For those considering properties in areas of historical significance, and income tax benefits, the Federal Historic Rehabilitation Tax Credit (HTC) may be of interest to you.
First established in 1976, this tax credit has resulted in the preservation of more than 42,000 buildings and has generated over $84 billion in economic development. And according to data from the National Conference of State Historic Preservation Officers (NCSHPO), “recent studies have shown that far from being a subsidy, the historic tax credit actually stimulates more revenue than it costs.”
Broadly, where the proper conditions are met, business taxpayers can claim a non-refundable 20% tax credit for “rehabilitation” expenditure over a five-year period. To qualify for the credit, however, both the building and the expenditure must meet several requirements (for both the structure and the expenditure).
Rehabilitation Tax Credit Requirements for the Structure
For the building to meet the requirements of the tax credit, it must be a “certified historic structure” which is either listed with the National Register of Historic Places or located in a registered historic district (and it is certified as being of historic significance). In Virginia alone, there are more than 3,000 certified historic structures or districts listed on the National Register.
Also, the building must be substantially rehabilitated, meaning that the expenditure during a two-year period must exceed either $5,000 or the adjusted basis of the building and its structural components. Further rules require the building to have been placed in service before the rehabilitation, and that depreciation must be an allowable tax deduction for the owner.
Rehabilitation Tax Credit Requirements for the Expenditure
Once the requirements of the building have been met, the expenditure from which the tax credit is calculated must also meet several measures.
Broadly, the expenditure needs to be for the rehabilitation of non-residential real property, historically significant residential real property, or real property with a class life greater than 12.5 years. Importantly, the “expenditure” cannot include the costs which were incurred to acquire or enlarge the building. Further, rehabilitation expenditure of historically significant properties must be certified by the Secretary of the Interior as being consistent with the historical character of the building or area.
Should the extensive requirements for the credit be met, taxpayers will be entitled to a 20% tax credit spread over five years (i.e., 4% p.a.). The rehabilitation expenditures used to calculate the credit will usually be considered in the year in which the building is placed into service. Where the rehabilitation is longer than two years, the expenditures may be taken into account in the years in which they are incurred.
The important thing to remember is that the tax benefit derived from this program is a tax credit, rather than a tax deduction. The difference is that a tax deduction reduces your taxable income from which your tax payable is calculated, whereas a tax credit provides an immediate reduction in tax payable.
As an example, if an individual owns a historic building and undertakes a rehabilitation of the building, he may be eligible for the rehabilitation tax credit. Where the building and expenditures comply with the requirements of the tax credit, and the rehabilitation expenditure totals $120,000, then the owner of the property would be eligible for a tax credit of $4,800 per year for five years, giving him a total tax saving of $24,000 over the period. The owner will then be required to reduce his basis in the property by $4,800 each year for the five-year period.
Tax Reform Changes to Note
As stated, the HTC offers incentive for owners to renovate and restore old or historic structures. Tax reform legislation passed in December 2017 changed when the credit is claimed and provides a transition rule:
- The credit is 20 percent of the taxpayer’s qualifying costs for rehabilitating a building.
- The credit doesn’t apply to the money spent on buying the structure.
- The legislation now requires taxpayers take the 20 percent credit spread out over five years beginning in the year they placed the building into service.
- The law eliminates the 10 percent rehabilitation credit for pre-1936 buildings.
- A transition rule provides relief to owners of either a certified historic structure or a pre-1936 building by allowing owners to use the prior law if the project meets these conditions:
- The taxpayer owned or leased the building on January 1, 2018, and the taxpayer continues to own or lease the building after that date.
- The 24- or 60-month period selected by the taxpayer for the substantial rehabilitation test begins by June 20, 2018.
For more detailed information and a link to the rehabilitation tax credit forms, visit the IRS website.
If you have questions on the topic, the IRS provides detailed tax tips. And if you would like to understand further how your international tax complexity may affect your ability to take advantage of this program, please contact us.