If you thought there was no financial incentive to rehabilitate a historic building instead of build a new one, you may want to think again.
The historic tax credit (HTC) is a federal program that has been around since it was first enacted by Congress in 1976. It has gained new popularity, however, due to recent revitalization efforts in historic areas that are close to city centers, such as Cincinnati’s Over-the-Rhine district. With a little bit of up-front planning, investing in historic structures can reduce an investor’s federal tax bill, dollar-for-dollar, by up to 20% of their investment.
The 20% Historic Tax Credit
The 20% credit applies to a project that the Secretary of the Interior deems to be a “certified rehabilitation” of a “certified historic structure.” At first glance, that may seem like a high bar to meet, but let’s take a look at what each of the terms actually means.
Certified Historic Structure
Simply put, a “certified historic structure” is a building that meets one of two criteria: it is listed in the National Register of Historic Places, or it is located in a “registered historic district” and certified as contributing to the historical significance of that district by the National Park Service (NPS). In the first case, if the building is listed in the National Register, it is automatically considered a “certified historic structure” without any additional approval, and meets that requirement to be eligible for the HTC. The second option requires a bit more planning to be considered a “certified historic structure.” Owners of buildings within registered historic districts can get their building certified by filling out an application that outlines the historical significance of the building and sending it to their State Historic Preservation Office (SHPO). The SHPO then recommends approval or denial and sends it to the NPS’s office, which makes the final determination. Once it is approved, the building then becomes a “certified historic structure,” meeting the first part of eligibility for the HTC. The National Register of Historic Places, along with a map of “registered historic districts,” can both be found on the NPS’s website, at: https://www.nps.gov/nr/.
Rehabilitation plans for a “certified historic structure” must be reflective of the historic period when the building was built, or of the historic district in which it resides. Consequently, the NPS makes the final determination whether the proposed plans meet the NPS’s standards of rehabilitation (see 36 CFR 67.7). An application is sent to the SHPO, which works with the owner and advises them on ensuring the requirements are met. It then recommends approval or denial and sends it to the NPS’s office, which makes the final determination. After the work is completed, it is again evaluated by the SHPO and certified by the NPS.
The IRS has a few final requirements that must be met for the 20% credit to apply. The first is that the building must be depreciable and placed in service, which already applies to most commercial real estate holdings. The second is that the rehabilitation must be “substantial,” which the IRS defines as the greater of $5,000 or the adjusted basis of the original building (and its structural components), with the qualified rehabilitation expenses counting toward this requirement being measured over a 24-month period (there is one exception that extends this window to 60 months).
The credit is claimed on Form 3468, and may be carried back one year, or forward 20 years, although it is non-refundable, meaning it can decrease the tax bill to $0, but not create or increase a refund. The HTC is also subject to certain at-risk and passive activity loss (PAL) limitations, and there is additional planning required when a non-profit is involved. One last caveat to the HTC is that if an investor sells the property within five years, the credit is recaptured on a prorated basis of 20% per year from the time the credit was originally claimed.
Not a Certified Historic Building? Not a Problem.
If your building does not meet one of the requirements for the 20% HTC, there is still an opportunity to take advantage of the 10% HTC. While the potential dollar-for-dollar tax reduction is relatively smaller, so are the requirements that must be met in order to take the credit. The 10% credit is available for “non-historic buildings” (i.e., ones that do not meet the requirements for the 20% credit above) originally placed in service before 1936.
One difference from the 20% HTC listed above is that the 10% HTC is available only for non-residential buildings (with hotels being considered non-residential). The 10% HTC requires that certain physical tests be met, namely:
- 75% or more of the internal structural framework of the building must remain in place,
- 50% or more of the external walls of the building must remain in place as external walls after the work is completed, and
- 75% or more of the external walls of the building must remain in place as either external or internal walls.
The New Old-Fashioned
While the credits above reduce an investor’s federal tax bill, what makes historic rehabilitations even better is that many states have similar credits available to reduce state tax, as well. With some up-front planning, developers can save their investors up to 20% of their investment on their federal tax bill. Contact your tax advisor to discuss specific scenarios where you can take advantage of this revitalized tax credit.