Historic Tax Credits
Historic tax credits are a specialized form of financial incentives offered by federal, state, and sometimes local governments to encourage the rehabilitation and preservation of certified historic buildings. These credits, a component of public policy aimed at heritage conservation and urban revitalization, directly reduce an investor's tax liability, making otherwise economically unfeasible real estate projects viable. They fall under the broader category of tax incentives within public and real estate finance.
The Federal Historic Preservation Tax Incentives program, often referred to as Historic Tax Credits (HTCs), is one of the nation's most significant mechanisms for private sector investment in historic rehabilitation.
History and Origin
The concept of tax incentives for historic preservation emerged in the United States in the mid-20th century, recognizing the economic and cultural value of existing building stock. The modern federal Historic Tax Credit program was formally established with the Tax Reform Act of 1976 and significantly expanded by the Economic Recovery Tax Act of 1981. This legislation introduced a 25% investment tax credit for the certified rehabilitation of historic structures and a lesser credit for older, non-historic buildings. The program was later streamlined and modified by the Tax Reform Act of 1986, which set the current credit at 20% of qualified rehabilitation expenses for certified historic structures. This enduring program is jointly administered by the National Park Service (NPS) and the Internal Revenue Service (IRS), in partnership with State Historic Preservation Offices.6 Since its inception in 1976, the program has leveraged over $131 billion in private investment for the rehabilitation of historic properties across the U.S.5
Key Takeaways
- Historic tax credits are federal (and often state) tax incentives for rehabilitating certified historic buildings.
- They provide a direct reduction in tax liability, not just a deduction.
- The federal credit is typically 20% of qualified rehabilitation expenses.
- Properties must be income-producing and certified as historic by the National Park Service.
- HTCs are crucial for financing complex preservation projects and promoting economic development.
Interpreting Historic Tax Credits
Historic tax credits are a valuable component of the capital stack for eligible rehabilitation projects, effectively lowering the overall cost of a development. For developers and investors, the 20% federal credit represents a significant portion of the total project expenses—specifically, the qualified rehabilitation expenses (QREs). These QREs typically include most hard costs and certain soft costs associated with the rehabilitation, but not the cost of acquiring the building or expenses related to a new addition or landscape work. The value of these credits can be substantial, influencing a project's overall profitability and making an otherwise marginal project financially appealing.
Because the credits are non-refundable and generally taken over five years, they often require syndication, where the credits are sold to investors with sufficient tax liability to utilize them. This process brings in much-needed equity to the project, improving its cash flow and reducing the reliance on traditional debt financing.
Hypothetical Example
Consider a hypothetical property development company, "Preserve & Prosper LLC," that acquires a vacant, dilapidated historic mill building for $1 million. The building is listed on the National Register of Historic Places and is located in a qualified census tract. Preserve & Prosper plans to rehabilitate the mill into mixed-use commercial and residential rental units.
The qualified rehabilitation expenses (QREs) for the project are estimated at $5 million.
The federal Historic Tax Credit is 20% of the QREs.
Calculation:
Federal HTC = 20% of QREs
Federal HTC = 0.20 * $5,000,000 = $1,000,000
This means Preserve & Prosper LLC is eligible for $1 million in federal historic tax credits. These credits are typically claimed over a five-year period. In addition, if their state offers a 20% state historic tax credit, as many do, the project could also qualify for an additional $1 million in state credits, further enhancing the project's financial viability. To monetize these credits and generate upfront equity, Preserve & Prosper might sell these tax credits to a large corporation or financial institution with substantial tax liability at a discounted rate.
Practical Applications
Historic tax credits are widely applied across various sectors of real estate and economic development:
- Urban Revitalization: HTCs are instrumental in transforming blighted urban areas by breathing new life into historic commercial buildings, factories, and warehouses. These rehabilitations often lead to increased property values and renewed vibrancy in once-neglected neighborhoods.
- Affordable Housing: A significant number of historic rehabilitation projects involve the adaptive reuse of buildings into affordable housing units, often in conjunction with the Low-Income Housing Tax Credit (LIHTC). For example, New York State has seen substantial investment, with 106 affordable housing projects utilizing these tax credit programs, creating or rehabilitating thousands of units.
