Nearly reduced to history itself, the federal Historic Rehabilitation Tax Credit program—the economic catalyst behind thousands of historic building transformations—eluded the congressional chopping block last fall 2017 as legislators rushed to pass the most sweeping tax overhaul in decades. Make no mistake, it was a cliff-hanger up to the very end, and while the Historic Tax Credit program has had its wings clipped, compared to what it could have become—which is a vastly reduced credit or none at all—historic building developers, owners, architects and planners are calling it a win and among the most successful political turnarounds for the preservation community to date. The question now is, what happens next?
To review, since it was launched in 1976, the Federal Historic Preservation Tax Incentives program has been a powerful driver of private sector investment in the rehabilitation and reuse of historic buildings, leveraging $89.97 billion in private investment to preserve more than 43,000 historic properties and thereby revitalize communities and create jobs. Its centerpiece, the Historic Rehabilitation Tax Credit (HTC), launched in the 1980s under the Reagan administration, offers a tax credit—a dollar-for-dollar reduction in taxes owed—for 20% of qualifying rehabilitation costs on certified historic buildings 50 years and older.
While the basic HTC program lives on and still retains the 20% credit, as of December 31, 2017, it has been modified by, in brief, 1) extending to five years the timing for how the credit is taken; and 2) eliminating a sister incentive, the 10% tax credit for rehabilitation of non-historic buildings.
As of this writing, the modified program is still very new, with lawyers and tax professionals studying and interpreting its language. Washington watchers even anticipate further tweaks to the reform bill in coming months. While the crystal ball for the full impact of the modified HTC remains murky, opinions on its immediate consequences, as well as some long-range possibilities, are becoming clearer.
“Uncertainty is result number one,” says Donovan Rypkema, Principal at PlaceEconomics, a heritage consulting firm in Washington, DC. “Whenever there’s uncertainty, people want to wait.” Carolyn Kiernat, AIA, Principal at Page & Turnbull in San Francisco, agrees. “There’s nothing that developers like more than certainty,” she explains. “Any time there are questions about process, or procedure, or value, then the more volatility there is that, I think, collectively can adversely impact a development project.” Adds Robert D. Loversidge Jr., FAIA, President/CEO at Schooley Caldwell Architects in Columbus, OH, “Like any change in the regulations, everybody gets nervous. So, there’s an adjustment period while the program turns into whatever it will be. The good news is, it wasn’t eliminated.”
The second evident effect is the deferral of the receipts of the tax credit. “It used to be that if I do a project and spend $1 million on qualifying rehabilitation expenditures (QREs),” summarizes Rypkema, “the day I put the project into service, I get a 20%—or $200,000—tax credit. There’s still going to be a $200,000 tax credit, but now I only get 4% a year for five years, which makes a substantial difference.” What the fallout is from that difference depends upon whom you ask. “Everybody’s putting their pencil to the equation,” says Rypkema, “but I suspect that the deferral could diminish the value of the tax credit in the neighborhood of 30%. So whatever the credit was worth last year, it’s going to be worth maybe a third less from here on out.”
Worth is the key here because, surprising as it may be to the man on the street, HTCs, once earned, are often bought and sold—and not for their original dollar value. Using the $1million project example that yields a $200,000 tax credit, Rypkema explains that if he doesn’t have $200,000 worth of tax liability, he has to stretch out the timing until he can use the credit up. “That old cliché that time is money really is true. The longer I have to wait to get paid, the less valuable that payment becomes.”
This is what has led to sharing out of tax credits in some form of syndication. “Some entity—Bank of America, for example—buys the tax credits giving me, say, 90 cents or 93 cents on the dollar for the credit because they have a high enough tax liability that they can use it all the minute they get it,” says Rypkema.
