If you are renovating an older property or looking for a tax-efficient real estate development project, the Rehabilitation Tax Credit may be a lucrative opportunity.Qualifying rehabilitation projects receive a credit for 20% of rehabilitation costs for certified historical structures or 10% of rehabilitation costs for buildings placed in service before 1936.This dollar-for-dollar tax credit can reduce out-of-pocket renovation costs and significantly improve return on investment. Questions abound, and The Tax Warriors® have the answers.
Is my building historical? To qualify for the 20% credit, the rehabilitation must be to a certified historical structure. The IRS defines the term historical as “listed in the National Register, or located in a registered historical district and is certified by the Secretary of the Interior or the Secretary of the Treasury as being of historic significance to the district.”You can check the National Register to see if your property has already been certified. If your building is not on the list, it maybe easier to apply than you think. A building doesn’t need to beBen Franklin’s house, but it shouldbear some sort of historical quirk or significance, like his favorite kite shop or watering hole.The property must also be business or income producing (residential or non-residential rental), so upgrading a personal residence won’t qualify.
My building is not historical,but it’s REALLY old… Even if your property is not a certified historic structure, you may still qualify for the 10% credit if the building was placed in service before 1936. However, for a rehabilitation project to qualify for the 10% credit, the building must be rehabilitated for non-residential use. Converting an old 1800’s factory into lofts won’t qualify for the 10% credit(but it may qualify for the 20% credit if it’s a certified historic structure). If your property happens to be in a historical district, you must obtain a decertification from the Department of the Interior if you want to qualify for the 10% credit. Heads up: decertification is granted only to buildings that are non-contributing to the historical significance of the district, which may include a building erected after the area was deemed historical.
How is the credit calculated?
The credit is calculated by multiplying the applicable credit percentage (either 10% or 20%) by the qualifying expenses of your rehabilitation. Qualifying expenses include expendituresfor structural components of the building and some soft costs like interest, taxes, and architect, engineering, construction and developer fees. Some types of costs that do not qualify include expenditures forfurniture, fixtures, land improvements (swimming pools, parking lots, sidewalks, landscaping), window treatments, and demolition. The credit is generally claimed in the year property is first placed in service after the rehabilitation or when the rehabilitation project is complete. Additionally, any rehabilitation credit allowed reduces the depreciable basis of the building.
I’m ready to break ground and claim this credit! What else do I need to know?
Not all rehabilitation projects qualify, even if your property does! First, your rehabilitation project must be substantial. This requires that your qualifying rehabilitation expenditures exceed the greater of your adjusted basis in the building (excluding land) or $5,000. If you purchased a historic property for $250,000, and $50,000 was attributable to land, your qualifying rehabilitation costs would need to be at least $200,000 to be eligible for the credit. Additionally, for the 20% credit on historic properties, your rehabilitation work MUST be reviewed by the National Park Service to ensure it complies with the Secretary’s Standards for Rehabilitation. For a project to qualify for the 10% credit, a minimum amount of the original structure must be retained:at least 50% of external walls must remainin place as external walls, at least 75% of external walls must remain in place as external or internal, and at least 75% of internal framework must be retained. The idea here is to retain the character of the building and memorialize the previous culture.
If you’ve gotten to this point and think your project may qualify for the credit, or are interested in starting a project,that’s great news; but the journey to the promised land is not over. You should consult with your tax advisor to confirm you or your investors will qualify andcanutilize the credits, since they may be subject to passive activity or alternative minimum tax limitations. There are also recapture provisions that reduce the credit if the building is sold or ceases to be business propertywithin a certain amount time after the rehabilitation project is complete. However, certain credits may be eligible to be passed to a buyer, so you’ll want to know these rules before crafting your exit strategy.
The saying goes “those who don’t know history are destined to repeat it.” So it is with understanding the qualifying factors of the Rehabilitation Tax Credit. Knowing where you stand before beginning a development project can avoid missing tax-saving opportunities. Call on us if you are still not sure and need help strategizing about your project. Our highly-skilled advisors have decades of experience in real estate ownership and development consulting.