This memorandum briefly update our last historic tax credit memo and describes the Federal Historic Rehabilitation and Texas Historic Preservation Tax Credits. Depending on the eligibility of a project, one or both of these tax credits can be utilized as important sources of financing for projects involving rehabilitation and revitalization of historic buildings and buildings within historic districts in Texas.
Federal Historic Rehabilitation Tax Credit
The Federal Historic Rehabilitation Credit provides a 20% tax credit to owners of buildings listed in or eligible for listing in the National Register of Historic Places. The program is administered by the
National Park Service (“NPS”). Owners apply for the credit through the NPS. The credit, provided for in Internal Revenue Code Section 47, is equal to 20% of qualified rehabilitation expenses for a certified historic structure. Buildings that do not qualify as certified historic structures may, nevertheless, be eligible for a 10% tax credit on qualified rehabilitation expenses provided the building was placed in service prior to 1936 and other requirements are satisfied. The tax credit has a compliance period of 5 years, during which the owner must hold the property, with the recapture amount reduced by 20% during each year of the compliance period. Additionally, there are special rules regarding use and ownership of historic buildings by tax-exempt entities for purposes of allowing the credit. Generally, these credits are used to provide financing for a project through investments in the project by banks and other investors in exchange for the tax credits. These credits can also be used in conjunction with New Markets Tax Credits or other investment tax credits to provide financing for a given project.
Texas Historic Preservation Tax Credit
In 2013, Texas enacted a state historic preservation credit. Generally, the legislation provides a 25% credit against Texas franchise tax for qualified expenses incurred with respect to certified historic structures placed in service on or after September 1, 2013. The Texas credit tracks many of the requirements of the federal tax credit and building-owners must follow a similar application process. The state credits may be taken beginning January 1, 2015 and are freely transferrable and assignable. On March 3, 2014, the Texas Attorney General’s office released an opinion clarifying sections of the legislation and the Texas Historic Commission has released proposed rules implementing the program. The Texas credit could add significant value to qualifying taxpayers who choose to proceed with the process for obtaining the federal tax credit. Further, the Texas credit may provide an opportunity for certain taxpayers or projects that do not qualify for the federal credit.
Certified Historic Structures
The 20% federal tax credit only applies to Certified Historic Structures. Historic buildings qualify as Certified Historic Structures if they are listed in the National Register of Historic Places. If they are not individually listed in the Register, they can still qualify if they are located in a registered historic district and are certified by the NPS as contributing to the historic significance of that district. Buildings not currently registered can apply to be listed in the National Register through the NPS application process.
As mentioned, buildings that are not eligible for certification may still qualify for the 10% tax credit provided they were placed in service prior to 1936. The 10% tax credit has no application or review process and is claimed on Form 3468. A rehabilitation project on a pre-1936 buildings will qualify provided the applicable existing external wall/internal structure test is met. For most projects, 50% or more of existing external walls must be retained as external walls, 75% or more of existing external walls must be retained as internal or external walls, and 75% or more of internal structural framework must be retained in place. Further, expenditures that increase the total volume of the building will not qualify for the credit.
Tax Credit Application Process
For the 20% federal credit, the applications are administered by the NPS through a three-step process. Part 1 allows currently unlisted buildings to apply for and obtain certification to be listed in the National Register of Historic Places, and therefore, become eligible for the credit. Part 2 provides a detailed plan of rehabilitation for the Certified Historic Structure and Part 3 is a request for Certification of Completed Work, which makes the tax credit available to the owner.
Part 1 consists of an application for Certified Historic Structure status. Buildings already listed in the National Register of Historic Places are already certified and do not have to complete this step of the application process. Upon completion of Part 1, the application is submitted to the applicable State Historic Preservation Office (“SHPO”) in the state the building is located. The SHPO reviews the application for compliance with the standards for registered historic structures and forwards the application to the NPS with a preliminary recommendation. The NPS then evaluates the application based on the Standards for Evaluating Significance within Registered Historic Districts, promulgated by the Secretary of the Interior. Among the relevant factors evaluated are the location, design, setting, materials, workmanship, feeling and association that add to the district’s sense of time and place and historical development. The NPS will also determine whether alterations to or deterioration of the building have been so extensive as to diminish its overall integrity. Generally, buildings constructed within the past fifty years will not be certified.
Part 2 of the application consists of certification of the plan of rehabilitation for the Certified Historic Structure. In determining whether the plan constitutes a Certified Rehabilitation, the NPS will look to its consistency with the historic character of the property and the historic character of the district in which it is located. Additionally, the plan of rehabilitation must not damage, destroy or cover materials or features that help define the building’s historic character or significance. Part 2 of the application is also initially overseen by the SHPO, which is available to provide technical assistance and literature on appropriate rehabilitation and advise owners on their applications. The SHPO will also make site visits to the structure as part of this review process. Finally, the SHPO will forward the application with a recommendation to the NPS. The NPS will review the application for conformity with the Standards for Rehabilitation issued by the Secretary of the interior and will issue a certification decision after reviewing the project. Once this certification has been obtained, construction on the project can commence.
Upon completion of the project, the owner submits Part 3 of the application, requesting Certification of Completed Work. Again the SHPO will review and make an initial recommendation to the NPS. The NPS will evaluate the completed project for conformity with the plan of rehabilitation that was certified in Part 2 of the application. Upon Certification of the Completed Work, the building is automatically eligible for the tax credit.