Charles A. Rhuda III, CPA, partner at Novogradac & Company LLP in Boston, a firm that specializes in historic tax credit developments, points out that because historic transactions come in all sizes, there’s no one type of buyer. “Some banks do participate in the program, but also some large consumer products companies, such as The Sherwin-Williams Company, are also very large buyers of historic credit, and a couple other corporate investors that are not financial institutions are fairly active in the market.” Sometimes small- and medium-sized deals involve individuals who have some specific tax liability situation, “and then there are regional buyers, such as a regional grocery store chain that purchases federal and state credits.”
Selling credits has value too for the developer or building owner. Kiernat cites the Exploratorium at Pier 15 in San Francisco, an adaptive reuse of a historic pier where Page & Turnbull guided the preservation, tax credits, and local entitlements for a science-based interactive museum. “This was a $220- million project where they received $36.6 million back in tax credits. These credits can be brought in early on through investors who are buying the tax credits. That’s money that the Exploratorium was able put into programming, exhibit building, and hiring teachers, and an example of a non-profit organization that’s able to benefit from the credit in a big way.”
Kiernat acknowledges that the Exploratorium also spent a lot on sitework and exhibits—work that doesn’t qualify for credits. “But many developers here look at the credit as one arm of the overall financing structure of the project. I believe that there are some projects that wouldn’t go forward, or would go forward in a much different way, if they didn’t have the credit.”
Loversidge agrees. “These incentives are not a windfall for somebody; they’re really a make-it-work kind of thing that seems to affect all these projects.” He is reminded of the current adaptive reuse of a former bank building in downtown Cincinnati. “These are difficult projects—they have no flexibility, mostly vacant—and the credits make these things possible.”
Most people agree that had the HTC been modified down to 10%—actually the case in later versions of the tax bill—it would have been rendered nearly useless, but at 20% with a five-year payout, what is the possible outcome of its new diminished dollar value? Again, it depends upon whom you talk to—and where and what size they are.
As Rhuda explains, “If you’re investing a dollar today, but you’re receiving tax savings over five years, there’s a yield adjustment that goes along with that.” In the past, he says, the time between the substantial equity contribution and the allocation of the credits was fairly close. “But now if the investor is going to have to invest today and be allocated credits over five years, the pricing might be more similar to the Long-Term Low-Income Housing Tax Credit, which is received over 10 years, so people will adjust the pricing accordingly.”
Some argue that large developers deal with changing percentages, such as interest rates and construction costs, all the time, and a diminished HTC is only one part of a complex financial puzzle. Moreover, any diminishment is merely a fraction of a fraction because the HTC itself is just a 20% credit of only qualifying rehabilitation expenditures—not the expense of property acquisition, sitework, new additions, and so on.
Not all would concur, however. “What we’ve seen is that the building is the most important part of the whole project,” says Kiernat. She explains that in California and other western states, seismic concerns mean that a large percentage of the construction budget is often invested in structural work, “tens of millions of dollars just in reinforcing the structure itself, so it is helpful to have the 20% credit to offset these costs.”
A Mixed New Normal?
As luck would have it, even the most ballyhooed and non-historical part of the federal tax overhaul looks to give HTCs the proverbial haircut. “The federal tax rate going down from 35% to 21% has a direct impact on the value of HTCs,” says Rhuda, “because for each dollar invested, the investor is not saving 35 cents anymore, they’re only saving 21 cents. So, on a yield-adjusted basis, there’s an automatic reduction in the value of the credit just for the fact that a dollar of credit buys less tax savings than it did last year.”
Kiernat adds, “In addition to the lower corporate tax rate, there are changes in how depreciation of the asset is calculated, and there are limits to the amount of mortgage interest that can be deducted, so there still seems to be a lot of speculation about this.”
So, assuming the modified HTC does influence historic rehabilitation projects, will it affect some more than others? “I think it will,” opines Rypkema, “The big-league developers will figure out a way to put a deal together and make it happen—or walk away.” As he explains, “If I’m a big developer, I’ve hired accountants and tax syndicators and architects who’ve done tax credit projects before, so I can live with those kinds of time and capital costs. Plus, when I’m done with this project, I’ll do one next year—and I did one last year—so there’s much less of a learning curve.” The opposite scenario, he speculates, is the mom-and-pop hardware store on Main Street considering a $400,000 tax-act rehabilitation. They’ll get back $80,000 in federal credits and $20,000 in state credits, but conceivably, this will be the only project they ever do, so the learning curve is really steep. “With all the paperwork, money, and hassle, those kinds of projects, particularly in states with no tax credit, might really take a hit.”
