Tax credits program

Implemented in 1978, this tax credits program aimed to curb the destruction of historic buildings by providing an enticement for developers and private investors to renovate, restore and reconstruct buildings deemed 'historic'. Since its conception, over 43,000 buildings have been revitalized into usable community spaces.Picture that charming retail storefront building that's in a prime location, right in the middle of your city's retail center. It's sorely in need of some love – in fact, a lot of love. Perhaps it may be more cost-effective for the building to be demolished and replaced with a more efficient, modern structure. But that's not necessarily always the case. Enter the Federal Preservation Tax Incentive Program. Why?

The historic tax credit, also called rehabilitation tax credit, entitles developers to a 20 percent tax credit on eligible tax credits.

  1. A building must be deemed historical to be eligible.
  2. Not all old buildings qualify for the tax credit. First, check the National Register. If it's listed there, you're good to go. Alternatively, you shouldn't have an issue if it's a contributing factor in a historic district. If the structure doesn't fall into either of these categories, you may be able to get it placed on the National Register or have the historic district expanded, but plan for that to take some time.
  3. Rehabilitation plans must be approved by the State Historic Preservation Office (SHPO).The second part of getting approval is having plans approved by the SHPO. Again, this can be challenging, as plans need to meet their requirements and expectations, both inside and out.
  4. The building’s rehabilitation needs to be considered substantial.What does the IRS officially deem as substantial? The cost of rehabilitation needs to exceed the original cost of the building. So applying this to an example, if a historic property is purchased for $160,000, the renovation costs need to exceed $160,000. Today’s rising cost of labor and raw materials coupled with the typically dilapidated state of historic buildings makes this often easily achievable.
  5. Developers will probably need a third-party investor. This requirement often catches people off-guard. Essentially, the tax credit can only be applied against the active income of a real estate professional. So for a developer to benefit, they will engage a C-corporation investor.
  6. Historic Boardwalk v. Commissioner of Internal Revenue has impacted how investor deals can be structured.In this lawsuit, the IRS successfully argued that an investor didn’t qualify for the tax credit because they did not have a significant risk of loss or reward. Therefore, for an investor to qualify for the tax credit, they need to have a real downside and a real upside.
  7. The building's title cannot be transferred for five years after completion.The tax credits that the IRS applies are subject to pro-rata recapture if the property changes ownership within five years. Therefore the original owner needs to hold a property for a minimum of five years after the rehabilitation is complete. This can become an issue for developers looking to condominium-ize a historic building.
  8. Nonprofits can be an issue.Typically, the IRS will not permit a nonprofit to be the owner or tenant of a building receiving the historic tax credit. However, there are some exceptions, so if this is a path you're looking to go down, it's strongly advised to consult a tax professional.
  9. You can access federal and state tax credits.That's right, there is more than one tax credit on offer. The federal tax credit is 20% of qualified rehabilitation expenses (QRE), while stats will have their offering. Check with your state to see what tax credit applies.
  10. There are specific expenses that qualify as a QRE.Costs that fall under the QRE are those from which the tax credit is drawn. They must be directly associated with the rehabilitation, such as hard costs of construction but also developer fees, architect fees, and other professional costs. What is not included is any work outside of the property, expansion costs, or the acquisition price.
  11. You will need to engage a bridge lender.

 

Cost and Risks

 

Unless you have a stockpile of cash, you will need a bridge lender who is comfortable assuming the risk of a project before the SHPO approves it and the rehabilitation is complete. At this time, the developer can refinance with a more traditional loan. Bridge lenders usually want a personal guarantee, or another property put up as collateral.

While getting historic tax credits is a long and arduous process, their potential monetary benefit can be huge and often make or break the profitability of a project. Those most successful at accessing them are experienced real estate developers with a team specialising in historic rehabilitations.