Federal Historic Tax Credit Aids Adaptive Reuse Developers
For adaptive reuse projects involving historic buildings, developers often tap into a federal tax incentive program known as the historic rehabilitation tax credit. This program generates a credit that directly reduces taxes rather than offering a tax deduction such as depreciation, which reduces taxable income.
The credit is available for all types of income-producing properties and is flexible: If a property originally was used as a hotel, it can find new life as an office building or multifamily project.
The amount of the tax credit issued through the program is either 10 percent or 20 percent of eligible costs, depending on a building's age and whether it is located in a historic district or on the National Register of Historic Places.
The eligible costs include both equipment and material costs and professional fees necessary to complete the rehabilitation. Costs that do not qualify toward the credit include: acquisition of the land and building; interest carried on all of the acquisition costs; items outside the building walls, such as site improvements, landscaping, and grading; personal property, such as furnishings or appliances; and an enlargement of a historic building.
The Internal Revenue Service and the National Park Service dually administer the credit. The IRS determines various tax rules, such as what costs generate credits. The NPS reviews compliance with the architectural standards and issues certificates of conformance.
Each project typically is required to undergo a three-part process. First, the NPS determines if a building qualifies for the credit. Second, it approves rehabilitation plans and specifications that comply with the architectural standards. Finally, it determines if the completed rehabilitation accurately maintains the building's history.
Rather than deal directly with the NPS, developers submit forms to state historic preservation officers. The state officers provide preliminary approval of each part, then forward the documents to the NPS along with their recommendations. The NPS makes the final decision. Experienced developers warn against relying on preliminary state approvals.
After the rehabilitation is completed, the entire credit amount is available to reduce taxes. However, property owners sometimes find that they cannot realize the entire credit amount simply due to the amount of their tax liability or by restrictions imposed by other areas of the tax law, such as passive activities, alternative minimum tax, and at-risk rules.
Accordingly, some property owners opt to sell the credits to a third party not subject to these limitations. The proceeds of the tax credit sale serve as project equity and reduce the required mortgage as well as fund the developer's profit. The credits accrue only to property owners, so these transactions are structured as partnerships with credit purchasers.
A five-year compliance rule requires that historic buildings cannot be transferred nor can any additional construction work be performed that adversely would affect their historic integrity.
If compliance is not achieved, a portion of the credit must be recaptured, or returned, to the government. The portion subject to recapture is reduced 20 percent per year over the five-year period.
Also, to prevent owners from receiving a double tax benefit, the depreciable base of the building must be reduced by the amount of the credit generated, effectively reducing the overall amount of depreciation that would otherwise be deducted on the tax return.
One of the latest trends in historic rehabilitation finance is the addition of a state credit to the subsidy pool. State credits range from 5 percent to 25 percent of eligible costs. Eighteen states now offer credit as an additional financing subsidy. Each state program varies somewhat from the federal program. Approximately 23 percent of all historic rehabilitation projects use state tax incentives in addition to the federal credit. Also, 30 states have enacted legislation to permit local governments to abate property taxes on historic buildings.