC.

(c) The ground lease structure creates a leasehold interest that is subject to specific federal, New York State, and New York City tax treatment. The ground lease should be respected as a bona fide lease (and not recharacterized as a deemed sale) for federal tax purposes.

(d) Delaware formation taxes and annual franchise taxes apply to the two Delaware LLCs, but Delaware does not impose income tax on the out-of-state real property income of these entities. The total annual Delaware tax cost is $600.

(e) New York State and New York City tax obligations arise from the SPEs' ownership of and activities related to New York real property. Although government instrumentality exemptions may apply to shield MTDC and the SPEs from corporate franchise tax, general corporation tax, and unincorporated business tax, significant transactional taxes — including mortgage recording tax, real property transfer tax, commercial rent tax, and sales and use tax — require careful analysis and, in several cases, affirmative application for available exemptions.

(f) Mortgage recording tax and real property transfer tax consequences at closing require immediate attention and budgeting. The combined mortgage recording tax exposure on $675,000,000 of recorded mortgage debt could reach $18,900,000 if no government instrumentality exemption is available. This is the single largest open tax issue on the transaction and warrants priority attention.

The estimated aggregate state and local tax exposure, assuming no exemptions are obtained, exceeds $30,000,000. If the exemptions discussed in this memorandum are successfully obtained, ongoing annual compliance costs can be reduced to under $1,000,000. We recommend prompt action on the five priority items identified in Section VIII.A of this memorandum.

II. BACKGROUND AND TRANSACTION OVERVIEW

A. Metropolitan Transit Development Corp. — Entity Profile

Metropolitan Transit Development Corp. ("MTDC") is an Illinois government instrumentality created by an act of the Illinois General Assembly, codified at 70 ILCS 3615/1.01 et seq. (the "Enabling Act"). MTDC was established for the purpose of promoting, developing, and managing transit-oriented development projects in furtherance of the public interest in efficient, integrated, and economically sustainable mass transit infrastructure and related commercial and residential development. MTDC is headquartered at 200 South Michigan Avenue, Suite 3100, Chicago, Illinois 60604, and has been assigned Employer Identification Number 36-2847501.

MTDC is a substantial public-purpose enterprise with significant financial resources and operational capacity. For the fiscal year ended December 31, 2024, MTDC reported operating revenue of approximately $1,120,000,000 and net assets of approximately $3,700,000,000. MTDC's real estate portfolio, which spans projects across eleven states, is valued at approximately $4,800,000,000 based on MTDC's most recent audited financial statements and independent appraisals. MTDC holds a credit rating of A– from Pinnacle Ratings Group (identifier PRG-MTDC-A-2024-1187), reflecting the organization's strong financial position, diversified revenue streams, and governmental backing.

MTDC's governance structure is established under the Enabling Act and provides for a board of directors appointed by the Governor of Illinois with the advice and consent of the Illinois Senate. The board is currently chaired by Margaret Kowalski. MTDC's executive management team includes David Harrington, Executive Director; Priya Subramanian, Chief Financial Officer; and Lydia Okafor, General Counsel. Each of these individuals has been involved in various aspects of the Project and may need to be consulted regarding certain of the open issues identified in this memorandum.

B. Project Description

The Project consists of a mixed-use transit-oriented development to be constructed on a leasehold interest in the Project site. The leasehold interest arises under a 99-year ground lease (the "Ground Lease") executed on June 1, 2020, between the New York City Economic Development Corporation ("NYCEDC"), as fee owner and ground lessor, and MTDC, as ground lessee. The Ground Lease was recorded in the Office of the City Register of the City of New York at City Register File Number ("CRFN") 2020000198762, as reflected in the Automated City Register Information System ("ACRIS") maintained by the New York City Department of Finance.

The Project site comprises the parcels identified as Block 729, Lots 1, 5, 12, and 15, on the Tax Map of the Borough of Manhattan, City of New York, situated at 450 West 34th Street, New York, New York 10001, in the Hudson Yards area of the West Side of Manhattan. The Project site is located within a special zoning district (the Hudson Yards Special District) and was the subject of Uniform Land Use Review Procedure ("ULURP") proceedings. The ULURP application (Application No. C 230415 ZSM) was approved by the New York City Planning Commission on September 12, 2023, and ratified by the New York City Council on October 25, 2023. The ULURP approvals authorize the development of a mixed-use building containing approximately 1,200,000 gross square feet, consisting of office space, retail space, residential units (including a mandatory affordable housing component), transit infrastructure improvements, and associated parking and amenity areas.

Construction of the Project will be performed by Cobalt Construction Group, Inc. ("Cobalt" or "CCG") under a guaranteed maximum price ("GMP") construction contract designated CCG-HYW-2025-001 (the "GMP Contract"). The GMP under the construction contract is $412,000,000. Substantial completion of the Project is projected for December 15, 2027, with the first temporary certificate of occupancy ("TCO") projected for March 15, 2028. The GMP Contract was negotiated at arm's length and reflects prevailing market pricing for construction of this type in Manhattan.

The Project is expected to generate rental income from office, retail, and residential tenants upon stabilization, as well as ancillary income from parking, signage, and transit-related operations. The development also furthers MTDC's core governmental mission of transit infrastructure development and the creation of transit-oriented communities, including the provision of affordable housing and the improvement of public transit access points.

C. Proposed SPE Structure

The proposed financing structure calls for a two-tier SPE stack, organized as follows:

Tier 1 — MTDC to Mezzanine Borrower: MTDC, as the ultimate parent and sole source of equity capital, will form Hudson Yards West Mezzanine LLC ("HYW Mezzanine LLC" or the "Mezzanine Borrower") as a Delaware limited liability company. MTDC will be the sole member of HYW Mezzanine LLC. HYW Mezzanine LLC will serve as the borrower under the $200,000,000 mezzanine loan from Granite Peak Capital Partners, LP. The mezzanine loan bears a fixed interest rate of 11.50% per annum and is secured by a pledge of HYW Mezzanine LLC's membership interest in the Mortgage Borrower (described below).

Tier 2 — Mezzanine Borrower to Mortgage Borrower: HYW Mezzanine LLC will, in turn, form Hudson Yards West Mortgage LLC ("HYW Mortgage LLC" or the "Mortgage Borrower") as a Delaware limited liability company. HYW Mezzanine LLC will be the sole member of HYW Mortgage LLC. HYW Mortgage LLC will hold the leasehold interest in the Project site (either through a direct assignment of the Ground Lease from MTDC or through a sublease or other appropriate conveyance mechanism to be determined in consultation with the deal team), will serve as the borrower under the $475,000,000 senior mortgage loan from Ironclad National Bank, N.A. (as administrative agent for the senior lending syndicate), and will be the entity that enters into the GMP Contract with Cobalt for construction of the Project. The senior mortgage loan bears interest at Term SOFR plus 425 basis points (with a 1.00% SOFR floor) and is secured by a first-priority leasehold mortgage on the Project site.

Both SPEs are to be newly formed entities; neither currently exists. Employer Identification Numbers will be obtained from the Internal Revenue Service upon formation. Each SPE will be organized under the Delaware Limited Liability Company Act, 6 Del. C. § 18-101 et seq., and will be qualified to do business in the State of New York as a foreign limited liability company.

The purpose of the two-tier SPE structure is to achieve bankruptcy remoteness, satisfy the structural and credit-separation requirements of the senior and mezzanine lenders, and provide clear delineation between the collateral packages supporting the senior debt (leasehold mortgage and assignment of rents and leases) and the mezzanine debt (pledge of membership interests). The SPE structure is a standard feature of institutional commercial real estate finance and is not intended to alter MTDC's fundamental tax posture. As discussed in detail in Section III below, the use of disregarded entities for this purpose is fully consistent with the preservation of MTDC's Section 115 exclusion from federal income tax and does not create any incremental federal tax liability.

III. FEDERAL TAX ANALYSIS

A. MTDC's Status as a Government Instrumentality — Section 115 and Related Authority

The threshold federal tax question in this transaction is whether MTDC qualifies for the income exclusion provided by Section 115(1) of the Code, and whether that exclusion is preserved when income is earned through the two disregarded-entity SPEs.

Section 115(1) of the Code provides that gross income does not include "income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia." The purpose of Section 115 is to ensure that the federal government does not tax the income of state and local governmental entities, consistent with the principle of intergovernmental tax immunity. Unlike the exemption provisions of Section 501 (which require an application and determination letter process), the Section 115 exclusion is self-executing — a qualifying entity simply excludes qualifying income from its gross income. No recognition letter from the IRS is required, though the entity must be prepared to demonstrate its qualification if challenged.

Qualification as a Government Instrumentality. To determine whether MTDC qualifies as a "political subdivision" or "instrumentality" of the State of Illinois, we apply the six-factor test set forth in Revenue Ruling 57-128, 1957-1 C.B. 311. Under this test, the following factors are considered:

(i) Sovereign powers. Whether the entity possesses sovereign powers such as the power of eminent domain, the police power, or the power to tax. MTDC possesses the power of eminent domain under its Enabling Act and has the authority to issue bonds backed by the full faith and credit of the State of Illinois, which are hallmarks of sovereign power.

(ii) Designation by state statute. Whether the entity is designated by the state as an agency, instrumentality, or political subdivision. The Enabling Act expressly designates MTDC as an "instrumentality of the State of Illinois" and a "body politic and corporate" created for public purposes.

(iii) State control. Whether state officials control or have oversight over the entity. MTDC's board of directors is appointed by the Governor of Illinois with the advice and consent of the Illinois Senate. The Governor retains the power to remove board members for cause. MTDC is subject to audit by the Illinois Auditor General and must submit an annual report to the Illinois General Assembly.

(iv) State-created purpose. Whether the entity was created to carry out a governmental purpose. MTDC was created to promote, develop, and manage transit-oriented development projects in furtherance of the public interest. This is quintessentially a governmental purpose.

(v) Accountability. Whether the entity is financially accountable to the state. MTDC's financial statements are audited annually by an independent auditor selected by the Illinois Auditor General. MTDC is subject to the Illinois Freedom of Information Act and the Open Meetings Act.

(vi) Duration. Whether the entity has perpetual duration or exists for a limited governmental purpose. MTDC was created with indefinite duration under the Enabling Act and will continue to exist until dissolved by act of the Illinois General Assembly.

All six factors support the conclusion that MTDC is an instrumentality of the State of Illinois for purposes of Section 115. MTDC possesses sovereign powers, is expressly designated as a state instrumentality by statute, is subject to meaningful state control and accountability mechanisms, was created for a governmental purpose, and has perpetual duration. We are confident that MTDC satisfies the Revenue Ruling 57-128 test.

Income from an Essential Governmental Function. Section 115(1) requires that the income in question be derived from the "exercise of any essential governmental function." The income from the Hudson Yards West Project will consist primarily of rental income from office, retail, and residential tenants, as well as development fee income, parking revenue, and ancillary income. While the rental of commercial space is not inherently a "governmental function," the relevant inquiry is whether the income-generating activity is conducted in furtherance of an essential governmental function.

Revenue Ruling 77-261, 1977-2 C.B. 45, addressed the question of whether income earned by a state housing authority from the development and operation of public housing constituted income from an essential governmental function. The IRS concluded that it did, reasoning that the housing authority was created by the state to serve a public purpose (the provision of affordable housing), and the rental income generated by the housing projects was incidental to and inseparable from that governmental purpose.

The Hudson Yards West Project is directly within MTDC's statutory mandate. The Project is a transit-oriented development that includes the construction and improvement of public transit infrastructure (a core governmental function), the provision of affordable housing (an essential governmental function recognized in Revenue Ruling 77-261 and numerous subsequent rulings), and the promotion of economic development in an area designated for urban renewal and transit improvement. The commercial and market-rate residential components of the Project are integral to the financial viability of the transit and affordable housing components and are consistent with the mixed-use, mixed-income development model that MTDC was created to pursue. Accordingly, we conclude that the income generated by the Project constitutes income derived from the exercise of an essential governmental function within the meaning of Section 115(1).

