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Rehabilitation Tax Credits

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 eligible.

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.

 

 

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