Technical Requirements of the Credit
In addition to the standards for Certified Historic Structure and Certified Rehabilitation status imposed by the NPS, Code Section 47 imposes technical requirements on the uses of the building and the amount, substance, and timing of the rehabilitation that will be eligible for the tax credit. The building must be depreciable, that is it must be used in a trade or business or otherwise held for the production of income. Additionally, the approved plan of rehabilitation must meet a “substantial rehabilitation test.” A rehabilitation plan will be considered substantial if expenditures exceed the greater of $5,000 or the adjusted basis of the building and structural components over a 24-month measuring period. Once these threshold requirements are met, the tax credit may be claimed for all qualified expenditures incurred before the measuring period, during the measuring period, or after the measuring period through the end of the taxable year in which the building is placed in service. Additional requirements are imposed of the plan of rehabilitation is to be completed in multiple phases.
The tax credit applies only to qualified expenses incurred during the rehabilitation. Generally, qualified expenses are those costs that are added to the property basis. Common examples include the cost of work on the building structure, architectural and engineering fees, site survey fees, legal fees, development fees and other construction-related costs. Qualified expenses, however, will not include acquisition or furnishing costs, the cost of any new additions or expansions, new building construction, parking lots, sidewalks, landscaping or other related facilities. An exhaustive list of qualifying and non-qualifying expenses can be found in Code Section 47 and the accompanying Treasury Regulations.
Claiming the Credit and Limitations
Once the rehabilitation is completed, the credit can be claimed for the tax year in which the building is placed in service. Unused tax credit can be carried back one year or carried forward 20 years. The credit is claimed on Form 3468 and the approved application is required to be filed with the tax return. The credit cannot be used to offset the Alternative Minimum Tax and is also subject to the passive and at-risk loss rules. To satisfy the five-year compliance period, the owner must hold the building for five years after completing the rehabilitation. If the owner transfers the building within the compliance period, recapture of the credit is 100% during year 1 and is phased out by 20% during each successive year. Finally, there are certain limitations on buildings that are leased to tax exempt entities. Subject to specific requirements, such leases may be disqualified and prevent the owner from taking the credit. Generally, a safe harbor will protect the owner’s use of the credit if less than 35% of a building is leased to a tax exempt entity.
Texas Historic Preservation Tax Credit
As mentioned above, the Texas credit follows many of the requirements of the Federal credit including the Certified Historic Structure and Qualified Rehabilitation Expenses requirements. Generally, historic rehabilitation projects located in Texas that qualify for the Federal credit will also qualify for the state credit. The proposed rules implementing the Texas credit state that while taxpayers must qualify for the federal and Texas credits independently, determinations by the National Park Service concerning, for example certified historic structures and qualified rehabilitation expenses, will be binding on the Texas Historical Commission in evaluating an application for the Texas credit. The three-part application, which has not yet been released, will also likely mirror the application for the federal credit.
In addition to this similarities between the federal and Texas credits, the Texas credit expands eligibility beyond buildings and districts listed in the National Register of Historic Places. Buildings may qualify for the Texas credit if they are designated as Recorded Texas Historic Landmarks, State Antiquities Landmarks, or buildings that contribute to the historic significance of certified local districts. Additionally, unlike the federal credit, qualified expenses need only exceed $5,000 and there is no adjusted basis test for the minimum expenditure threshold. Eligibility for the credit requires certification by the Texas Historical Commission after completion of the project.
Once the project has been certified, owners of buildings placed in service after September 1, 2013 are eligible for a 25% franchise tax credit against qualified expenses. Buildings placed in service after September 1, 2013 and before January 1, 2015 may include eligible costs and expenses incurred up to 48 months prior to the date the property is placed in service. While the review process may begin prior to the effective date of the credit (January 1, 2015), no certificates of eligibility will be issued and no tax credits may be claimed prior to that date. For buildings placed in service after January 1, 2015, Part A of the application (requesting certification of the building as a historic structure) must be submitted prior to the building being placed in service.
In order to claim the credit, an owner must submit to the Comptroller the certification issued by the Texas Historical Commission, an audited cost report itemized eligible costs and expenses incurred in the rehabilitation, evidence of the date the building was placed in service after the rehabilitation, and an attestation as to the qualifying expenses incurred. The credit may be carried forward for five years. The credit may also be freely transferred or assigned to other entities, provided that notice of the sale or assignment is submitted to the Comptroller. There is no limit as to the number of sales or assignments allowed, but the credit may only be claimed on an annual report by one entity. This free transferability allows more flexibility than the federal credit as entities not subject to the franchise tax may claim the tax credits and sell or assign such credits to taxable entities. This feature could potentially allow non-profits and other entities not subject to Texas franchise tax to benefit from the credit by claiming the credit for a qualifying project and selling or assigning to a taxable entity.
We expect further clarification and guidance regarding the application of the Texas historic credit throughout the year. The comment period for the proposed rules issued May 23, 2014 will end June 22, 2014 and we expect final regulations and the application to be released later this Summer. In the meantime, we recommend that entities interested in potentially qualifying for both the Texas and federal credits to proceed with the certification and approval process for the federal tax credit. This should streamline the approval process for obtaining a certificate of eligibility for the state credit. Further, taxpayers who placed historic rehabilitations in service after September 1, 2013 should examine whether they may be eligible to claim franchise tax credits on part or all of their rehabilitation expenses.
For further information regarding the either the Federal or Texas Historic Tax Credits, please contact us at (210) 228-9500 or visit us on the web at http://kslawllp.com.