June 29, 2006
Saving historic buildings with tax credits
By ALAN PASTERNACK and DENNIS OSTGARD
Schwabe, Williamson & Wyatt
At their worst, run-down buildings are symptomatic of urban decay and blight. But this need not be the case. Older buildings can be historically significant bridges to a community’s past, adding character and diversity to the cityscape while providing economic benefits to the building owner as well as the community.
Because of the upside potential of historic buildings to provide both tangible and intangible benefits to the community, the federal government has implemented a number of programs to encourage preservation of historic buildings. One such program is the Rehabilitation Tax Credit, more commonly known as the Historic Tax Credit or HTC.
The HTC subsidizes renovation of qualified buildings by providing the owners with a tax credit equal to 20 percent of the qualified rehabilitation expenditures for a certified historic structure, or a tax credit equal to 10 percent of the qualified rehabilitation expenditures for a building other than a certified historic structure.
The Internal Revenue Code defines a “certified historic structure” as any building, and its structural components, that is either listed in the National Register of Historic Places, or that is located in a registered historic district and certified as being of historic significance to the district.
The fact that a building is neither listed in the National Register nor located in a registered historic district does not necessarily mean that it does not qualify for the 20 percent credit. The owner of such a building may apply for a preliminary determination that the building or the district is historically significant.
Upon receiving such a determination, the owner may proceed with the rehabilitation while the process of nominating the building or the district for listing proceeds. The determination will only become final, however, upon the building or district being listed. A building that is not a certified historic structure qualifies for the 10 percent credit, provided that it was originally placed in service prior to 1936. It is important to note that the determination of which credit applies, the 20 percent or 10 percent credit, depends solely on the building -- it is not elective, and the two credits are mutually exclusive.
So, how does the HTC actually help finance rehabilitation?
Assume that you recently acquired a building that is listed on the National Register, qualifying for the 20 percent credit. Assume further that the rehabilitation of the building will require $10 million in construction and other qualified expenditures.
You can go out and seek traditional financing to pay for the entire project, but considering the condition of the building, you may have trouble obtaining all the financing on favorable terms.
However, since this project qualifies for the 20 percent credit, it will generate $2 million in tax credits, which can be “sold” to an investor. If we assume an investor will pay between 90 cents and 95 cents for each dollar of tax credits, the result is an additional $1.8 million to $1.9 million in equity for the project, and a commensurately lower debt burden.
While we have described the credits as being “sold” to an investor, this is not strictly true. In a relatively simple HTC transaction, the building would be transferred to, and owned by, a limited liability company in which the developer, or an affiliate, is the managing member, and the investor acquires a non-managing member interest. This allows the credits to flow out to the investor. This ownership structure must be maintained for five years or a portion of the tax credits will be recaptured. Once this five-year period has ended, the investor typically exits the limited liability company through an option arrangement, leaving the developer as the sole member of the building owner.
Before traveling down the HTC road, you should consult with qualified professionals and avail yourself of the many resources available from the IRS and the National Park Service, which jointly administer the HTC program. A good place to start would be the National Park Service’s Web site: http://www.cr.nps.gov/hps/tps/tax/incentives.
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