Through the Internal Revenue Code Section 47, the federal government
offers lucrative rehabilitation tax credits to encourage preservation
and adaptive reuse of historic and old buildings. The federal tax
credit is a dollar-for-dollar reduction of federal income tax liability.
Calculated as a percentage of the eligible rehabilitation expenses,
federal tax law offers a 20% tax credit for substantial rehabilitations
of historic buildings, and a 10% tax credit for substantial rehabilitations
of non-historic, non-residential buildings built before 1936. A
substantial rehabilitation means that the rehabilitation expenditures
during a 24-month or 60-month measuring period must exceed the aggregate
"adjusted basis" of the building.
The adjusted basis is
generally defined as the purchase price, minus the value (or cost)
of the land, plus the value of any capital improvements made since
the building acquisition, minus any depreciation already claimed.
In addition, because properties must be income-producing to qualify
for rehabilitation tax credits, owner-occupied residences are not
The tax credit program for historic buildings is administered by
each state's historic preservation office and requires approval
from the National Park Service, a division of the U.S. Department
of the Interior. In contrast, the 10% rehabilitation tax credit
for substantial rehabilitations of non-historic, non-residential
buildings built before 1936 is a single IRS tax form submission
and requires no federal or state involvement.
These tax credits can be either used to offset the building owner's
federal tax liability or transferred to a tax credit investor in
exchange for additional equity capital that can be utilized for
long-term financing of the project. Because the Internal Revenue
Code's Passive Activity Rules and Alternative Minimum Tax Regulations
severely limit and, sometimes, prohibit the use of tax credits by
individuals, most building owners syndicate the tax credits to a
third-party institutional investor who can utilize the tax credits.
Syndicated tax credit transactions require the tax credit investor
to be admitted into a legal entity, such as a limited partnership
or limited liability company that will either own the building or
hold a long-term operating lease on the building. In these circumstances,
the tax credit investor acts as either the limited partner or investor
member while the building owner serves as either the general partner
or managing member.
Recognizing the success of the federal program, several states have
adopted legislation establishing state historic rehabilitation tax
credits. Among the states that offer rehabilitation tax credits
for historic preservation are Colorado, Connecticut, Florida, Indiana,
Maine, Maryland, Michigan, Missouri, New Mexico, North Carolina,
Rhode Island, Utah, Vermont, Virginia, West Virginia, and Wisconsin,
with rumors of pending legislation in other states such as California,
New Jersey, New York, Oklahoma and Pennsylvania. These historic
rehabilitation tax credit programs tend to have varying eligibility
requirements and restrictions from state to state.