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Federal Historic Rehabilitation Tax Credits

The use of Federal Rehabilitation Tax Credits is a means to supplement funds required to rehabilitate historic buildings. Buildings qualify for a federal tax credits equal to 20% of qualified rehabilitation expenses because they are listed individually on the National Register of Historic Places or are contributing buildings in a National Register District. Qualified rehabilitation expenses include costs of construction, architecture and engineering, site surveys, legal and development fees, among other expenses. They do not include acquisition cost, furnishings, new additions, demolition, and landscaping.

The program was established in 1976 by National Park Service in cooperation with the Internal Revenue Service and State Historic Preservation Officers to encourage the preservation of historic buildings. Over the years it has provided billions of dollars of tax credit equity to leverage private investment to support rehabilitation projects. This program has resulted in new job generation, enhanced property values, and urban revitalization, as well as preservation.

In order to participate in the program, the entity requesting federal tax credits must submit detailed rehabilitation plans first to the State Historic Preservation Officer responsible for the jurisdiction in which the property is located. The SHPO’s are designated by the NPS as the initial body responsible for review and approval of plans. Upon approval by the SHPO, plans are forwarded for final approval to the NPS. These plans must meet Secretary of the Interior’s Standards for Rehabilitation. These standards insure that significant architectural features of the building are preserved. These are not so strict that they prevent modern upgrades to systems and facilities. There are no politics involved in the federal program. If rehabilitation plans meet the Secretary of the Interior’s Standards the tax credits are granted by right. It is necessary that the organization receiving tax credits retain possession of the property rehabilitated for a period of five years after rehabilitation in order to avoid tax recapture.

In ordinary circumstances the tax credits are sold to corporate investors to raise cash to fund the project’s rehabilitation costs. The investors typically buy the credits at some modest (10-15%) discount to their face value and apply them against their federal income tax liability. Funds are typically delivered when the project goes into service. It is also possible to borrow against a commitment to purchase tax credits. In addition to the purchase discount, the IRS also requires that investors have an “economic interest” in the project. This requirement is typically satisfied by providing the investor with a nominal cash flow return during the recapture period. At the conclusion of the recapture period, the project sponsor typically buys the investor out of the partnership at a nominal price paid out of refinancing or sale proceeds.

Many states have similar programs which provide credits against state income tax liability. In the case of Virginia, there is a 25% historic rehabilitation tax credit which is very similar to the federal program in its operation and requirements.

A link to the National Park Service website describing the historic rehabilitation tax incentive program is www.nps.gov/history/hps/tps/tax/brochure1.htm.

New Market Tax Credits

The New Markets Tax Credit was created by Congress in 2000 to stimulate business development in low income communities. This program is more complex than the Federal Rehabilitation Tax Credit program, as credits are administered by “Community Development Entities,” which must qualify for an annual allocation of tax credits by the Department of the Treasury. Investors purchase an equity interest in the CDE in exchange for the tax credits. The CDE in turn invests the proceeds into a project or business in a qualified community. The New Markets credit is equal to 39% of project cost and is earned by the investor over a period of seven years at a rate of 5% in each of the first three years and 6% per year for the final four years. The investor typically purchases the credits at a discount that yields approximately 25% of the project cost to the CDE, depending on the discount rate applied.

An organization must apply to the Department of the Treasury’s CDFI Fund to obtain a designation as a CDE. The CDE’s mission must be to encourage business development in low-income communities. Qualified low income communities are defined as census tracts with a 20% poverty rate or those where median income is 80% or less of the greater of statewide median household income or metropolitan area median household income.

New Markets Tax Credits can be combined with federal and state historic rehabilitation tax credits to provide an equity contribution that can approach 50% of a project’s development budget. This amount of equity can help to leverage a significant amount of debt funding, increasing the feasibility of projects in low income communities. One significant restriction on New Markets Tax Credits is that they cannot be used for housing, but must be used in connection with a job creating business. In mixed use projects, New Markets Tax Credits can only be applied to that portion of the project cost that is applicable to the business use.

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