"Accruing to" Requirement. The final requirement of Section 115(1) is that the income "accrue to" a state or political subdivision thereof. Because MTDC is an instrumentality of the State of Illinois, income that accrues to MTDC satisfies this requirement. As discussed in Section III.C below, the use of disregarded entities does not alter this analysis because income earned by a disregarded entity is treated as earned by its owner for federal tax purposes.

Conclusion. MTDC itself is not subject to federal income tax on income from the Hudson Yards West Project under Section 115(1) of the Code, provided that (i) the income accrues to MTDC (directly or through disregarded entities), (ii) the activities giving rise to the income remain within MTDC's governmental purpose, and (iii) MTDC continues to satisfy the Revenue Ruling 57-128 factors for treatment as a government instrumentality.

B. Entity Classification of the Delaware LLCs — Check-the-box Regulations

Under the entity classification regulations set forth in Treasury Regulations Section 301.7701-3(b), a domestic "eligible entity" — that is, a business entity that is not automatically classified as a corporation under Section 301.7701-2(b) — is classified by default based on its ownership structure. A domestic eligible entity with a single owner is classified by default as a disregarded entity. A domestic eligible entity with two or more owners is classified by default as a partnership.

A limited liability company formed under the Delaware Limited Liability Company Act is an "eligible entity" for purposes of the check-the-box regulations, as it is not listed among the entities treated as per se corporations under Treasury Regulations Section 301.7701-2(b)(1)–(8). Both HYW Mortgage LLC and HYW Mezzanine LLC will be domestic eligible entities with a single owner. HYW Mezzanine LLC will be owned solely by MTDC. HYW Mortgage LLC will be owned solely by HYW Mezzanine LLC. Accordingly, each entity is, by default, classified as a disregarded entity for federal income tax purposes.

We note that HYW Mortgage LLC's sole owner is HYW Mezzanine LLC, which is itself a disregarded entity owned by MTDC. Under Treasury Regulations Section 301.7701-2(c)(2)(i), if the owner of a disregarded entity is itself a disregarded entity, the first entity is treated as owned by the person that owns the chain of disregarded entities. Accordingly, HYW Mortgage LLC is treated as owned by MTDC for all federal income tax purposes.

Recommendation. We recommend that neither HYW Mortgage LLC nor HYW Mezzanine LLC file a Form 8832 (Entity Classification Election) with the Internal Revenue Service. By refraining from filing, the default disregarded-entity classification will apply automatically upon formation. Filing a Form 8832 to affirmatively elect disregarded-entity status is permissible but unnecessary and could introduce administrative complexity or risk of error. The default classification achieves the desired result.

Effect of Disregarded-Entity Classification. As disregarded entities, HYW Mortgage LLC and HYW Mezzanine LLC are treated as transparent for federal income tax purposes. All items of income, deduction, gain, loss, and credit attributable to the SPEs are treated as if earned or incurred directly by MTDC. The SPEs are not required to file federal income tax returns (Forms 1065 or 1120), and no separate taxpayer identification is required for income tax purposes (though EINs may be needed for other purposes, including employment tax, excise tax, and certain reporting obligations, as discussed below).

Importantly, the disregarded-entity classification for federal income tax purposes does not undermine the SPEs' status as separate legal entities under Delaware law or affect their bankruptcy-remoteness features. State-law limited liability protections, the separateness of the SPEs' assets and liabilities from those of MTDC, and the lender-required separateness covenants all remain fully effective notwithstanding the federal tax classification. The check-the-box regulations operate exclusively in the tax domain and do not alter the legal, contractual, or creditor-rights analysis.

Single-Member Restriction Caution. If, at any point, either SPE were to admit a second member, the default classification would automatically shift from disregarded entity to partnership. A partnership classification would require the filing of federal partnership returns (Form 1065) and the issuance of Schedules K-1. More importantly, the shift to partnership classification could raise questions about whether the income of the partnership "accrues to" MTDC for purposes of Section 115, particularly if the second member is a non-governmental entity. To prevent this outcome, we recommend that the operating agreements for both SPEs contain express restrictions prohibiting the admission of additional members without the prior written consent of MTDC's General Counsel and tax counsel. These restrictions should be drafted as fundamental provisions that cannot be amended without the consent of the lenders, consistent with standard SPE operating agreement practice. We will coordinate with Douglas Fairchild and Grace Nakamura on these provisions.

C. Preservation of Section 115 Exclusion Through Disregarded Entities

A critical question is whether the interposition of the two disregarded-entity SPEs between MTDC and the Project income jeopardizes MTDC's Section 115 exclusion. We conclude that it does not.

The analysis proceeds from the fundamental principle that a disregarded entity does not exist as a separate entity for federal income tax purposes. Income earned by a disregarded entity is treated as earned by its owner. Because both SPEs are disregarded entities owned (directly and indirectly) by MTDC, all income generated by the Project is treated as earned directly by MTDC for federal tax purposes. The "accruing to" requirement of Section 115(1) is therefore satisfied: the income accrues to MTDC, a government instrumentality of the State of Illinois.

This conclusion is supported by several private letter rulings and IRS guidance documents. In PLR 200727005, the IRS addressed a situation in which a state government entity formed a single-member LLC to hold and operate real estate. The IRS concluded that the income earned by the LLC was treated as earned by the state entity for Section 115 purposes and was therefore excluded from gross income. While private letter rulings may not be cited as precedent by other taxpayers under Section 6110(k)(3), they are indicative of the IRS's analytical approach and provide a useful gauge of IRS thinking on this issue. Similar conclusions have been reached in analogous rulings involving governmental instrumentalities that use disregarded-entity subsidiaries for real estate investment, infrastructure development, and other governmental purposes.

The IRS's analytical framework is straightforward. Because the check-the-box regulations treat a single-member LLC as nonexistent for federal income tax purposes, the income earned by the LLC is treated as if it were earned directly by the member. If that member is a Section 115 entity, the income retains its Section 115 character. The SPE structure does not introduce any intermediary "person" that could intercept the income or divert it from the governmental entity.

To preserve this result, the following conditions must be maintained:

(i) Single-member status must be maintained. As discussed above, the admission of a second member to either SPE would convert the entity from a disregarded entity to a partnership, potentially disrupting the Section 115 analysis.

(ii) Income must not be diverted to non-governmental purposes. All net income from the Project must accrue to MTDC and be used in furtherance of MTDC's governmental mandate. Distributions to non-governmental parties (other than arm's-length payments for goods and services, debt service, and similar ordinary-course expenditures) would raise questions about whether the income "accrues to" a governmental entity.

(iii) The Project must continue to serve MTDC's governmental mandate. If the character of the Project were to change such that it no longer served MTDC's transit-development and public-purpose mission, the "essential governmental function" requirement of Section 115(1) could be called into question.

Based on the facts as we understand them, all three conditions are currently satisfied and are expected to continue to be satisfied throughout the term of the Project. We recommend that the deal team monitor these conditions on an ongoing basis and consult with tax counsel before making any material changes to the SPE structure or the nature of the Project.

D. Unrelated Business Taxable Income (UBTI) Considerations

The unrelated business taxable income ("UBTI") provisions of the Code (Sections 511 through 514) impose a tax on the unrelated business income of certain tax-exempt entities, including organizations described in Section 501(c)(3) and, in some cases, state colleges and universities. A question arises as to whether MTDC, as a Section 115 government instrumentality that engages in commercial real estate activities financed with substantial debt, could be subject to the UBTI regime.

Section 511(a)(2)(B) of the Code provides that the UBTI tax applies to "any college or university which is an agency or instrumentality of any government or any political subdivision thereof, or which is owned or operated by a government or any political subdivision thereof, or by any agency or instrumentality of one or more governments or political subdivisions." This provision is narrowly targeted at governmental colleges and universities, not at government instrumentalities generally. MTDC is not a college or university, and therefore Section 511(a)(2)(B) does not apply.

More broadly, government instrumentalities that are excluded from gross income under Section 115 are not within the UBTI regime at all. The UBTI provisions apply to entities that are "exempt from taxation under this subtitle" by reason of specific exemption provisions (primarily Section 501). Section 115 operates differently — it provides an exclusion from gross income, not an exemption from tax. An entity whose income is excluded under Section 115 is simply not a taxpayer with respect to that income, and the UBTI provisions have no application.

This distinction is particularly relevant in the context of the debt-financed property rules of Section 514. Section 514 subjects certain exempt organizations to UBTI on income from "debt-financed property" — property acquired or improved with the proceeds of indebtedness. If Section 514 applied to MTDC, the $675,000,000 in mortgage and mezzanine debt used to finance the Project could create significant UBTI exposure. However, because MTDC is a Section 115 entity (not a Section 501 entity) and is not a governmental college or university within the scope of Section 511(a)(2)(B), Section 514 does not apply.

Conclusion. The UBTI provisions of Sections 511 through 514 do not apply to MTDC or the disregarded SPEs. The leveraged nature of the Project — $475,000,000 in senior mortgage debt and $200,000,000 in mezzanine debt — does not create UBTI exposure for MTDC. This is a meaningful advantage of MTDC's Section 115 status as compared to the treatment of tax-exempt organizations under Section 501(c)(3), which would face significant UBTI exposure on debt-financed real property income.

E. Federal Tax Treatment of Interest Payments

Interest paid on the senior mortgage loan and the mezzanine loan is, in principle, deductible by the borrower entities under Section 163(a) of the Code. However, because the borrower entities are disregarded and MTDC's income is excluded under Section 115, the deductions have no practical effect at the federal level. MTDC does not have taxable income against which to apply the deductions, and no federal tax benefit is derived from the interest payments.

With respect to withholding obligations, no federal withholding is anticipated on the interest payments. Both Ironclad National Bank, N.A. and Granite Peak Capital Partners, LP are domestic entities, and there is no requirement under the Code to withhold on interest payments to domestic payees (absent backup withholding requirements triggered by a failure to provide a correct taxpayer identification number, which is not expected to be an issue with institutional lenders).

Regarding information reporting, the question arises whether the SPEs or MTDC are required to file Forms 1099-INT with respect to the interest payments. Under the general reporting rules, any person engaged in a trade or business that makes payments of interest aggregating $600 or more during a calendar year must file a Form 1099-INT. However, exceptions apply for certain payments, including payments to corporations (which would cover Ironclad, a national banking association) and payments to entities that provide a Form W-9 certifying their exempt status from backup withholding. We note that disregarded entities may have separate reporting obligations under Treasury Regulations Section 301.7701-2(c)(2)(iv) for employment tax and excise tax purposes, but income tax reporting (including information reporting with respect to interest payments) follows through to MTDC as the owner of the disregarded entities. We recommend that the deal team coordinate with Sandra Okonkwo of Whitfield Albrecht to confirm the precise reporting obligations and ensure compliance.

F. Impact of the NYC Transit Infrastructure Grant ($45,000,000)

The $45,000,000 NYC Transit Infrastructure Grant represents a government-to-government transfer from the City of New York to MTDC, an instrumentality of the State of Illinois, for the purpose of funding transit infrastructure improvements associated with the Project. As a government-to-government transfer, the grant does not constitute gross income to MTDC for federal income tax purposes. Even if the grant were analyzed as a payment to a private party, it would be excludable under Section 115(1) as income accruing to a government instrumentality from the exercise of an essential governmental function.

