Historic Tax Credits Could Make Your Deal Doable

For months you’ve been looking. Best Technology Company, Inc. (BTC), your long-time national client, has charged you with finding office space they can lease for their new headquarters. Their requirements are few.

In addition to the obvious (i.e., being cost effective and large enough to house their workforce), the building must: (1) have state-of-the-art office facilities, (2) be unique enough that the public, both locally and nationally, identify the structure’s character with the uniqueness of BTC, (3) be convenient to public transportation and retail services to serve its employees, and (4) provide a significant benefit to the community.

You’ve scoured the downtown for Class A office properties, searched the surrounding suburbs that have growing infrastructure and retail development, reached out to brokers for Class B (and even C) offices that might fit the bill with some updating, but you’re running into dead-end after dead-end. Virtually nothing fits your client’s criteria, and the few that do just won’t pencil.

And then you get a call from your real estate lawyer.

“I have a solution for you,” she says. “The McKenzie Building, Main and Main, next to the subway’s Blue Line, in the middle of about 40 retail shops and restaurants, one-of-a-kind, and the City will love you if you do the deal.”

You’re confused.

“It’s ancient and decrepit, it would cost a fortune to gut and rebuild everything, no one’s been in it for 30 years, and I’m pretty sure the City’s going to condemn it so something new and pretty can go up. Why would I want that thing? If I find a developer to fix it, how could they even make anything close to market?”

“Historic tax credits. Come in tomorrow morning and we’ll talk.”

You hang up, put the cell phone in your pocket, and start making a list of questions for her. Hopefully she’ll have answers:

  1. How will credits make this deal more profitable?
  2. Why does the government give credits for this? What’s the benefit?
  3. Are there any other credits I can get to fix the building?
  4. What if the developer doesn’t need the credits? Can he sell them to reduce the cash he has put into the deal?
  5. What buildings are eligible?
  6. How do I calculate the amount of credits the developer will get?
  7. Can they tear out the old (like mechanicals and just about everything else) to make the property state-of-the-art?
  8. Can BTC be the tenant?
  9. Who approves the deal? What’s the process? Is there a fee?
  10. Can the developer sell the building after they fix it? What happens if they do?
  11. Is this deal big enough to make this whole process worth it?

Time to get some answers.

How Can Credits Make My Deal Feasible?

Where a party does a certified rehabilitation of an income-producing, certified historic structure, the Federal government will award Historic Tax Credits (HTCs) equal to 10% or 20% of the qualified rehabilitation expenses incurred rehabbing the property. These credits offset on a dollar-for-dollar basis the party’s federal income tax liability. For example:

  • You owe $100,000 in federal income tax
  • You spend $500,000 rehabbing a certified historic structure
  • You receive HTCs equal to 20% of $500,000, or $100,000
  • Now you owe $0 in federal taxes
  • By doing this deal, and utilizing the HTCs, you just saved $100,000
  • More savings, more profit…

“Cool,” you say, “but how do I know if I get a 10% or 20% credit?”

“It depends on the building,” your attorney says.

“Is the credit calculated against all the project costs? Like acquisition costs? Your legal fees? Landscaping?”

“No. Some costs are excluded from the calculation,” she says, “but one question at a time please.”

“Okay. Then…”

What is the Purpose of HTCs?

“Because I know you appreciate it when I support my statements with the insight of other sources,” she says, “here’s a good summary of the purpose of HTCs from an HTC consultant:”

Historic tax credits…are intended to make old buildings economically viable. Historic tax credits are not about restoring historic buildings to their original use and appearance…. Instead, tax credits encourage the preservation of original building materials, configurations, and appearance where possible while adapting the building for continued use in the modern world. The credits help offset the additional costs associated with the rehabilitation of historic buildings.

Historic tax credit projects create jobs and stimulate the economy. Because historic projects are more labor-intensive, they provide more jobs than comparable new construction projects. Rehabilitation preserves not only historic buildings, but also precious natural resources. By rehabilitating a building rather than demolishing and building new, historic projects preserve the embodied energy in the building and avoid sending waste to the landfill. Preservationists everywhere know that the greenest building is the one already built.