*4 Commercial and Mixed-Use Development: Developers frequently use HTCs to convert historic structures into modern office spaces, retail establishments, hotels, or mixed-use properties that combine residential and commercial functions. This helps preserve the unique character of communities while addressing contemporary needs. - Job Creation: The rehabilitation work itself is labor-intensive, generating construction jobs and stimulating local economies. The federal HTC program is reported to have leveraged over $199 billion in private investment since 1976, contributing to the creation of over three million jobs.
3## Limitations and Criticisms
Despite their significant benefits, historic tax credits have certain limitations and face criticisms:
- Complexity: The application process for historic tax credits is notoriously complex, requiring adherence to strict federal guidelines set by the Secretary of the Interior's Standards for Rehabilitation. This necessitates specialized expertise from architects, historic preservation consultants, and tax attorneys, which can add to project costs and timelines.
- Limited Applicability: The credits are only available for income-producing properties, excluding owner-occupied residential buildings. This limits their reach to a specific segment of the real estate market.
- Basis Reduction and Recapture: The basis of the rehabilitated property for depreciation purposes must be reduced by the amount of the credit. Additionally, if the property is sold or ceases to be a qualified income-producing property within five years of the rehabilitation's completion, a portion or all of the credit may be "recaptured" by the IRS, requiring the taxpayer to repay the credit.
- Market Dependency: The value of the tax credits is tied to the existence of sufficient tax liability from potential investors. In economic downturns, the demand for tax credits can decrease, impacting the ability to syndicate them effectively and reducing their market price.
- Oversight Challenges: Assessing the overall effectiveness of tax expenditures, including historic rehabilitation tax credits, can be challenging due to limitations in data collection and evaluation methodologies. This can make it difficult for policymakers to fully understand their impact.
2## Historic Tax Credits vs. Preservation Easements
While both historic tax credits and Preservation easements are tools used in historic preservation, they differ fundamentally in their nature and application.
Historic Tax Credits are a direct reduction in tax liability provided by the government to incentivize the physical rehabilitation of income-producing historic properties. They are a form of investment incentive directly tied to the costs incurred in restoring a building to meet specific historical standards. The benefit is financial, aimed at offsetting development costs and improving project profitability for the owner.
Preservation easements, on the other hand, are legal agreements, often granted to a qualified non-profit preservation organization or government entity, that permanently protect a property's historic character. The property owner agrees to maintain the historic features and typically gives up certain development rights. In exchange, the owner may be eligible for a charitable contribution deduction on their income taxes, equivalent to the value of the development rights relinquished. Unlike HTCs, easements do not directly fund rehabilitation work but rather ensure the long-term preservation of a property's historic integrity, even if ownership changes. The primary benefit of an easement is the ongoing protection of the historic resource, with a potential tax code deduction as a secondary incentive.
FAQs
What types of properties qualify for Historic Tax Credits?
To qualify, a property must generally be an income-producing building (commercial, industrial, or rental residential) that is listed on the National Register of Historic Places or is certified as contributing to the significance of a registered historic district. Owner-occupied residential properties do not qualify.
1### How much is the federal Historic Tax Credit?
The federal Historic Tax Credit is equal to 20% of the qualified rehabilitation expenses (QREs). QREs include most costs associated with the physical rehabilitation of the historic building.
Are state historic tax credits available?
Yes, many states offer their own historic tax credit programs, often in conjunction with the federal credit. These state credits can significantly enhance the financial viability of a rehabilitation project, sometimes providing an additional 10% to 25% (or more) in credits, though they often have their own specific rules and caps.
Can Historic Tax Credits be combined with other incentives?
Yes, Historic Tax Credits are frequently combined with other financial incentives, most notably the Low-Income Housing Tax Credit (LIHTC), to finance large-scale affordable housing projects in historic buildings. They can also be used in conjunction with New Markets Tax Credits or other local programs depending on the project and location.
Who can use Historic Tax Credits?
Primarily, property owners and developers of eligible income-producing historic buildings can use Historic Tax Credits. However, because the credits are non-refundable and require sufficient tax liability, they are often "syndicated" or sold to investors (such as corporations or financial institutions) who can effectively utilize the tax benefits. This syndication allows the developer to raise equity for the project.