Historic Tax Credits (HTC) in Commercial Real Estate

What are Historic Tax Credits?

The Historic Tax Credit, or HTC, is a 20% federal tax credit designed to encourage investors to fund the substantial rehabilitation of historic structures. Since 1976, Historic Tax Credits have been responsible for creating $144.6 billion in private investment while preserving more than 43,000 historic structures across the country. With the credit, an investor can take 20% of the project’s qualified costs as a deduction from their federal income taxes.

What Buildings are Eligible Under the HTC Program?

In order to qualify for the HTC program, a building must fall into one of several categories. It may either be listed in the National Register of Historic Places as a certified historic building. Alternatively, a building may qualify if it’s located in a registered historic district and has been certified by the National Park Service as a historically significant structure. In addition, other commercial (i.e. non-residential) structures built before 1936 may also qualify. However, unlike certified buildings, non-certified buildings only qualify for a 10% Qualified Rehabilitation Expenditures credit.

HTC projects are generally intended to become income-generating properties that help revitalize the local economy. For instance, an older warehouse or outdated office building could be converted into a mixed-use property, a hotel, a community center, or even a modernized factory or industrial property.

What Are The Other Requirements of the HTC Program?

In order to qualify for the Historic Tax Credit, rehab and improvement expenses need to be more than either $5,000 or the owner's adjusted basis of the building and its structural improvements. A sponsor can calculate adjusted basis by taking the property’s purchase price and subtracting land costs, previous improvements, and previous depreciation. This expenditure needs to occur either over a 24-month period, or a 60-month period for “phased developments.” The project’s sponsor is allowed to determine when this period begins.

In order to qualify, a building must comply with the Secretary of the Interior's Standards for Rehabilitation, which should help encourage an “efficient contemporary use” while retaining parts of the building “which are significant to its historic, architectural, and cultural values." These rules include preserving “distinctive features, finishes, and construction techniques” as well as “examples of craftsmanship that characterize a property.” Overall, minimal changes should be made to the historic elements of property, and improvements should not be made which mislead , or create a “false sense of historical development.”

While multifamily rental properties qualify for the program, an apartment building or home cannot be solely the private residence of the owner— other tenants must also rent the property. A single-family home could be eligible for the HTCs, but it would generally need to be converted into multi-unit residential or commercial space, or be repurposed as a community center, educational center, or another type of income-producing property. Only traditional multifamily residential and commercial buildings are permitted— monuments, bridges, railroad cars, and other miscellaneous structures are not eligible.

What are Qualified Rehabilitation Expenditures (QREs)?

As mentioned earlier, only 20% of qualified expenses may be counted against an investor’s federal income taxes. These are referred to as Qualified Rehabilitation Expenditures (QREs). In general, QREs include most primary rehab costs, including costs associated with upgrading, replacing, or installing floors, walls, windows, doors, stairs, escalators, elevators, chimneys, and electrical systems. In addition, certain core development costs, such as architectural and engineering fees, construction management and construction interest fees, and reasonable developer fees may also count as qualified expenses.

Peripheral development and financing costs, such as signage, yard lighting, appliances/cabinets, moving expenses, financing fees, parking lots, third-party reports, decks, sidewalks, and other similar expenses are generally not included in QREs. Porches and porticos only qualify if they were part of the original structure.

Do States Also Offer Historic Tax Credits?

In addition to the federal Historic Tax Credit, many states offer State Historic Tax Credit programs, which allow investors to offset a certain amount of their state income taxes if they invest in the substantial rehabilitation of eligible historic buildings. In most cases, State Historic Tax Credits are combined with the federal Historic Tax Credit in order to maximize a property’s investment yield.

Can Historic Tax Credits Be Combined With the LIHTC or NMTC Programs?

Historic Tax Credits typically only provide part of the funding for a historic rehabilitation project, but fortunately, HTCs can often be combined with other tax credit programs, such as Low Income Housing Tax Credits (LIHTCs), or New Market Tax Credits (NMTCs). LIHTCs are designed to encourage investment in affordable housing, and thus require that a building rent out a certain number of its units to borrowers making no more than a certain fraction of the Area Median Income (AMI), a statistic published by HUD indicating the median household income in a specific area.

In contrast, New Market Tax Credits (NMTCs) are intended to encourage the development of businesses and commercial properties in specific low-income census tracts. Investment must be done via an investment vehicle called a Certified Development Entity. Competition for both of these tax credit programs is fierce, so developers/sponsors must prepare well and demonstrate how their proposed project will positively impact the surrounding community.

Finally, it may be important to mention that all three of the aforementioned tax credit programs can often be used for investing in Opportunity Zones, specific low-income census tracts that have been nominated by the U.S. Treasury Department as economically disadvantaged. By placing funds in a specialized investment vehicle called an Opportunity Fund, investors can achieve significant tax benefits, including deferring their capital gains taxes until 2027, and paying no capital gains taxes on any appreciation their investment has experienced while in the fund (given that they hold their investment for at least 10 years).

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