If you understand what the consultant said, the benefits of HTC are generally thought of as falling into one of two categories: cultural or economic. Clearly the preservation of historic buildings preserves a part of our history. It’s a tangible connection to and reminder of eras past. But even this cultural benefit has economic value.

Ever been to Rome? Athens? London? Did you go for the nightclubs? Maybe, I don’t know what you do outside your brokerage, but many travel to these cities to see the historic sites, their architecture, learn of the cultures they used to house, and learn what came before where we are today. Tourism can have an enormous impact on a local economies: tourism jobs, hotels, rental cars, entertainment, and of course the resulting increases to sales and income taxes.

Additionally, rehabilitating these kinds of structures can spur surrounding development. Because many of these historic properties are in downtown areas, incenting their preservation and modernization can revitalize an entire downtown. Conversely, failing to do so can result in a neglected and dying downtown.

Yes, new buildings can revitalize an area, but with the help of HTCs it may be more viable for developers to preserve the unique aesthetics of an existing circa-1900 building than to hire Frank Gehry to design something of equal architectural significance.

To take this thought one step further, a vibrant downtown is more likely to attract folks living downtown, and urban planners will talk to you all day long about the value of preventing urban sprawl….

In any case, the experts agree that the HTC program works. The National Park Service (NPS) reports that the program “is one of the nation’s most successful and cost-effective community revitalization programs, leveraging over $84 billion in private investment to preserve 42,293 historic properties since 1976.”

Are There Other Tax Credits for Historic Preservation?

Yes. According to the National Association of Realtors, as of “2016, 34 states had some kind of historic tax credits, with at least 23 of them offered to residential homeowners to reduce their state income taxes.” This last phrase is important.

While the state programs may mirror the federal HTC program, often they allow state income tax credits for rehabilitations that would not qualify for federal HTCs (e.g., rehabbing a personal residence). Because the rules are different for each state, the best thing to do is to contact your state for it’s eligibility criteria.

Next question?

Can I Sell the Credits?

No, but….

Technically HTCs can’t be sold by the property’s owner. However, it’s common practice for owners/developers to enter into partnerships (typically limited liability companies) with parties who have federal income tax liability (or state income tax liability if state credits are used), and allocate the credits to the partners based on their interests in partnership profits. For example, where a partner owns a 99.9% interest in the LLC, 99.9% of HTCs will be allocated to that partner.

Typically the federal credits are claimed for the tax year when the rehabbed property is placed in service (the date the rehabilitation is done and a certificate of occupancy issued), though the credits can also be carried back one year and carried forward 20 years or until the credits are fully used.

Of course, the party using the credits will have to pay for the partnership interest, and this equity infusion will be used to offset the costs of rehabilitation. This allows the developer to put in less of its own money, borrow less funds, and thus increase its return.

Investor funding often occurs when the building is placed in service, though the developer may be able to borrow funds based on an investor’s commitment to purchase partnership interest/credits, and then pay-off such loans when the capital contribution is made.

In such partnerships the developer will act as the general partner, directing the rehabilitation and operating the property. In contrast, the investor acts in a limited partner role, making no decisions as to the property’s operations. However, as noted in this 2013 article, at least one court held that where an investor did not have a clear stake in the economic success of a rehabilitation project, it was just a tax credit investor, and not entitled to any HTCs from the property.

Although this ruling resulted in part because the “deal was carefully structured with guarantees so that the investor would achieve the same yield whether the rehabbed property turned a profit or not,” it has raised awareness that investors may need to establish that they have “a legitimate upside and a legitimate downside” in a deal.

As explained in the article, this may be achieved by carefully structuring the partnership to:

  • Provide fewer guarantees from developers
  • Where guarantees are used, have them burn off as the project progresses
  • Require investors to put their capital contributions into a project more quickly
  • Provide that an investor’s cash returns from tax credit investments are variable depending on the performance of the asset (i.e., give the investor a “real share of upside cash”),
  • Not use put/call (buy/sell) provisions that allow an investor to sell its partnership share to the developer sponsor for a set price, and a developer the right to buy the investor’s share, before the five-year holding period, and
  • Provide the investor with a nominal cash flow return during the recapture period

“I’m going to jump ahead to one of your other questions,” your attorney notes. “You were wondering if you can sell the property once its been rehabbed, right?”


