Converting Tax Incentives into Profitable Historic Rehabilitation Projects

By Goldie, Gordon; Frens, Timothy A. | Real Estate Issues, Winter 2004 | Go to article overview

Converting Tax Incentives into Profitable Historic Rehabilitation Projects


Goldie, Gordon, Frens, Timothy A., Real Estate Issues


SINCE 1976, RESOURCEFUL DEVELOPERS HAVE taken advantage of significant tax incentives to rehabilitate historic properties into profitable development projects. Such incentives have sparked renewed interest in reviving forgotten local landmarks and have enabled developers to successfully tap into an emerging market of commercial and residential tenants who are looking for unique space.

However, according to the National Trust for Historic Preservation, historic tax credits are widely underutilized. So, what tax incentives are available for historic rehabilitation projects and how can a developer take advantage of them? It depends upon the location of the property--in many cases a project may qualify for federal and state historic tax credits and New Markets Tax Credits.

FEDERAL REHABILITATION TAX CREDIT

The Internal Revenue Code (IRC) provides a federal tax credit of either 10 or 20 percent of qualified rehabilitation expenditures (QREs) incurred in connection with the rehabilitation of a qualified building. QREs represent all rehabilitation costs that are capitalized as part of the depreciable cost of the building and its structural components. QREs exclude acquisition costs, land improvements, and personal property. However, they may include capitalized interest and property taxes, as well as reasonable construction management fees and developer fees paid to related parties. Property owners may claim the credit in the year that the QREs incurred on a project are placed in service. Tax credits are extremely valuable, because they represent a dollar-for-dollar reduction in your federal income tax liability.

ELIGIBILITY REQUIREMENTS FOR FEDERAL HISTORIC TAX CREDITS

To be eligible for the 20 percent credit, the following requirements must be met: (1) The building must be individually listed in the National Register of Historic Places or contribute to a historic district that is listed in the National Register, and (2) The rehabilitation must comply with the design and construction principles of the Secretary of Interior's Standards for Rehabilitation. These standards are designed to ensure that the architectural and historic significance of a property will be maintained during the rehabilitation process.

Nonresidential, nonhistoric buildings that were originally placed in service prior to 1936 are eligible for a 10 percent federal credit. The 10 percent credit can also be applied to a mixed-use project (e.g., first floor retail and upper floor loft apartments) as long as the revenue generated by the residential portion of the project is less than 80 percent of the project's total annual gross revenue.

In addition, there are some general restrictions that apply to both credits. For example, to qualify for either the 10 percent or the 20 percent credit, a building must be used in a trade or business. Therefore, personal residences are not eligible. In addition, the availability of the credit may be restricted if the property is owned or used by a tax-exempt entity. The property owner also must select either a 24- or 60-month rehabilitation period and the owner's QRE during that time must exceed the building's adjusted basis at the beginning of the period.

OBTAINING FEDERAL HISTORIC TAX CREDITS

To claim a 20 percent credit, the rehabilitation must be certified by the National Park Service. To obtain certification, taxpayer's must prepare and submit a three-part Historic Preservation Certification Application. The three-part application addresses the following: Part 1 of the application provides information regarding the historical significance of the building and Part 2 includes a description of the proposed rehabilitation. Part 3 is submitted upon completion of the rehabilitation to request certification. Taxpayers must submit the application to the State Historic Preservation Office (SHPO). Applicants must pay a fee ranging from $500 to $2,500 with their application. …

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