Financial Link to the Past

By Robert J. Birch

Robert J. Birch is an associate at Cohen, Seglias, Pallas, Greenhall & Furman in Philadelphia, Pa. He can be reached at (215) 564-1700.

The Rehabilitation Tax Credit provides a viable incentive to preserve our area's historic structures.

The Mid-Atlantic region is rich with historic structures, but rehabilitation can be a financial drain. Fortunately, Congress recognized the need to keep these projects financially feasible and has created tax incentives to help preserve our past.

The Rehabilitation Tax Credit is a federal tax incentive that encourages the rehabilitation of historic buildings. Prior to the enactment of the RTC, there was no incentive to preserve historical buildings. Today, the National Park Service, Internal Revenue Service and state historic preservation offices provide historic preservation tax incentives to reward private developers who rehabilitate historic properties.

The RTC is a one-time, federal income tax credit claimed by developers and investors for 20 percent of the costs of rehabilitating buildings designated as historic by the federal government, or located in a national historic district. Buildings may be residential, commercial or industrial to qualify for the tax credit.

The RTC is 20 percent of the costs of restoring or improving a historic structure, known as qualified rehabilitation expenses. If the developer incurs $100,000 in qualified rehabilitation expenses, the developer receives a $20,000 tax credit. The credit is a dollar-for-dollar reduction against the developer's federal income tax liability.

Qualified rehabilitation expenditures include most hard and soft rehabilitation expenditures, including professional fees for developers, architects, engineers, accountants and attorneys, as well as insurance premiums, construction interest and taxes. In addition, costs for updated mechanical equipment and related items such as new heating, air conditioning, ventilation, plumbing, electrical and elevators can be included. However, the acquisition cost of the building can not be counted, as well as costs for walks, fences, retaining walls, parking and landscaping.

The preservation tax incentives are available for any qualified project which is designated as certified rehabilitation of a certified historic structure. A certified historic structure is a building which is individually listed in the National Register of Historic Places or a building which contributes to a registered historic district. A certified rehabilitation is a renovation project in keeping with the historic character of the property and, where applicable, the district in which it is located. Evaluations are based on standards which encourage new uses and modern alterations while preserving important features and characteristics of historic properties.

Eligibility for the RTC also depends on meeting some additional requirements. For example, the building must be depreciable, such as an income property. The rehabilitation must be substantial, generally defined as incurring expenditures over a two-year period exceeding the greater of $5,000 or the adjusted basis of the building and its structural components.

Each project typically is required to undergo a three-part process. First, the NPS determines if a building qualifies for the credit. Second, the NPS approves rehabilitation plans and specifications that comply with the architectural standards. Finally, the NPS determines if the completed rehabilitation accurately maintains the building's history. Once the NPS has approved the Part 3 application, the developer calculates the total qualified rehabilitation expenses incurred and multiplies this number by percent to determine the total tax credit earned. Another benefit of the tax credit is the ability to carry the credit back to previous tax periods. If, during the year that tax credits are generated, the developer has more tax credits than it can utilize, the credit can be carried back for one year and forward for 20 years. Thus, the credit can potentially generate cash refunds.

Some developers, depending upon their particular circumstances, may obtain little or no benefit from the tax credits generated from a rehabilitation project due to the effect of net operating losses, the federal alternative minimum tax, or other sources of tax credits. The RTC can be passed to a buyer of the building provided that no one has already claimed the RTC and the building acquired has not been placed in service by the seller before the date of acquisition. The RTC may not be bought or sold because it is only available to the person or entity that holds title to the property. However, syndication through limited partnerships is permitted to bring investors into rehabilitation projects.

Although rehabilitation costs are significantly higher than new construction costs, the RTC can provide the necessary tax incentive to make rehabilitation projects financially feasible.