Well you can, but not until the building has been in service for five years; the “holding period” mentioned above. So, if you’re going to use a put/call provision that may operate before this period has run, there’s a risk the IRS will treat it as a disguised sale.

“Okay,” you say. “Then answer my related upcoming question: what happens then?”

Recapture happens. If, before the holding period expires, the property (i) is sold (including if the IRS treats the exercise of a put/call as a disguised sale), (ii) stops being income-producing, or (iii) is changed to the point where it no longer meets the required rehabilitation standards, the credits can be recaptured. The amount of recapture depends on when non-compliance occurred before the holding period ended, but in all cases, it will be time to get that checkbook out…

Of course, once the holding period has passed, developers typically buy out any investors’ interest for a nominal amount (the investor made their return on the purchase and use of the credits) and then can sell or hold the property as they choose.

What Buildings Are Eligible?

“Historic buildings,” your lawyer says. “I’ll send my bill in the morning,” she smiles. You don’t smile, so she gives the details.

First, the property must be depreciable, meaning it must either be income producing or used in a business. Accordingly, commercial uses and residential rental properties may qualify, but personal residences do not. Second, it must be either (i) historic or (ii) built before 1936.

To qualify as historic, a property must either:

  • Be listed in the National Register of Historic Places (National Register), or
  • Be a contributing element of a historic district listed in the National Register or another qualifying local historic district

If the building satisfies one of the above (and that determination is made by the Secretary of the Interior, through the National Park Service), it is historic and the rehabilitation can be eligible for a 20% HTC. If a building doesn’t meet the historic standard, it can still be eligible for a 10% HTC so long as it was built before 1936 and is depreciable.

Calculating the Tax Credit

Three relatively simple steps. First, determine if the project will qualify for the 10% or 20% credit. Second, determine the amount of qualified rehabilitation expenses (QREs). Third, multiply.

QREs are defined by the Internal Revenue Service, and include reasonable costs of construction, as well as depreciable soft costs such as architectural, engineering (including survey), legal and development fees. What is not included? These: acquisition costs, personal property, new building additions or construction, demolition, parking lots and landscaping.

Quick math problem. If you project a rehab of the McKenzie Building for BTC will include:

  1. $5,000,000 acquisition price
  2. $5,000,000 building rehabilitation
  3. $500,000 professional fees
  4. $500,000 developer fees
  5. $500,000 non-building improvements

Of the $11,500,000 total project costs, only $6,000,000 will be included as QREs (assuming the amounts are reasonable). And because the McKenzie Building is already on the National Register, it will qualify for a 20% credit. So, the credit to your developer (or investor(s) if the owner chooses to partner up) will be $6,000,000 x 20% = $1,200,000.

One quick jump back to a previous question. If you were an investor, would you pay $1,200,000 for $1,200,000 of tax credits (or more accurately, $1,200,000 for a partnership interest that would give you the right to use those credits)? Of course not. A 0% return doesn’t keep you in business for very long. Accordingly, investors will purchase the partnership interest and corresponding right to credits at a discount. While the discount will vary depend on many things, generally investors purchase at a 10-20% discount.

What Rehabilitation is Required?

In order to qualify for HTCs, the rehabilitation must be “substantial” and comply with the Secretary of the Interior’s Standards for Rehabilitation. “Substantial” is defined as an investment of at least $5,000 or the adjusted basis of the property, whichever is greater, within a 24-month test period (or 60 months if the project is completed in phases). A property’s adjusted basis is calculated as (i) its purchase price, (ii) less the value of the land, (iii) less the any previously claimed depreciation, (iv) plus the value of building improvements made between the purchase date and the end of the 24- or 60-month test period.