For completeness, we note that Section 118 of the Code, which provides that contributions to the capital of a corporation are not included in gross income, is not technically applicable to this transaction. Section 118 applies to corporations, and while MTDC is a "body politic and corporate" under its Enabling Act, it is not a "corporation" within the meaning of Section 118. Moreover, Section 118 is unnecessary here because the grant is already excluded from MTDC's gross income under Section 115(1).

No federal tax consequence arises from the receipt of the Transit Grant by MTDC or the SPEs.

IV. FEDERAL TAX TREATMENT OF THE GROUND LEASE

A. Characterization of the Ground Lease

As described in Section II.B above, MTDC holds a leasehold interest in the Project site under the Ground Lease executed on June 1, 2020, with NYCEDC as fee owner and ground lessor. The Ground Lease has an initial term of 99 years, with no renewal options beyond the initial term. MTDC pays annual ground rent of $4,200,000, subject to CPI-based escalation every five years. Upon expiration or termination of the Ground Lease, all improvements revert to NYCEDC as ground lessor.

A threshold question for federal tax purposes is whether the Ground Lease should be characterized as a bona fide lease or recharacterized as a deemed sale (or financing arrangement). If the Ground Lease were recharacterized as a sale, MTDC (through the Mortgage Borrower) would be treated as the owner of the fee interest in the land, and the ground rent payments would be recharacterized as payments of principal and interest on a purchase-money obligation. This would have implications for depreciation, interest deductions, and gain or loss on disposition.

The IRS and the courts apply a multi-factor test to distinguish a lease from a sale or financing arrangement. The relevant factors include:

(i) Length of the lease term relative to the useful life of the property. A lease term that exhausts substantially all of the economic useful life of the property suggests a sale. Here, the Ground Lease term is 99 years, which is long but does not exhaust the useful life of land (which has an indefinite useful life). This factor is neutral to slightly favorable for lease treatment.

(ii) Presence and terms of renewal options. Options to renew at below-market rents suggest a sale. The Ground Lease does not contain renewal options. This factor supports lease treatment.

(iii) Whether the rent represents fair market rental value. Rent that is substantially below fair market value (particularly when combined with a nominal purchase option) suggests a sale. The $4,200,000 annual ground rent, subject to CPI escalation, appears to represent a reasonable market rent for the Ground Lease based on comparable ground lease transactions in the Hudson Yards area. This factor supports lease treatment.

(iv) Whether the lessee has an option to purchase the fee. A purchase option, especially at a nominal or below-market price, strongly suggests a sale. The Ground Lease does not grant MTDC a purchase option. This factor supports lease treatment.

(v) Reversion of improvements to the lessor. The fact that all improvements revert to NYCEDC upon expiration of the Ground Lease is consistent with lease treatment, as it confirms that NYCEDC retains the residual economic interest in the property.

(vi) Risk of loss and economic benefits. During the lease term, MTDC bears the risk of loss (through its obligations to maintain, insure, and repair the premises) and enjoys the economic benefits of the property (through rental income from subtenants). This is consistent with either a lease or a sale, but the reversion of the property to NYCEDC tips this factor toward lease treatment.

Conclusion. Applying the multi-factor test, we conclude that the Ground Lease should be respected as a bona fide lease for federal tax purposes. MTDC (through HYW Mortgage LLC, as disregarded entity) is the lessee and holds a leasehold interest, not a fee ownership interest, in the Project site. NYCEDC is the fee owner and retains the residual interest.

B. Deductibility of Ground Rent

Under Section 162(a)(3) of the Code, a taxpayer engaged in a trade or business is entitled to deduct "rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity." The $4,200,000 annual ground rent paid under the Ground Lease is deductible under this provision.

However, because MTDC's income is excluded under Section 115(1), the deduction is technically available but has no practical effect at the federal level. MTDC does not compute taxable income, and there is no federal tax liability against which to offset the deduction. The treatment of ground rent for New York State and City tax purposes is discussed separately in Section V below, where the deduction may have greater practical significance depending on the resolution of the exemption questions.

C. Leasehold Improvements and Depreciation

Improvements constructed by a lessee on leased land are depreciable by the lessee under the Modified Accelerated Cost Recovery System ("MACRS") provisions of Section 168 of the Code. The lessee's depreciable basis in leasehold improvements generally includes the cost of construction, which in this case is the $412,000,000 GMP under the construction contract with Cobalt, plus any additional soft costs, development costs, and pre-development expenditures capitalized into the cost of the improvements.

The classification of the Project's improvements for MACRS purposes will depend on the nature and use of the specific building components:

(i) Nonresidential real property. The office, retail, and commercial components of the building are classified as "nonresidential real property" under Section 168(e)(2)(B) and are depreciable over a 39-year recovery period using the straight-line method.

(ii) Residential rental property. If the residential rental component of the building qualifies as "residential rental property" under Section 168(e)(2)(A) — meaning that 80% or more of the gross rental income from the residential component is from dwelling units — that component is depreciable over a 27.5-year recovery period. Whether the residential component meets this threshold will depend on the mix of market-rate and affordable units and the treatment of any non-residential uses within the residential portion of the building.

(iii) Personal property and land improvements. Certain components of the building (such as movable partitions, decorative lighting, certain flooring, landscaping, sidewalks, parking structures, and specialized mechanical systems) may qualify as personal property or land improvements with shorter MACRS recovery periods (5, 7, or 15 years, as applicable). Identification and segregation of these components requires a detailed cost segregation study.

Cost Segregation Study. We recommend that MTDC engage a qualified cost segregation firm to perform a cost segregation study of the Project upon substantial completion. A cost segregation study would analyze the engineering and construction specifications of the building and allocate the total cost among the applicable MACRS asset classes. While the depreciation deductions have no practical federal tax consequence to MTDC under Section 115 (for the same reasons discussed above with respect to interest deductions and ground rent), the cost segregation analysis may be relevant for several ancillary purposes: (a) New York State and City tax analysis, if any taxable component of the Project is identified; (b) lender underwriting and financial modeling, which typically incorporates depreciation in cash flow projections; and (c) financial statement presentation under GASB or other applicable accounting standards.

Treatment at Lease Expiration or Termination. Upon expiration or termination of the Ground Lease, the improvements constructed by MTDC will revert to NYCEDC as ground lessor. Under Section 109 of the Code, a lessor is not required to include in gross income the value of improvements made by a lessee that revert to the lessor upon the termination of the lease. Under Section 1019, the lessor does not receive an increase in basis in the property by reason of such improvements. These provisions primarily affect NYCEDC (as fee owner and ground lessor) rather than MTDC or the SPEs. MTDC's remaining depreciable basis in the improvements at the time of lease termination would give rise to a loss deduction, but again, this deduction would have no practical federal tax effect for a Section 115 entity.

D. Mortgage Recording and Financing Considerations

The senior mortgage loan from Ironclad and the mezzanine loan from Granite Peak are structured as bona fide debt obligations on arm's-length terms with unrelated institutional lenders. Under standard debt-equity analysis principles (see, e.g., Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972)), the following factors support debt characterization: (i) the loans bear a fixed or determinable maturity date; (ii) the interest rates (Term SOFR + 425 bps for the senior loan; 11.50% fixed for the mezzanine loan) are consistent with market rates for comparable commercial real estate loans; (iii) the lenders have no equity participation, profit-sharing, or management rights in the Project; (iv) the loans are documented with standard loan agreements, promissory notes, and security instruments; (v) the lenders are unrelated, arm's-length institutional parties; and (vi) there is a reasonable expectation of repayment from Project cash flows. Accordingly, the mortgage and mezzanine loans are properly characterized as debt, not equity, for federal tax purposes.

No federal tax issue arises from recording the mortgage on a leasehold interest (as opposed to a fee interest). Leasehold mortgages are a well-established feature of commercial real estate finance and are treated as debt instruments for federal tax purposes in the same manner as fee mortgages.

V. NEW YORK STATE AND CITY TAX CONSIDERATIONS

A. New York State Tax Treatment of MTDC and the SPEs

1. Corporate Franchise Tax (Article 9-A). New York State imposes a corporate franchise tax under Article 9-A of the Tax Law on corporations and certain other entities that are "doing business, employing capital, owning or leasing property, or maintaining an office" in New York. Tax Law § 209.1. The tax is imposed on the greater of several alternative bases, including a tax on business income (allocated to New York), a tax on capital, and a fixed dollar minimum.

The initial question is whether MTDC, as an out-of-state government instrumentality, is subject to the Article 9-A franchise tax by reason of its ownership of real property and conduct of development activities in New York. Government entities are generally exempt from the New York corporate franchise tax. Tax Law § 209.4 excludes from the definition of "taxpayer" any entity that is "exempt from taxation under this article by any other provision of law." While no single provision of the Tax Law expressly exempts out-of-state government instrumentalities by name, the New York State Department of Taxation and Finance has consistently taken the position — articulated in various Technical Services Bureau Memoranda ("TSB-M") and advisory opinions — that government entities and their instrumentalities are not subject to Article 9-A franchise tax. This position is grounded in the principle of intergovernmental tax immunity and in the recognition that government instrumentalities are not "corporations" subject to the franchise tax within the meaning of Tax Law § 209.

With respect to the disregarded Delaware LLCs, New York generally follows the federal check-the-box classification for purposes of the corporate franchise tax. Single-member LLCs that are disregarded for federal income tax purposes are also disregarded for New York State franchise tax purposes, and their income and activities are attributed to the single member. Accordingly, the income and activities of HYW Mortgage LLC and HYW Mezzanine LLC would be attributed to MTDC for Article 9-A purposes.

Conclusion. MTDC and the disregarded SPEs are not subject to Article 9-A corporate franchise tax. MTDC's status as a government instrumentality provides an exemption from the tax, and the disregarded-entity classification of the SPEs ensures that the exemption flows through the SPE structure.

2. LLC Filing Fee — Tax Law § 658(c). Notwithstanding the disregarded-entity classification for income tax purposes, New York State imposes an annual filing fee on limited liability companies and disregarded entities that have New York-source gross income. Tax Law § 658(c). This filing fee applies regardless of whether the LLC is subject to the franchise tax or income tax — it is a separate fee based on the LLC's New York-source gross income.

HYW Mortgage LLC and HYW Mezzanine LLC will each have New York-source gross income by reason of the Project. The annual filing fee is calculated on a tiered basis, ranging from $25 for entities with New York-source gross income of $100,000 or less to $4,500 for entities with New York-source gross income exceeding $25,000,000. Given that the Project is expected to generate gross rental income significantly in excess of $25,000,000 annually at stabilization, both HYW Mortgage LLC and HYW Mezzanine LLC will likely fall into the highest tier.

The total annual New York LLC filing fee for the two entities is estimated at $9,000 per year ($4,500 per entity). The filing is made on Form IT-204-LL, which is due on or before March 15 of each year.

We note that there does not appear to be an exemption from the LLC filing fee for LLCs owned by government instrumentalities. The fee is a relatively modest compliance cost and should be budgeted as an ongoing annual obligation.

3. Real Property Gains Tax (Article 31-B). For completeness, we note that New York formerly imposed a real property gains tax under Article 31-B of the Tax Law on certain transfers of real property with consideration exceeding $1,000,000. This tax was repealed effective for transfers occurring on or after June 15, 1996. The real property gains tax is therefore not applicable to the transactions contemplated in connection with the Project.

B. New York City Tax Considerations

1. General Corporation Tax / Unincorporated Business Tax. General Corporation Tax. New York City imposes a general corporation tax ("GCT") under Title 11, Chapter 6 of the New York City Administrative Code on corporations that are "doing business, employing capital, owning or leasing property in a corporate or organized capacity, or maintaining an office" in New York City. Admin. Code § 11-603. As a government instrumentality, MTDC is exempt from the GCT under the same intergovernmental immunity principles that apply at the state level. The disregarded-entity classification of the SPEs ensures that the GCT analysis looks through the SPEs to MTDC as the ultimate owner. Because MTDC is exempt, no GCT liability arises.

