Prior to the passage of the Tax Cuts and Jobs Act (TCJA) in late 2017, the future of the Historic Tax Credit (HTC) for rehabilitating historic buildings was questionable. The HTC–also known as the federal rehabilitation credit–survived and remains a valuable tool for developers, even though it is slightly less beneficial than it was for projects completed before 2018.
The HTC program encourages private sector investment in the rehabilitation and reuse of certified historic buildings. Eligible buildings are those listed on the National Register of Historic Places or architecturally contributing to a National Register district.
To qualify for HTCs, a building also must be depreciable, so it must be income-producing or used in a trade or business. In addition, a “substantial” amount must be directed toward rehabilitation. This requirement is satisfied if the cost of rehabilitation exceeds the building’s pre-rehabilitation cost, i.e. the cost of the building doubles.
The program provides tax credits, equal to 20% of qualified rehabilitation expenditures (QREs), that the taxpayer can use to offset its federal tax liability on a dollar-for-dollar basis. The credit passes through to partners or shareholders if the building is held in a pass-through entity. QREs include, but are not limited to, costs related to the repair or replacement of items such as walls, ceilings, windows and floors. They also include air conditioning and heating systems and plumbing and electrical fixtures.
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Most often, developers offer HTCs on a discounted basis to third-party investors to raise equity funding for their projects and reduce the need for debt financing. In a traditional single-tier structure, the investor obtains a substantial interest (generally 99.9%) in a limited partnership (LP) or limited liability company (LLC) that owns the project and incurs the QREs. Alternatively, the developer owns the property and gives the LP or LLC a master lease. The LP or LLC obtains an interest in the developer, which incurs the QREs and transfers the credits to the LP or LLC.
Until 2018, the LP or LLC would receive the tax credits the year the rehabilitation project was completed. However, under the TCJA, HTCs generally are spread out over five years after completion, on a prorated basis. This, plus the reduced corporate tax rate, reduces the net present value of the credits.
Still worth considering
The five-year payout on HTCs likely will affect investors’ strategies, such as whether they are willing to make their entire investment upfront. However, even if investors’ interest does fade, developers may find that prorating the credits allows them to use the HTCs themselves to offset their own federal income taxes or to generate net operating losses to use in future tax years.
For more information, contact Kathy Jeziorski at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.