As described by the NPS, the Standards for Rehabilitation provide that:

  1. A property shall be used for its historic purpose or be placed in a new use that requires minimal change to the defining characteristics of the building and its site and environment.
  2. The historic character of a property shall be retained and preserved. The removal of historic materials or alteration of features and spaces that characterize a property shall be avoided.
  3. Each property shall be recognized as a physical record of its time, place, and use. Changes that create a false sense of historical development, such as adding conjectural features or architectural elements from other buildings, shall not be undertaken.
  4. Most properties change over time; those changes that have acquired historic significance in their own right shall be retained and preserved.
  5. Distinctive features, finishes, and construction techniques or examples of craftsmanship that characterize a historic property shall be preserved.
  6. Deteriorated historic features shall be repaired rather than replaced. Where the severity of deterioration requires replacement of a distinctive feature, the new feature shall match the old in design, color, texture, and other visual qualities and, where possible, materials. Replacement of missing features shall be substantiated by documentary, physical, or pictorial evidence.
  7. Chemical or physical treatments, such as sandblasting, that cause damage to historic materials shall not be used. The surface cleaning of structures, if appropriate, shall be undertaken using the gentlest means possible.
  8. Significant archeological resources affected by a project shall be protected and preserved. If such resources must be disturbed, mitigation measures shall be undertaken.
  9. New additions, exterior alterations, or related new construction shall not destroy historic materials that characterize the property. The new work shall be differentiated from the old and shall be compatible with the massing, size, scale, and architectural features to protect the historic integrity of the property and its environment.
  10. New additions and adjacent or related new construction shall be undertaken in such a manner that if removed in the future, the essential form and integrity of the historic property and its environment would be unimpaired.

Eligible Property Users

Is your long-time national client Best Technology Company, Inc. exempt from taxes?


Will they be the only tenant?


Then you’ll be fine. With limited exceptions, tax exempt entities can’t lease more than 35% of a HTC property’s rentable area, but there are no similar restrictions on non-tax exempt entities.

Application and Approval Process

If you’ve read our articles on Low Income Housing Tax Credits or New Markets Tax Credits then you know that some tax credit programs can award only a limited amount of credits, causing the application process to become highly competitive. That’s not the case with HTCs. If the program’s requirements are met, then the credits are awarded.

The entities involved in the application and approval process include :

  1. The U.S. Department of the Interior through the National Park Service
  2. The Department of the Treasury through the IRS, and
  3. The Department of Natural Resources’ State Historic Preservation Office (SHPO)

The process starts when the owner submits the three-part Preservation Certification Application to the SHPO with jurisdiction over the subject property. Part 1 of the application (“Evaluation of Significance”) determines if the property is historic or non-historic/pre-1936, and Part 2 (“Description of Rehabilitation”) sets out a detailed plan for the rehabilitation.

The SHPO performs the initial review of both parts, and if the project meets the historic/non-historic criteria, and the plans comply with the Secretary of the Interior’s Standards, it forwards Parts 1 and 2 to the NPS for final certification. If the Standards are met, the credits are approved.

When the rehabilitation work is done, the owner submits Part 3, “Request for Certification of Completed Work,” providing evidence that the project was completed as proposed in its rehabilitation plans. As with Parts 1 and 2, SHPO makes the initial review and then forwards Part 3 to the NPS for final certification. If certified, the owner then includes the certification with its tax return.

It should be noted that the NPS charges a fee to perform its Part 2 and 3 review. According the NPS’s site, the current fees (based on project cost) are:

Project Cost Federal Fee
  $5,000 – $79,999   $0
  $80,000 – $3,849,999   $845 + 0.15% of rehabilitation costs over $80,000
  $3,850,000 or more   $6,500

Minimum Project Size

Aside from the $5,000 minimum investment to meet the “substantial” rehabilitation requirement, there is no minimum project size requirement. However, because the application and approval process requires significant design, legal and accounting costs, professionals in the HTC arena have suggested that projects seeking credits should have at least $1,000,000 in QREs. This number may need to be even higher if the owner wants to syndicate the credits.


The McKenzie Building may just be the answer. An equity contribution from a tax credit investor will increase your developer’s return. Your client BTC might love the chance to call this historic building home (provided of course your rehab plans get you up to their “state-of-the-art” requirement). The City might even kick in some additional incentives once they understand this project can provide a dramatic spark to their downtown.

It might not get the City to Rome-level tourism, but it could be a good start.

In any case, while I am your (fictional) lawyer, because this (fictional) discussion we’ve just had is provided only for your information, and isn’t legal advice, if you have any specific historic tax credit issues, it’s best to hire a (non-fictional) lawyer to answer your questions.

Thoughts? More questions? HTC-related limericks? Please drop them in the comments section below.

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