Unincorporated Business Tax. New York City also imposes an unincorporated business tax ("UBT") on the "unincorporated business taxable income" of individuals, partnerships, and other unincorporated entities that carry on a "trade, business, profession or occupation" wholly or partly within New York City. Admin. Code § 11-502 et seq. The UBT rate is 4% of taxable income, with certain deductions and exemptions.

The application of the UBT to the SPEs requires analysis. HYW Mortgage LLC and HYW Mezzanine LLC are single-member LLCs that are disregarded for federal and New York income tax purposes. As disregarded entities, they are not separate "persons" for UBT purposes, and their activities are attributed to MTDC. The question is whether MTDC is subject to the UBT with respect to these activities.

Government instrumentalities are not "individuals" or "unincorporated businesses" within the meaning of the UBT provisions. The UBT is designed to apply to private-sector unincorporated businesses — sole proprietorships, partnerships, and similar enterprises — that compete with incorporated businesses subject to the GCT. Government entities are categorically outside this framework. The New York City Department of Finance has recognized this principle in various rulings and advisory opinions addressing the treatment of government entities and their instrumentalities under the UBT.

Moreover, even if MTDC's activities could theoretically be characterized as an "unincorporated business," the UBT provides an exemption for entities that are exempt from federal income tax. While MTDC's income is excluded under Section 115 (rather than exempted under Section 501), the underlying principle is the same — MTDC is a tax-exempt government entity, and subjecting it to the UBT would be inconsistent with the intergovernmental immunity doctrine.

Conclusion. No GCT or UBT liability is anticipated for MTDC or the disregarded SPEs. We recommend that MTDC maintain documentation of its government instrumentality status to support its exempt position in the event of an inquiry from the New York City Department of Finance.

2. Commercial Rent Tax (CRT). New York City imposes a commercial rent tax ("CRT") on tenants of commercial premises located in Manhattan south of 96th Street (the "CRT zone") whose annual commercial rent exceeds the applicable threshold, which is currently $250,000. Admin. Code § 11-701 et seq. The CRT is imposed on the tenant (not the landlord) and is calculated as a percentage of the tenant's "base rent" (total rent less a 35% base rent reduction) in excess of the threshold amount.

MTDC, through HYW Mortgage LLC (as disregarded entity), pays annual ground rent of $4,200,000 to NYCEDC under the Ground Lease. The Project site is located at 450 West 34th Street, which is within the CRT zone. The ground rent of $4,200,000 substantially exceeds the $250,000 threshold. Accordingly, the CRT would apply unless an exemption is available.

Government Instrumentality Exemption. Admin. Code § 11-704(a) provides certain exemptions from the CRT. We must analyze whether MTDC, as an out-of-state government instrumentality, qualifies for any of these exemptions. The CRT exemptions include exemptions for tenants that are government agencies, but the scope of this exemption — particularly as applied to instrumentalities of other states — requires careful review. The CRT provisions were designed primarily to tax commercial tenants in Manhattan, and the exemption for government tenants may be limited to agencies of the City, State, and federal governments.

If MTDC qualifies for the government instrumentality exemption, it should apply for a CRT exemption certificate from the New York City Department of Finance. If the exemption is not available, the CRT liability would be calculated as follows:

• Gross rent: $4,200,000

• Base rent reduction (35%): ($1,470,000)

• Adjusted rent: $2,730,000

• Less threshold ($250,000): $2,480,000

• CRT rate: 3.9%

• Estimated annual CRT: approximately $96,720

While the estimated annual CRT liability of approximately $96,720 is not a dealbreaker, it is a recurring cost that should be budgeted if the exemption is unavailable. We recommend that MTDC pursue the exemption application as a priority item.

Recommendation. Prepare and file a CRT exemption application with the NYC Department of Finance. If the exemption is denied, budget approximately $96,720 per year (subject to increase as ground rent escalates with CPI adjustments) as an ongoing operating cost.

3. Real Property Tax Considerations. Real property tax is one of the most significant fiscal considerations for the Project, and the resolution of the real property tax question will have a material impact on the Project's economics.

The Project site is on land owned in fee by NYCEDC, an instrumentality of the City of New York. Under Section 412 of the Real Property Tax Law ("RPTL"), property owned by a municipal corporation (including a city agency or instrumentality) and used for a public purpose is exempt from real property taxation. NYCEDC's fee ownership of the land therefore provides a basis for exemption of the land from real property taxation.

However, the treatment of the leasehold improvements constructed by MTDC on the NYCEDC-owned land is more complex. Under RPTL § 412, the exemption applies to property "owned by" a municipal corporation. The leasehold improvements will be owned by MTDC (through the disregarded SPEs), not by NYCEDC. While MTDC is a government instrumentality, it is an instrumentality of the State of Illinois, not of the City of New York or the State of New York. RPTL § 412 may not extend to property owned by an out-of-state government instrumentality.

RPTL § 420 provides exemptions for real property owned by certain nonprofit organizations and used for specified exempt purposes. This provision may be applicable if MTDC's governmental activities qualify, but the analysis is fact-intensive and depends on the specific exemption categories enumerated in the statute.

If the leasehold improvements are not exempt from real property taxation, the Project will be assessed and subject to New York City real property taxes at applicable rates. For a large mixed-use development in the Hudson Yards area, annual real property taxes could be substantial — potentially in the range of $15,000,000 to $25,000,000 or more per year at stabilization, depending on assessed value and applicable tax rates.

PILOT Arrangements. In many large-scale commercial developments in New York City, particularly those involving government-owned land, the parties enter into a Payment in Lieu of Taxes ("PILOT") agreement under which the developer or lessee makes payments to the city in lieu of real property taxes, often at reduced rates or on a phased schedule. PILOT agreements are common in developments sponsored by NYCEDC and other city agencies.

We recommend that the deal team coordinate with Marcus Jennings (MTDC Vice President, Real Estate Development) and Connor McBride (Project Director) to determine whether the Ground Lease contains PILOT provisions or whether a separate PILOT agreement with the City of New York is contemplated. If a PILOT agreement is in place or can be negotiated, it could significantly reduce the Project's real property tax burden and improve the economics of the development.

Tax Abatement Programs. In addition to PILOT arrangements, large commercial developments in New York City may qualify for tax abatement programs such as the Industrial and Commercial Abatement Program ("ICAP") under RPTL § 489. ICAP provides a phased abatement of the increase in assessed value attributable to eligible commercial and industrial construction, renovation, or conversion. Eligibility, abatement percentages, and abatement periods vary based on the type of project and its location. We recommend that Raymond Cho of Hargrove & Linden be consulted regarding ICAP eligibility and any other zoning-related tax incentive programs that may be available.

Conclusion. The real property tax treatment of the Project is a significant open issue with potentially substantial financial implications. We flag this as a high-priority item requiring coordination among the MTDC development team, NYCEDC, the deal team, and land-use counsel. Definitive resolution of the real property tax question should be achieved before closing.

C. Mortgage Recording Tax

New York State imposes a mortgage recording tax ("MRT") under Tax Law § 253 on the recording of a mortgage on real property located in New York. New York City adds an additional local component. For commercial mortgages on real property located in New York City, the combined state and local MRT rate is 2.80% of the principal amount of the mortgage debt (comprising a basic tax of 0.50%, an additional tax of 0.25%, a special additional tax of 0.25%, and a New York City component of 1.80%).

The MRT exposure on the senior mortgage loan and the mezzanine loan is as follows:

• Senior mortgage loan: $475,000,000 × 2.80% = $13,300,000

• Mezzanine loan (if separately recorded as a mortgage): $200,000,000 × 2.80% = $5,600,000

• Total potential MRT exposure: $18,900,000

We note that the mezzanine loan is typically secured by a pledge of membership interests (a UCC security interest) rather than a mortgage on real property. If the mezzanine loan is secured solely by a pledge and no mortgage is recorded with respect to the mezzanine debt, MRT would apply only to the senior mortgage loan ($13,300,000). However, in some transactions, lenders require the recording of a mezzanine mortgage or a "consolidated, restated, and amended" mortgage that encompasses both the senior and mezzanine tranches. The precise MRT exposure will depend on the structuring of the security instruments, which should be confirmed with the deal team and the lenders.

Government Instrumentality Exemption. Tax Law § 253(1-a) provides an exemption from MRT for mortgages executed by certain government entities and instrumentalities. The statute exempts "the state of New York or any of its agencies, instrumentalities, political subdivisions or public corporations." The question is whether this exemption extends to MTDC, which is an instrumentality of the State of Illinois (not New York), and to the SPEs, which are Delaware LLCs (not direct agencies of any state).

The statutory language of Section 253(1-a) is limited to "the state of New York or any of its agencies, instrumentalities, political subdivisions or public corporations." On its face, this language does not encompass instrumentalities of other states. However, the intergovernmental immunity doctrine may provide an independent basis for exemption, and the New York State Department of Taxation and Finance may take a broader view of the exemption in appropriate cases.

Even if MTDC itself were to qualify for the exemption as an out-of-state government instrumentality, a further question arises: the mortgagor on the senior mortgage loan is HYW Mortgage LLC, a Delaware limited liability company — not MTDC directly. The issue is whether the disregarded-entity status and government-instrumentality ownership of HYW Mortgage LLC is sufficient to claim the exemption. Under a "look-through" approach, the MRT exemption would apply because the mortgage is, in substance, being executed by MTDC (the disregarded entity being treated as nonexistent for tax purposes). However, the MRT provisions are administered by the county clerks and the city registers, who may apply a more formalistic approach and require the mortgagor to be the exempt entity itself.

We have reviewed available New York tax authority, advisory opinions, and county-level precedent on this question and have found limited direct guidance. The outcome is uncertain, and we believe it warrants a formal advisory opinion request to the New York State Department of Taxation and Finance.

Financial Impact. If the MRT exemption is available, the potential savings are up to $18,900,000 (or $13,300,000 if the exemption applies only to the senior mortgage and the mezzanine loan is not separately recorded as a mortgage). These are significant sums that would materially reduce closing costs. If the exemption is not available, the MRT must be budgeted as a closing cost and funded from Project sources.

