Revitalize and Save: Federal Rehabilitation Tax Credit
Getting a blank canvas property in city centers is harder and harder to come by for developers. More often than not the city’s infrastructure is already well established, and instead of the “out with the old, in with the new” mentality, governments are looking to developers to utilize and restore older buildings in order to keep the small-town historic feel while still breathing new life into older communities.
With that desire in mind, the government has incentivized developers and investors to revitalize and save instead of remove and replace by establishing the Federal Rehabilitation Tax Credit, otherwise known as the Historic Tax Credit (HTC) which provides a dollar-for-dollar reduction in income tax owed, up to as much as 20% of qualified rehabilitation expenditures (QREs) for income-producing historic buildings.
As with any tax credit, there are certain requirements that must be met.
Building and Rehabilitation Qualifications
First, the property must meet an HTC’s definition of a “building”. It must (1) be an enclosed structure usually covered by a roof, and (2) be depreciable. Depreciable buildings commonly include commercial or residential rental buildings, including, but not limited to, apartments, hotels, office buildings, warehouses, distribution facilities, sports facilities or any combination of the above.
Second, in order for a building to qualify for an HTC, the building must be certified by the National Park Service (NPS) as either (1) a building that contributes to the historic significance of a registered historic district, or (2) a building that is listed in the National Register of Historic Places.
Third, for the rehabilitation project to qualify for an HTC, the QREs incurred during the 24-month period ending in the taxable year in which the building is placed into service and usable for its particular purpose must exceed the greater of either $5,000 or the cost of acquiring the building prior to renovation.
Finally, the rehabilitation must follow the Secretary of the Interior’s standard for rehabilitation. This includes, but is not limited to, the preservation of the historic character and distinctive features, repairment of deteriorated historic features and if structures or decor are too dilapidated or deteriorated to save, comparable color, texture and other visual qualities of the new construction must match the historic nature of the building so as to not impair its integrity.
What are QREs?
QREs are development costs in connection with the renovation, restoration or reconstruction of a qualified building. QREs directly relate to the size of an HTC for a particular project, given that an HTC equals up to 20% of all QREs incurred within the 24-month window of the rehabilitation process.
For example, if the QREs total $250,000 over the course of 24 months prior to the building being put into service, the individual/entity’s federal income liability would be reduced by $50,000. ($250,000 x 20% = $50,000)
QREs include repairs or replacement of structural components of a building, i.e. walls, partitions, floors, ceilings, windows and doors, chimneys, heating and cooling systems, plumbing, and also can include architectural fees, design fees, engineering fees, construction management costs and reasonable developer fees.
QREs do not include items like demolition and enlargement costs, building acquisition costs, parking lots, site improvements and landscaping, tax exempt use of the property and personal property.
Who Can Claim an HTC?
An HTC is available to the taxpayer(s) or the entity who holds title when the QREs are incurred and placed into service. The credit may also be passed along to long-term tenants by a landlord of a property that incurs QREs and otherwise qualifies for an HTC.
Risk vs. Reward
While when claimed properly the credit is advantageous to developers and investors, it is important to understand that in order to keep the credit from being recaptured later, particular rules must be followed. For example, developers and investors risk having to repay an HTC if any of the following occur: (1) change in ownership occurs prior to the building being owned for five years, (2) additional rehabilitation occurs that does not meet NPS standards, (3) the building goes out of service, is foreclosed on or sold during the first five years, (4) over 50% of the building is leased to a tax-exempt entity, or (5) if building is converted to personal use.
Overall, an HTC is a valuable federal income tax credit that when utilized effectively, can significantly reduce cost, increase the economic viability of a development for developers and investors, and revitalize your community without harming its unique historic integrity. If you are looking to take advantage of an HTC, have your financial and legal advisors analyze if the project size and purpose qualifies for an HTC and would make economic sense given its requirements.