Recommendations:

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY–CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
TO: Douglas Fairchild, Partner, Corporate/Real Estate Department Angela Fontaine, Senior Associate, Corporate/Real Estate Department Grace Nakamura, Associate, Corporate/Real Estate Department
FROM: Sylvia Hartwell, Partner, Tax Department
DATE: February 25, 2025
RE: Hudson Yards West — Tax Analysis of SPE Structure, Government Instrumentality Status, Ground Lease Treatment, and State/Local Tax Considerations
Matter No.: 1031-00004
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I. EXECUTIVE SUMMARY
This memorandum analyzes the federal, state, and local tax implications of the proposed dual–special purpose entity ("SPE") financing structure for the Hudson Yards West mixed-use transit-oriented development located at 450 West 34th Street, New York, New York 10001 (Block 729, Lots 1, 5, 12, and 15) (the "Project"). The total estimated Project cost is approximately $920,000,000, to be financed through a combination of (a) a $475,000,000 senior mortgage loan from Ironclad National Bank, N.A. ("Ironclad"), as administrative agent, (b) a $200,000,000 mezzanine loan from Granite Peak Capital Partners, LP ("Granite Peak"), (c) $200,000,000 in equity contributed by Metropolitan Transit Development Corp. ("MTDC"), and (d) a $45,000,000 infrastructure grant from the City of New York through the NYC Transit Infrastructure Grant Program (the "Transit Grant").
The proposed structure contemplates the formation of two Delaware limited liability companies: (i) Hudson Yards West Mortgage LLC (the "Mortgage Borrower"), which will hold the leasehold interest in the Project site and serve as the borrower under the senior mortgage loan, and (ii) Hudson Yards West Mezzanine LLC (the "Mezzanine Borrower"), which will serve as the sole member of the Mortgage Borrower and as the borrower under the mezzanine loan. Each of the Mortgage Borrower and the Mezzanine Borrower will be a single-member LLC, with the Mezzanine Borrower being wholly owned by MTDC directly and the Mortgage Borrower being wholly owned by the Mezzanine Borrower. The two-tier SPE stack is designed to satisfy lender requirements for bankruptcy remoteness, credit separation, and intercreditor separation while preserving MTDC's fundamental tax posture.
Our principal conclusions are as follows:
(a) MTDC's tax-exempt status as an Illinois government instrumentality is preserved through the SPE structure under Section 115 of the Internal Revenue Code of 1986, as amended (the "Code"), and applicable administrative and judicial authority. The interposition of the SPEs does not compromise this status, provided the conditions discussed herein are satisfied and maintained.
(b) Single-member LLC treatment as disregarded entities for federal income tax purposes is available under the default classification rules of Treasury Regulations Section 301.7701-3(b) and is recommended. No Form 8832 elections should be filed. Both SPEs will be treated as transparent for federal income tax purposes, with all items of income, deduction, gain, loss, and credit flowing through to MTDC.
(c) The ground lease structure creates a leasehold interest that is subject to specific federal, New York State, and New York City tax treatment. The ground lease should be respected as a bona fide lease (and not recharacterized as a deemed sale) for federal tax purposes.
(d) Delaware formation taxes and annual franchise taxes apply to the two Delaware LLCs, but Delaware does not impose income tax on the out-of-state real property income of these entities. The total annual Delaware tax cost is $600.
(e) New York State and New York City tax obligations arise from the SPEs' ownership of and activities related to New York real property. Although government instrumentality exemptions may apply to shield MTDC and the SPEs from corporate franchise tax, general corporation tax, and unincorporated business tax, significant transactional taxes — including mortgage recording tax, real property transfer tax, commercial rent tax, and sales and use tax — require careful analysis and, in several cases, affirmative application for available exemptions.
(f) Mortgage recording tax and real property transfer tax consequences at closing require immediate attention and budgeting. The combined mortgage recording tax exposure on $675,000,000 of recorded mortgage debt could reach $18,900,000 if no government instrumentality exemption is available. This is the single largest open tax issue on the transaction and warrants priority attention.
The estimated aggregate state and local tax exposure, assuming no exemptions are obtained, exceeds $30,000,000. If the exemptions discussed in this memorandum are successfully obtained, ongoing annual compliance costs can be reduced to under $1,000,000. We recommend prompt action on the five priority items identified in Section VIII.A of this memorandum.
II. BACKGROUND AND TRANSACTION OVERVIEW
A. Metropolitan Transit Development Corp. — Entity Profile
Metropolitan Transit Development Corp. ("MTDC") is an Illinois government instrumentality created by an act of the Illinois General Assembly, codified at 70 ILCS 3615/1.01 et seq. (the "Enabling Act"). MTDC was established for the purpose of promoting, developing, and managing transit-oriented development projects in furtherance of the public interest in efficient, integrated, and economically sustainable mass transit infrastructure and related commercial and residential development. MTDC is headquartered at 200 South Michigan Avenue, Suite 3100, Chicago, Illinois 60604, and has been assigned Employer Identification Number 36-2847501.
MTDC is a substantial public-purpose enterprise with significant financial resources and operational capacity. For the fiscal year ended December 31, 2024, MTDC reported operating revenue of approximately $1,120,000,000 and net assets of approximately $3,700,000,000. MTDC's real estate portfolio, which spans projects across eleven states, is valued at approximately $4,800,000,000 based on MTDC's most recent audited financial statements and independent appraisals. MTDC holds a credit rating of A– from Pinnacle Ratings Group (identifier PRG-MTDC-A-2024-1187), reflecting the organization's strong financial position, diversified revenue streams, and governmental backing.
MTDC's governance structure is established under the Enabling Act and provides for a board of directors appointed by the Governor of Illinois with the advice and consent of the Illinois Senate. The board is currently chaired by Margaret Kowalski. MTDC's executive management team includes David Harrington, Executive Director; Priya Subramanian, Chief Financial Officer; and Lydia Okafor, General Counsel. Each of these individuals has been involved in various aspects of the Project and may need to be consulted regarding certain of the open issues identified in this memorandum.
B. Project Description
The Project consists of a mixed-use transit-oriented development to be constructed on a leasehold interest in the Project site. The leasehold interest arises under a 99-year ground lease (the "Ground Lease") executed on June 1, 2020, between the New York City Economic Development Corporation ("NYCEDC"), as fee owner and ground lessor, and MTDC, as ground lessee. The Ground Lease was recorded in the Office of the City Register of the City of New York at City Register File Number ("CRFN") 2020000198762, as reflected in the Automated City Register Information System ("ACRIS") maintained by the New York City Department of Finance.
The Project site comprises the parcels identified as Block 729, Lots 1, 5, 12, and 15, on the Tax Map of the Borough of Manhattan, City of New York, situated at 450 West 34th Street, New York, New York 10001, in the Hudson Yards area of the West Side of Manhattan. The Project site is located within a special zoning district (the Hudson Yards Special District) and was the subject of Uniform Land Use Review Procedure ("ULURP") proceedings. The ULURP application (Application No. C 230415 ZSM) was approved by the New York City Planning Commission on September 12, 2023, and ratified by the New York City Council on October 25, 2023. The ULURP approvals authorize the development of a mixed-use building containing approximately 1,200,000 gross square feet, consisting of office space, retail space, residential units (including a mandatory affordable housing component), transit infrastructure improvements, and associated parking and amenity areas.
Construction of the Project will be performed by Cobalt Construction Group, Inc. ("Cobalt" or "CCG") under a guaranteed maximum price ("GMP") construction contract designated CCG-HYW-2025-001 (the "GMP Contract"). The GMP under the construction contract is $412,000,000. Substantial completion of the Project is projected for December 15, 2027, with the first temporary certificate of occupancy ("TCO") projected for March 15, 2028. The GMP Contract was negotiated at arm's length and reflects prevailing market pricing for construction of this type in Manhattan.
The Project is expected to generate rental income from office, retail, and residential tenants upon stabilization, as well as ancillary income from parking, signage, and transit-related operations. The development also furthers MTDC's core governmental mission of transit infrastructure development and the creation of transit-oriented communities, including the provision of affordable housing and the improvement of public transit access points.
C. Proposed SPE Structure
The proposed financing structure calls for a two-tier SPE stack, organized as follows:
Tier 1 — MTDC to Mezzanine Borrower: MTDC, as the ultimate parent and sole source of equity capital, will form Hudson Yards West Mezzanine LLC ("HYW Mezzanine LLC" or the "Mezzanine Borrower") as a Delaware limited liability company. MTDC will be the sole member of HYW Mezzanine LLC. HYW Mezzanine LLC will serve as the borrower under the $200,000,000 mezzanine loan from Granite Peak Capital Partners, LP. The mezzanine loan bears a fixed interest rate of 11.50% per annum and is secured by a pledge of HYW Mezzanine LLC's membership interest in the Mortgage Borrower (described below).
Tier 2 — Mezzanine Borrower to Mortgage Borrower: HYW Mezzanine LLC will, in turn, form Hudson Yards West Mortgage LLC ("HYW Mortgage LLC" or the "Mortgage Borrower") as a Delaware limited liability company. HYW Mezzanine LLC will be the sole member of HYW Mortgage LLC. HYW Mortgage LLC will hold the leasehold interest in the Project site (either through a direct assignment of the Ground Lease from MTDC or through a sublease or other appropriate conveyance mechanism to be determined in consultation with the deal team), will serve as the borrower under the $475,000,000 senior mortgage loan from Ironclad National Bank, N.A. (as administrative agent for the senior lending syndicate), and will be the entity that enters into the GMP Contract with Cobalt for construction of the Project. The senior mortgage loan bears interest at Term SOFR plus 425 basis points (with a 1.00% SOFR floor) and is secured by a first-priority leasehold mortgage on the Project site.
Both SPEs are to be newly formed entities; neither currently exists. Employer Identification Numbers will be obtained from the Internal Revenue Service upon formation. Each SPE will be organized under the Delaware Limited Liability Company Act, 6 Del. C. § 18-101 et seq., and will be qualified to do business in the State of New York as a foreign limited liability company.
The purpose of the two-tier SPE structure is to achieve bankruptcy remoteness, satisfy the structural and credit-separation requirements of the senior and mezzanine lenders, and provide clear delineation between the collateral packages supporting the senior debt (leasehold mortgage and assignment of rents and leases) and the mezzanine debt (pledge of membership interests). The SPE structure is a standard feature of institutional commercial real estate finance and is not intended to alter MTDC's fundamental tax posture. As discussed in detail in Section III below, the use of disregarded entities for this purpose is fully consistent with the preservation of MTDC's Section 115 exclusion from federal income tax and does not create any incremental federal tax liability.
III. FEDERAL TAX ANALYSIS
A. MTDC's Status as a Government Instrumentality — Section 115 and Related Authority
The threshold federal tax question in this transaction is whether MTDC qualifies for the income exclusion provided by Section 115(1) of the Code, and whether that exclusion is preserved when income is earned through the two disregarded-entity SPEs.
Section 115(1) of the Code provides that gross income does not include "income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia." The purpose of Section 115 is to ensure that the federal government does not tax the income of state and local governmental entities, consistent with the principle of intergovernmental tax immunity. Unlike the exemption provisions of Section 501 (which require an application and determination letter process), the Section 115 exclusion is self-executing — a qualifying entity simply excludes qualifying income from its gross income. No recognition letter from the IRS is required, though the entity must be prepared to demonstrate its qualification if challenged.
Qualification as a Government Instrumentality. To determine whether MTDC qualifies as a "political subdivision" or "instrumentality" of the State of Illinois, we apply the six-factor test set forth in Revenue Ruling 57-128, 1957-1 C.B. 311. Under this test, the following factors are considered:
(i) Sovereign powers. Whether the entity possesses sovereign powers such as the power of eminent domain, the police power, or the power to tax. MTDC possesses the power of eminent domain under its Enabling Act and has the authority to issue bonds backed by the full faith and credit of the State of Illinois, which are hallmarks of sovereign power.
(ii) Designation by state statute. Whether the entity is designated by the state as an agency, instrumentality, or political subdivision. The Enabling Act expressly designates MTDC as an "instrumentality of the State of Illinois" and a "body politic and corporate" created for public purposes.
(iii) State control. Whether state officials control or have oversight over the entity. MTDC's board of directors is appointed by the Governor of Illinois with the advice and consent of the Illinois Senate. The Governor retains the power to remove board members for cause. MTDC is subject to audit by the Illinois Auditor General and must submit an annual report to the Illinois General Assembly.
(iv) State-created purpose. Whether the entity was created to carry out a governmental purpose. MTDC was created to promote, develop, and manage transit-oriented development projects in furtherance of the public interest. This is quintessentially a governmental purpose.
(v) Accountability. Whether the entity is financially accountable to the state. MTDC's financial statements are audited annually by an independent auditor selected by the Illinois Auditor General. MTDC is subject to the Illinois Freedom of Information Act and the Open Meetings Act.
(vi) Duration. Whether the entity has perpetual duration or exists for a limited governmental purpose. MTDC was created with indefinite duration under the Enabling Act and will continue to exist until dissolved by act of the Illinois General Assembly.
All six factors support the conclusion that MTDC is an instrumentality of the State of Illinois for purposes of Section 115. MTDC possesses sovereign powers, is expressly designated as a state instrumentality by statute, is subject to meaningful state control and accountability mechanisms, was created for a governmental purpose, and has perpetual duration. We are confident that MTDC satisfies the Revenue Ruling 57-128 test.
Income from an Essential Governmental Function. Section 115(1) requires that the income in question be derived from the "exercise of any essential governmental function." The income from the Hudson Yards West Project will consist primarily of rental income from office, retail, and residential tenants, as well as development fee income, parking revenue, and ancillary income. While the rental of commercial space is not inherently a "governmental function," the relevant inquiry is whether the income-generating activity is conducted in furtherance of an essential governmental function.
Revenue Ruling 77-261, 1977-2 C.B. 45, addressed the question of whether income earned by a state housing authority from the development and operation of public housing constituted income from an essential governmental function. The IRS concluded that it did, reasoning that the housing authority was created by the state to serve a public purpose (the provision of affordable housing), and the rental income generated by the housing projects was incidental to and inseparable from that governmental purpose.
The Hudson Yards West Project is directly within MTDC's statutory mandate. The Project is a transit-oriented development that includes the construction and improvement of public transit infrastructure (a core governmental function), the provision of affordable housing (an essential governmental function recognized in Revenue Ruling 77-261 and numerous subsequent rulings), and the promotion of economic development in an area designated for urban renewal and transit improvement. The commercial and market-rate residential components of the Project are integral to the financial viability of the transit and affordable housing components and are consistent with the mixed-use, mixed-income development model that MTDC was created to pursue. Accordingly, we conclude that the income generated by the Project constitutes income derived from the exercise of an essential governmental function within the meaning of Section 115(1).
"Accruing to" Requirement. The final requirement of Section 115(1) is that the income "accrue to" a state or political subdivision thereof. Because MTDC is an instrumentality of the State of Illinois, income that accrues to MTDC satisfies this requirement. As discussed in Section III.C below, the use of disregarded entities does not alter this analysis because income earned by a disregarded entity is treated as earned by its owner for federal tax purposes.
Conclusion. MTDC itself is not subject to federal income tax on income from the Hudson Yards West Project under Section 115(1) of the Code, provided that (i) the income accrues to MTDC (directly or through disregarded entities), (ii) the activities giving rise to the income remain within MTDC's governmental purpose, and (iii) MTDC continues to satisfy the Revenue Ruling 57-128 factors for treatment as a government instrumentality.
B. Entity Classification of the Delaware LLCs — Check-the-box Regulations
Under the entity classification regulations set forth in Treasury Regulations Section 301.7701-3(b), a domestic "eligible entity" — that is, a business entity that is not automatically classified as a corporation under Section 301.7701-2(b) — is classified by default based on its ownership structure. A domestic eligible entity with a single owner is classified by default as a disregarded entity. A domestic eligible entity with two or more owners is classified by default as a partnership.
A limited liability company formed under the Delaware Limited Liability Company Act is an "eligible entity" for purposes of the check-the-box regulations, as it is not listed among the entities treated as per se corporations under Treasury Regulations Section 301.7701-2(b)(1)–(8). Both HYW Mortgage LLC and HYW Mezzanine LLC will be domestic eligible entities with a single owner. HYW Mezzanine LLC will be owned solely by MTDC. HYW Mortgage LLC will be owned solely by HYW Mezzanine LLC. Accordingly, each entity is, by default, classified as a disregarded entity for federal income tax purposes.
We note that HYW Mortgage LLC's sole owner is HYW Mezzanine LLC, which is itself a disregarded entity owned by MTDC. Under Treasury Regulations Section 301.7701-2(c)(2)(i), if the owner of a disregarded entity is itself a disregarded entity, the first entity is treated as owned by the person that owns the chain of disregarded entities. Accordingly, HYW Mortgage LLC is treated as owned by MTDC for all federal income tax purposes.
Recommendation. We recommend that neither HYW Mortgage LLC nor HYW Mezzanine LLC file a Form 8832 (Entity Classification Election) with the Internal Revenue Service. By refraining from filing, the default disregarded-entity classification will apply automatically upon formation. Filing a Form 8832 to affirmatively elect disregarded-entity status is permissible but unnecessary and could introduce administrative complexity or risk of error. The default classification achieves the desired result.
Effect of Disregarded-Entity Classification. As disregarded entities, HYW Mortgage LLC and HYW Mezzanine LLC are treated as transparent for federal income tax purposes. All items of income, deduction, gain, loss, and credit attributable to the SPEs are treated as if earned or incurred directly by MTDC. The SPEs are not required to file federal income tax returns (Forms 1065 or 1120), and no separate taxpayer identification is required for income tax purposes (though EINs may be needed for other purposes, including employment tax, excise tax, and certain reporting obligations, as discussed below).
Importantly, the disregarded-entity classification for federal income tax purposes does not undermine the SPEs' status as separate legal entities under Delaware law or affect their bankruptcy-remoteness features. State-law limited liability protections, the separateness of the SPEs' assets and liabilities from those of MTDC, and the lender-required separateness covenants all remain fully effective notwithstanding the federal tax classification. The check-the-box regulations operate exclusively in the tax domain and do not alter the legal, contractual, or creditor-rights analysis.
Single-Member Restriction Caution. If, at any point, either SPE were to admit a second member, the default classification would automatically shift from disregarded entity to partnership. A partnership classification would require the filing of federal partnership returns (Form 1065) and the issuance of Schedules K-1. More importantly, the shift to partnership classification could raise questions about whether the income of the partnership "accrues to" MTDC for purposes of Section 115, particularly if the second member is a non-governmental entity. To prevent this outcome, we recommend that the operating agreements for both SPEs contain express restrictions prohibiting the admission of additional members without the prior written consent of MTDC's General Counsel and tax counsel. These restrictions should be drafted as fundamental provisions that cannot be amended without the consent of the lenders, consistent with standard SPE operating agreement practice. We will coordinate with Douglas Fairchild and Grace Nakamura on these provisions.
C. Preservation of Section 115 Exclusion Through Disregarded Entities
A critical question is whether the interposition of the two disregarded-entity SPEs between MTDC and the Project income jeopardizes MTDC's Section 115 exclusion. We conclude that it does not.
The analysis proceeds from the fundamental principle that a disregarded entity does not exist as a separate entity for federal income tax purposes. Income earned by a disregarded entity is treated as earned by its owner. Because both SPEs are disregarded entities owned (directly and indirectly) by MTDC, all income generated by the Project is treated as earned directly by MTDC for federal tax purposes. The "accruing to" requirement of Section 115(1) is therefore satisfied: the income accrues to MTDC, a government instrumentality of the State of Illinois.
This conclusion is supported by several private letter rulings and IRS guidance documents. In PLR 200727005, the IRS addressed a situation in which a state government entity formed a single-member LLC to hold and operate real estate. The IRS concluded that the income earned by the LLC was treated as earned by the state entity for Section 115 purposes and was therefore excluded from gross income. While private letter rulings may not be cited as precedent by other taxpayers under Section 6110(k)(3), they are indicative of the IRS's analytical approach and provide a useful gauge of IRS thinking on this issue. Similar conclusions have been reached in analogous rulings involving governmental instrumentalities that use disregarded-entity subsidiaries for real estate investment, infrastructure development, and other governmental purposes.
The IRS's analytical framework is straightforward. Because the check-the-box regulations treat a single-member LLC as nonexistent for federal income tax purposes, the income earned by the LLC is treated as if it were earned directly by the member. If that member is a Section 115 entity, the income retains its Section 115 character. The SPE structure does not introduce any intermediary "person" that could intercept the income or divert it from the governmental entity.
To preserve this result, the following conditions must be maintained:
(i) Single-member status must be maintained. As discussed above, the admission of a second member to either SPE would convert the entity from a disregarded entity to a partnership, potentially disrupting the Section 115 analysis.
(ii) Income must not be diverted to non-governmental purposes. All net income from the Project must accrue to MTDC and be used in furtherance of MTDC's governmental mandate. Distributions to non-governmental parties (other than arm's-length payments for goods and services, debt service, and similar ordinary-course expenditures) would raise questions about whether the income "accrues to" a governmental entity.
(iii) The Project must continue to serve MTDC's governmental mandate. If the character of the Project were to change such that it no longer served MTDC's transit-development and public-purpose mission, the "essential governmental function" requirement of Section 115(1) could be called into question.
Based on the facts as we understand them, all three conditions are currently satisfied and are expected to continue to be satisfied throughout the term of the Project. We recommend that the deal team monitor these conditions on an ongoing basis and consult with tax counsel before making any material changes to the SPE structure or the nature of the Project.
D. Unrelated Business Taxable Income (UBTI) Considerations
The unrelated business taxable income ("UBTI") provisions of the Code (Sections 511 through 514) impose a tax on the unrelated business income of certain tax-exempt entities, including organizations described in Section 501(c)(3) and, in some cases, state colleges and universities. A question arises as to whether MTDC, as a Section 115 government instrumentality that engages in commercial real estate activities financed with substantial debt, could be subject to the UBTI regime.
Section 511(a)(2)(B) of the Code provides that the UBTI tax applies to "any college or university which is an agency or instrumentality of any government or any political subdivision thereof, or which is owned or operated by a government or any political subdivision thereof, or by any agency or instrumentality of one or more governments or political subdivisions." This provision is narrowly targeted at governmental colleges and universities, not at government instrumentalities generally. MTDC is not a college or university, and therefore Section 511(a)(2)(B) does not apply.
More broadly, government instrumentalities that are excluded from gross income under Section 115 are not within the UBTI regime at all. The UBTI provisions apply to entities that are "exempt from taxation under this subtitle" by reason of specific exemption provisions (primarily Section 501). Section 115 operates differently — it provides an exclusion from gross income, not an exemption from tax. An entity whose income is excluded under Section 115 is simply not a taxpayer with respect to that income, and the UBTI provisions have no application.
This distinction is particularly relevant in the context of the debt-financed property rules of Section 514. Section 514 subjects certain exempt organizations to UBTI on income from "debt-financed property" — property acquired or improved with the proceeds of indebtedness. If Section 514 applied to MTDC, the $675,000,000 in mortgage and mezzanine debt used to finance the Project could create significant UBTI exposure. However, because MTDC is a Section 115 entity (not a Section 501 entity) and is not a governmental college or university within the scope of Section 511(a)(2)(B), Section 514 does not apply.
Conclusion. The UBTI provisions of Sections 511 through 514 do not apply to MTDC or the disregarded SPEs. The leveraged nature of the Project — $475,000,000 in senior mortgage debt and $200,000,000 in mezzanine debt — does not create UBTI exposure for MTDC. This is a meaningful advantage of MTDC's Section 115 status as compared to the treatment of tax-exempt organizations under Section 501(c)(3), which would face significant UBTI exposure on debt-financed real property income.
E. Federal Tax Treatment of Interest Payments
Interest paid on the senior mortgage loan and the mezzanine loan is, in principle, deductible by the borrower entities under Section 163(a) of the Code. However, because the borrower entities are disregarded and MTDC's income is excluded under Section 115, the deductions have no practical effect at the federal level. MTDC does not have taxable income against which to apply the deductions, and no federal tax benefit is derived from the interest payments.
With respect to withholding obligations, no federal withholding is anticipated on the interest payments. Both Ironclad National Bank, N.A. and Granite Peak Capital Partners, LP are domestic entities, and there is no requirement under the Code to withhold on interest payments to domestic payees (absent backup withholding requirements triggered by a failure to provide a correct taxpayer identification number, which is not expected to be an issue with institutional lenders).
Regarding information reporting, the question arises whether the SPEs or MTDC are required to file Forms 1099-INT with respect to the interest payments. Under the general reporting rules, any person engaged in a trade or business that makes payments of interest aggregating $600 or more during a calendar year must file a Form 1099-INT. However, exceptions apply for certain payments, including payments to corporations (which would cover Ironclad, a national banking association) and payments to entities that provide a Form W-9 certifying their exempt status from backup withholding. We note that disregarded entities may have separate reporting obligations under Treasury Regulations Section 301.7701-2(c)(2)(iv) for employment tax and excise tax purposes, but income tax reporting (including information reporting with respect to interest payments) follows through to MTDC as the owner of the disregarded entities. We recommend that the deal team coordinate with Sandra Okonkwo of Whitfield Albrecht to confirm the precise reporting obligations and ensure compliance.
F. Impact of the NYC Transit Infrastructure Grant ($45,000,000)
The $45,000,000 NYC Transit Infrastructure Grant represents a government-to-government transfer from the City of New York to MTDC, an instrumentality of the State of Illinois, for the purpose of funding transit infrastructure improvements associated with the Project. As a government-to-government transfer, the grant does not constitute gross income to MTDC for federal income tax purposes. Even if the grant were analyzed as a payment to a private party, it would be excludable under Section 115(1) as income accruing to a government instrumentality from the exercise of an essential governmental function.
For completeness, we note that Section 118 of the Code, which provides that contributions to the capital of a corporation are not included in gross income, is not technically applicable to this transaction. Section 118 applies to corporations, and while MTDC is a "body politic and corporate" under its Enabling Act, it is not a "corporation" within the meaning of Section 118. Moreover, Section 118 is unnecessary here because the grant is already excluded from MTDC's gross income under Section 115(1).
No federal tax consequence arises from the receipt of the Transit Grant by MTDC or the SPEs.
IV. FEDERAL TAX TREATMENT OF THE GROUND LEASE
A. Characterization of the Ground Lease
As described in Section II.B above, MTDC holds a leasehold interest in the Project site under the Ground Lease executed on June 1, 2020, with NYCEDC as fee owner and ground lessor. The Ground Lease has an initial term of 99 years, with no renewal options beyond the initial term. MTDC pays annual ground rent of $4,200,000, subject to CPI-based escalation every five years. Upon expiration or termination of the Ground Lease, all improvements revert to NYCEDC as ground lessor.
A threshold question for federal tax purposes is whether the Ground Lease should be characterized as a bona fide lease or recharacterized as a deemed sale (or financing arrangement). If the Ground Lease were recharacterized as a sale, MTDC (through the Mortgage Borrower) would be treated as the owner of the fee interest in the land, and the ground rent payments would be recharacterized as payments of principal and interest on a purchase-money obligation. This would have implications for depreciation, interest deductions, and gain or loss on disposition.
The IRS and the courts apply a multi-factor test to distinguish a lease from a sale or financing arrangement. The relevant factors include:
(i) Length of the lease term relative to the useful life of the property. A lease term that exhausts substantially all of the economic useful life of the property suggests a sale. Here, the Ground Lease term is 99 years, which is long but does not exhaust the useful life of land (which has an indefinite useful life). This factor is neutral to slightly favorable for lease treatment.
(ii) Presence and terms of renewal options. Options to renew at below-market rents suggest a sale. The Ground Lease does not contain renewal options. This factor supports lease treatment.
(iii) Whether the rent represents fair market rental value. Rent that is substantially below fair market value (particularly when combined with a nominal purchase option) suggests a sale. The $4,200,000 annual ground rent, subject to CPI escalation, appears to represent a reasonable market rent for the Ground Lease based on comparable ground lease transactions in the Hudson Yards area. This factor supports lease treatment.
(iv) Whether the lessee has an option to purchase the fee. A purchase option, especially at a nominal or below-market price, strongly suggests a sale. The Ground Lease does not grant MTDC a purchase option. This factor supports lease treatment.
(v) Reversion of improvements to the lessor. The fact that all improvements revert to NYCEDC upon expiration of the Ground Lease is consistent with lease treatment, as it confirms that NYCEDC retains the residual economic interest in the property.
(vi) Risk of loss and economic benefits. During the lease term, MTDC bears the risk of loss (through its obligations to maintain, insure, and repair the premises) and enjoys the economic benefits of the property (through rental income from subtenants). This is consistent with either a lease or a sale, but the reversion of the property to NYCEDC tips this factor toward lease treatment.
Conclusion. Applying the multi-factor test, we conclude that the Ground Lease should be respected as a bona fide lease for federal tax purposes. MTDC (through HYW Mortgage LLC, as disregarded entity) is the lessee and holds a leasehold interest, not a fee ownership interest, in the Project site. NYCEDC is the fee owner and retains the residual interest.
B. Deductibility of Ground Rent
Under Section 162(a)(3) of the Code, a taxpayer engaged in a trade or business is entitled to deduct "rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity." The $4,200,000 annual ground rent paid under the Ground Lease is deductible under this provision.
However, because MTDC's income is excluded under Section 115(1), the deduction is technically available but has no practical effect at the federal level. MTDC does not compute taxable income, and there is no federal tax liability against which to offset the deduction. The treatment of ground rent for New York State and City tax purposes is discussed separately in Section V below, where the deduction may have greater practical significance depending on the resolution of the exemption questions.
C. Leasehold Improvements and Depreciation
Improvements constructed by a lessee on leased land are depreciable by the lessee under the Modified Accelerated Cost Recovery System ("MACRS") provisions of Section 168 of the Code. The lessee's depreciable basis in leasehold improvements generally includes the cost of construction, which in this case is the $412,000,000 GMP under the construction contract with Cobalt, plus any additional soft costs, development costs, and pre-development expenditures capitalized into the cost of the improvements.
The classification of the Project's improvements for MACRS purposes will depend on the nature and use of the specific building components:
(i) Nonresidential real property. The office, retail, and commercial components of the building are classified as "nonresidential real property" under Section 168(e)(2)(B) and are depreciable over a 39-year recovery period using the straight-line method.
(ii) Residential rental property. If the residential rental component of the building qualifies as "residential rental property" under Section 168(e)(2)(A) — meaning that 80% or more of the gross rental income from the residential component is from dwelling units — that component is depreciable over a 27.5-year recovery period. Whether the residential component meets this threshold will depend on the mix of market-rate and affordable units and the treatment of any non-residential uses within the residential portion of the building.
(iii) Personal property and land improvements. Certain components of the building (such as movable partitions, decorative lighting, certain flooring, landscaping, sidewalks, parking structures, and specialized mechanical systems) may qualify as personal property or land improvements with shorter MACRS recovery periods (5, 7, or 15 years, as applicable). Identification and segregation of these components requires a detailed cost segregation study.
Cost Segregation Study. We recommend that MTDC engage a qualified cost segregation firm to perform a cost segregation study of the Project upon substantial completion. A cost segregation study would analyze the engineering and construction specifications of the building and allocate the total cost among the applicable MACRS asset classes. While the depreciation deductions have no practical federal tax consequence to MTDC under Section 115 (for the same reasons discussed above with respect to interest deductions and ground rent), the cost segregation analysis may be relevant for several ancillary purposes: (a) New York State and City tax analysis, if any taxable component of the Project is identified; (b) lender underwriting and financial modeling, which typically incorporates depreciation in cash flow projections; and (c) financial statement presentation under GASB or other applicable accounting standards.
Treatment at Lease Expiration or Termination. Upon expiration or termination of the Ground Lease, the improvements constructed by MTDC will revert to NYCEDC as ground lessor. Under Section 109 of the Code, a lessor is not required to include in gross income the value of improvements made by a lessee that revert to the lessor upon the termination of the lease. Under Section 1019, the lessor does not receive an increase in basis in the property by reason of such improvements. These provisions primarily affect NYCEDC (as fee owner and ground lessor) rather than MTDC or the SPEs. MTDC's remaining depreciable basis in the improvements at the time of lease termination would give rise to a loss deduction, but again, this deduction would have no practical federal tax effect for a Section 115 entity.
D. Mortgage Recording and Financing Considerations
The senior mortgage loan from Ironclad and the mezzanine loan from Granite Peak are structured as bona fide debt obligations on arm's-length terms with unrelated institutional lenders. Under standard debt-equity analysis principles (see, e.g., Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972)), the following factors support debt characterization: (i) the loans bear a fixed or determinable maturity date; (ii) the interest rates (Term SOFR + 425 bps for the senior loan; 11.50% fixed for the mezzanine loan) are consistent with market rates for comparable commercial real estate loans; (iii) the lenders have no equity participation, profit-sharing, or management rights in the Project; (iv) the loans are documented with standard loan agreements, promissory notes, and security instruments; (v) the lenders are unrelated, arm's-length institutional parties; and (vi) there is a reasonable expectation of repayment from Project cash flows. Accordingly, the mortgage and mezzanine loans are properly characterized as debt, not equity, for federal tax purposes.
No federal tax issue arises from recording the mortgage on a leasehold interest (as opposed to a fee interest). Leasehold mortgages are a well-established feature of commercial real estate finance and are treated as debt instruments for federal tax purposes in the same manner as fee mortgages.
V. NEW YORK STATE AND CITY TAX CONSIDERATIONS
A. New York State Tax Treatment of MTDC and the SPEs
1. Corporate Franchise Tax (Article 9-A). New York State imposes a corporate franchise tax under Article 9-A of the Tax Law on corporations and certain other entities that are "doing business, employing capital, owning or leasing property, or maintaining an office" in New York. Tax Law § 209.1. The tax is imposed on the greater of several alternative bases, including a tax on business income (allocated to New York), a tax on capital, and a fixed dollar minimum.
The initial question is whether MTDC, as an out-of-state government instrumentality, is subject to the Article 9-A franchise tax by reason of its ownership of real property and conduct of development activities in New York. Government entities are generally exempt from the New York corporate franchise tax. Tax Law § 209.4 excludes from the definition of "taxpayer" any entity that is "exempt from taxation under this article by any other provision of law." While no single provision of the Tax Law expressly exempts out-of-state government instrumentalities by name, the New York State Department of Taxation and Finance has consistently taken the position — articulated in various Technical Services Bureau Memoranda ("TSB-M") and advisory opinions — that government entities and their instrumentalities are not subject to Article 9-A franchise tax. This position is grounded in the principle of intergovernmental tax immunity and in the recognition that government instrumentalities are not "corporations" subject to the franchise tax within the meaning of Tax Law § 209.
With respect to the disregarded Delaware LLCs, New York generally follows the federal check-the-box classification for purposes of the corporate franchise tax. Single-member LLCs that are disregarded for federal income tax purposes are also disregarded for New York State franchise tax purposes, and their income and activities are attributed to the single member. Accordingly, the income and activities of HYW Mortgage LLC and HYW Mezzanine LLC would be attributed to MTDC for Article 9-A purposes.
Conclusion. MTDC and the disregarded SPEs are not subject to Article 9-A corporate franchise tax. MTDC's status as a government instrumentality provides an exemption from the tax, and the disregarded-entity classification of the SPEs ensures that the exemption flows through the SPE structure.
2. LLC Filing Fee — Tax Law § 658(c). Notwithstanding the disregarded-entity classification for income tax purposes, New York State imposes an annual filing fee on limited liability companies and disregarded entities that have New York-source gross income. Tax Law § 658(c). This filing fee applies regardless of whether the LLC is subject to the franchise tax or income tax — it is a separate fee based on the LLC's New York-source gross income.
HYW Mortgage LLC and HYW Mezzanine LLC will each have New York-source gross income by reason of the Project. The annual filing fee is calculated on a tiered basis, ranging from $25 for entities with New York-source gross income of $100,000 or less to $4,500 for entities with New York-source gross income exceeding $25,000,000. Given that the Project is expected to generate gross rental income significantly in excess of $25,000,000 annually at stabilization, both HYW Mortgage LLC and HYW Mezzanine LLC will likely fall into the highest tier.
The total annual New York LLC filing fee for the two entities is estimated at $9,000 per year ($4,500 per entity). The filing is made on Form IT-204-LL, which is due on or before March 15 of each year.
We note that there does not appear to be an exemption from the LLC filing fee for LLCs owned by government instrumentalities. The fee is a relatively modest compliance cost and should be budgeted as an ongoing annual obligation.
3. Real Property Gains Tax (Article 31-B). For completeness, we note that New York formerly imposed a real property gains tax under Article 31-B of the Tax Law on certain transfers of real property with consideration exceeding $1,000,000. This tax was repealed effective for transfers occurring on or after June 15, 1996. The real property gains tax is therefore not applicable to the transactions contemplated in connection with the Project.
B. New York City Tax Considerations
1. General Corporation Tax / Unincorporated Business Tax. General Corporation Tax. New York City imposes a general corporation tax ("GCT") under Title 11, Chapter 6 of the New York City Administrative Code on corporations that are "doing business, employing capital, owning or leasing property in a corporate or organized capacity, or maintaining an office" in New York City. Admin. Code § 11-603. As a government instrumentality, MTDC is exempt from the GCT under the same intergovernmental immunity principles that apply at the state level. The disregarded-entity classification of the SPEs ensures that the GCT analysis looks through the SPEs to MTDC as the ultimate owner. Because MTDC is exempt, no GCT liability arises.
Unincorporated Business Tax. New York City also imposes an unincorporated business tax ("UBT") on the "unincorporated business taxable income" of individuals, partnerships, and other unincorporated entities that carry on a "trade, business, profession or occupation" wholly or partly within New York City. Admin. Code § 11-502 et seq. The UBT rate is 4% of taxable income, with certain deductions and exemptions.
The application of the UBT to the SPEs requires analysis. HYW Mortgage LLC and HYW Mezzanine LLC are single-member LLCs that are disregarded for federal and New York income tax purposes. As disregarded entities, they are not separate "persons" for UBT purposes, and their activities are attributed to MTDC. The question is whether MTDC is subject to the UBT with respect to these activities.
Government instrumentalities are not "individuals" or "unincorporated businesses" within the meaning of the UBT provisions. The UBT is designed to apply to private-sector unincorporated businesses — sole proprietorships, partnerships, and similar enterprises — that compete with incorporated businesses subject to the GCT. Government entities are categorically outside this framework. The New York City Department of Finance has recognized this principle in various rulings and advisory opinions addressing the treatment of government entities and their instrumentalities under the UBT.
Moreover, even if MTDC's activities could theoretically be characterized as an "unincorporated business," the UBT provides an exemption for entities that are exempt from federal income tax. While MTDC's income is excluded under Section 115 (rather than exempted under Section 501), the underlying principle is the same — MTDC is a tax-exempt government entity, and subjecting it to the UBT would be inconsistent with the intergovernmental immunity doctrine.
Conclusion. No GCT or UBT liability is anticipated for MTDC or the disregarded SPEs. We recommend that MTDC maintain documentation of its government instrumentality status to support its exempt position in the event of an inquiry from the New York City Department of Finance.
2. Commercial Rent Tax (CRT). New York City imposes a commercial rent tax ("CRT") on tenants of commercial premises located in Manhattan south of 96th Street (the "CRT zone") whose annual commercial rent exceeds the applicable threshold, which is currently $250,000. Admin. Code § 11-701 et seq. The CRT is imposed on the tenant (not the landlord) and is calculated as a percentage of the tenant's "base rent" (total rent less a 35% base rent reduction) in excess of the threshold amount.
MTDC, through HYW Mortgage LLC (as disregarded entity), pays annual ground rent of $4,200,000 to NYCEDC under the Ground Lease. The Project site is located at 450 West 34th Street, which is within the CRT zone. The ground rent of $4,200,000 substantially exceeds the $250,000 threshold. Accordingly, the CRT would apply unless an exemption is available.
Government Instrumentality Exemption. Admin. Code § 11-704(a) provides certain exemptions from the CRT. We must analyze whether MTDC, as an out-of-state government instrumentality, qualifies for any of these exemptions. The CRT exemptions include exemptions for tenants that are government agencies, but the scope of this exemption — particularly as applied to instrumentalities of other states — requires careful review. The CRT provisions were designed primarily to tax commercial tenants in Manhattan, and the exemption for government tenants may be limited to agencies of the City, State, and federal governments.
If MTDC qualifies for the government instrumentality exemption, it should apply for a CRT exemption certificate from the New York City Department of Finance. If the exemption is not available, the CRT liability would be calculated as follows:
• Gross rent: $4,200,000
• Base rent reduction (35%): ($1,470,000)
• Adjusted rent: $2,730,000
• Less threshold ($250,000): $2,480,000
• CRT rate: 3.9%
• Estimated annual CRT: approximately $96,720
While the estimated annual CRT liability of approximately $96,720 is not a dealbreaker, it is a recurring cost that should be budgeted if the exemption is unavailable. We recommend that MTDC pursue the exemption application as a priority item.
Recommendation. Prepare and file a CRT exemption application with the NYC Department of Finance. If the exemption is denied, budget approximately $96,720 per year (subject to increase as ground rent escalates with CPI adjustments) as an ongoing operating cost.
3. Real Property Tax Considerations. Real property tax is one of the most significant fiscal considerations for the Project, and the resolution of the real property tax question will have a material impact on the Project's economics.
The Project site is on land owned in fee by NYCEDC, an instrumentality of the City of New York. Under Section 412 of the Real Property Tax Law ("RPTL"), property owned by a municipal corporation (including a city agency or instrumentality) and used for a public purpose is exempt from real property taxation. NYCEDC's fee ownership of the land therefore provides a basis for exemption of the land from real property taxation.
However, the treatment of the leasehold improvements constructed by MTDC on the NYCEDC-owned land is more complex. Under RPTL § 412, the exemption applies to property "owned by" a municipal corporation. The leasehold improvements will be owned by MTDC (through the disregarded SPEs), not by NYCEDC. While MTDC is a government instrumentality, it is an instrumentality of the State of Illinois, not of the City of New York or the State of New York. RPTL § 412 may not extend to property owned by an out-of-state government instrumentality.
RPTL § 420 provides exemptions for real property owned by certain nonprofit organizations and used for specified exempt purposes. This provision may be applicable if MTDC's governmental activities qualify, but the analysis is fact-intensive and depends on the specific exemption categories enumerated in the statute.
If the leasehold improvements are not exempt from real property taxation, the Project will be assessed and subject to New York City real property taxes at applicable rates. For a large mixed-use development in the Hudson Yards area, annual real property taxes could be substantial — potentially in the range of $15,000,000 to $25,000,000 or more per year at stabilization, depending on assessed value and applicable tax rates.
PILOT Arrangements. In many large-scale commercial developments in New York City, particularly those involving government-owned land, the parties enter into a Payment in Lieu of Taxes ("PILOT") agreement under which the developer or lessee makes payments to the city in lieu of real property taxes, often at reduced rates or on a phased schedule. PILOT agreements are common in developments sponsored by NYCEDC and other city agencies.
We recommend that the deal team coordinate with Marcus Jennings (MTDC Vice President, Real Estate Development) and Connor McBride (Project Director) to determine whether the Ground Lease contains PILOT provisions or whether a separate PILOT agreement with the City of New York is contemplated. If a PILOT agreement is in place or can be negotiated, it could significantly reduce the Project's real property tax burden and improve the economics of the development.
Tax Abatement Programs. In addition to PILOT arrangements, large commercial developments in New York City may qualify for tax abatement programs such as the Industrial and Commercial Abatement Program ("ICAP") under RPTL § 489. ICAP provides a phased abatement of the increase in assessed value attributable to eligible commercial and industrial construction, renovation, or conversion. Eligibility, abatement percentages, and abatement periods vary based on the type of project and its location. We recommend that Raymond Cho of Hargrove & Linden be consulted regarding ICAP eligibility and any other zoning-related tax incentive programs that may be available.
Conclusion. The real property tax treatment of the Project is a significant open issue with potentially substantial financial implications. We flag this as a high-priority item requiring coordination among the MTDC development team, NYCEDC, the deal team, and land-use counsel. Definitive resolution of the real property tax question should be achieved before closing.
C. Mortgage Recording Tax
New York State imposes a mortgage recording tax ("MRT") under Tax Law § 253 on the recording of a mortgage on real property located in New York. New York City adds an additional local component. For commercial mortgages on real property located in New York City, the combined state and local MRT rate is 2.80% of the principal amount of the mortgage debt (comprising a basic tax of 0.50%, an additional tax of 0.25%, a special additional tax of 0.25%, and a New York City component of 1.80%).
The MRT exposure on the senior mortgage loan and the mezzanine loan is as follows:
• Senior mortgage loan: $475,000,000 × 2.80% = $13,300,000
• Mezzanine loan (if separately recorded as a mortgage): $200,000,000 × 2.80% = $5,600,000
• Total potential MRT exposure: $18,900,000
We note that the mezzanine loan is typically secured by a pledge of membership interests (a UCC security interest) rather than a mortgage on real property. If the mezzanine loan is secured solely by a pledge and no mortgage is recorded with respect to the mezzanine debt, MRT would apply only to the senior mortgage loan ($13,300,000). However, in some transactions, lenders require the recording of a mezzanine mortgage or a "consolidated, restated, and amended" mortgage that encompasses both the senior and mezzanine tranches. The precise MRT exposure will depend on the structuring of the security instruments, which should be confirmed with the deal team and the lenders.
Government Instrumentality Exemption. Tax Law § 253(1-a) provides an exemption from MRT for mortgages executed by certain government entities and instrumentalities. The statute exempts "the state of New York or any of its agencies, instrumentalities, political subdivisions or public corporations." The question is whether this exemption extends to MTDC, which is an instrumentality of the State of Illinois (not New York), and to the SPEs, which are Delaware LLCs (not direct agencies of any state).
The statutory language of Section 253(1-a) is limited to "the state of New York or any of its agencies, instrumentalities, political subdivisions or public corporations." On its face, this language does not encompass instrumentalities of other states. However, the intergovernmental immunity doctrine may provide an independent basis for exemption, and the New York State Department of Taxation and Finance may take a broader view of the exemption in appropriate cases.
Even if MTDC itself were to qualify for the exemption as an out-of-state government instrumentality, a further question arises: the mortgagor on the senior mortgage loan is HYW Mortgage LLC, a Delaware limited liability company — not MTDC directly. The issue is whether the disregarded-entity status and government-instrumentality ownership of HYW Mortgage LLC is sufficient to claim the exemption. Under a "look-through" approach, the MRT exemption would apply because the mortgage is, in substance, being executed by MTDC (the disregarded entity being treated as nonexistent for tax purposes). However, the MRT provisions are administered by the county clerks and the city registers, who may apply a more formalistic approach and require the mortgagor to be the exempt entity itself.
We have reviewed available New York tax authority, advisory opinions, and county-level precedent on this question and have found limited direct guidance. The outcome is uncertain, and we believe it warrants a formal advisory opinion request to the New York State Department of Taxation and Finance.
Financial Impact. If the MRT exemption is available, the potential savings are up to $18,900,000 (or $13,300,000 if the exemption applies only to the senior mortgage and the mezzanine loan is not separately recorded as a mortgage). These are significant sums that would materially reduce closing costs. If the exemption is not available, the MRT must be budgeted as a closing cost and funded from Project sources.
Recommendations:
(i

MEMORANDUM

I. EXECUTIVE SUMMARY

II. BACKGROUND AND TRANSACTION OVERVIEW

III. FEDERAL TAX ANALYSIS

IV. FEDERAL TAX TREATMENT OF THE GROUND LEASE

V. NEW YORK STATE AND CITY TAX CONSIDERATIONS

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