After talking to smaller developers, Kiernat has a different perspective. “If they don’t have enough taxable income to use the credit in a year, they tend to like the option of spreading it out over five years.” As she explains, these might be developers under $5 million—perhaps individuals—who are not selling the credit and do not have other investors coming in. “My hunch is our smaller developers are moving forward anyway. They’re often taking the credit themselves, so this change to a five-year payout doesn’t impact them as much.” This contrasts with larger projects with larger overall dollar amounts that need to have investors use the credit immediately. “They’re the ones who may pull out.”
There’s also the question of states with tax credit programs versus those that don’t. “In Ohio, it’s really the combination of federal and state credits that is such a great thing for projects all over the state,” says Loversidge. He points to the Leveque Tower in Columbus, an early, 47-story, terra-cotta clad skyscraper completed in 1927. “The expense in dealing with that 90-year-old terra-cotta skin is incredible.” Plus, he says it’s a narrow little tower where they had to add an extra stairway due to code requirements. “Anything that happens at the federal level could have a ripple effect at the state level, and that would be really bad.”
Turns out, in many cases the impact on state programs is well beyond speculation. Renee Kuhlman, Director of Policy Outreach at the National Trust for Historic Preservation, says that the Trust is urging every one of the 35 states with HTC incentives to look at their statutes. “States need to see if either their timing is linked to the federal program, or if there are ways to increase the effectiveness of their state credits to make up for the diminishment of the federal HTC.”
She notes, for example, that in Wisconsin, the department of revenue was surprised to find that their statutes tie the timing of the state tax credit to the timing of the federal credit and will now have to be taken over a five-year period. “By my counting, there are about three states that work this way.” This coupling has its origins in the way many state tax credits build upon the federal program. “A lot of them are written so that if you get the federal credit, then you automatically qualify for the state credit.”
Says Kiernat, “States like California are at a disadvantage because we don’t have a state credit to couple with the federal credit.” Nonetheless, there’s a lot of support in California for a state tax credit. “In fact, in 2014 the state legislature passed a bill to create a state tax credit.” Ultimately the bill did not make it past the Governor’s desk, she says, but coming that far demonstrated the support that it had throughout the state.
There’s already evidence of states looking to take up the slack left by the modified federal credit. “In Wisconsin, for example, the recent legislative session just increased the amount of its per-project cap from $500 thousand to $3.5 million,” says Kuhlman, “so that’s going to do great things.” West Virginia raised its HTC from 10% to 25% in October, and in New York there is a movement now to de-couple their program from the federal structure as well as extend it to December 2024.
Of course, the opposite may also be afoot. Says Kuhlman, “I do think that states are also going to see a lot of push from state Republican legislators to take a page out of the federal credit playbook and say, ‘You know, we need to simplify our tax code.’”
As ever, change remains the only constant. “There’s some ten months left in the 115th congress,” says Kuhlman, “so if they do start making technical corrections to the tax code, there may be a possibility to look at incorporating provisions in the HTC Improvement Act. Because Congress retained the program, but they didn’t improve it—and there’s ‘always room for improvement.’”
The Transition Situation
Projects already in the works may be “grandfathered” in under the old HTC rules if, in a nutshell, they meet two requirements:
1: The taxpayer has to have owned or leased the property in question by December 31, 2017 and then continuously own or lease it thereafter;
2: The project has to be placed in service—that is substantially completed—by either 2020 or 2023 (dates determined by eligibility to use either the 24-month or 60-month measuring period under the Substantial Rehabilitation Test).
Tax experts are still interpreting how these rules apply to specific projects, especially regarding terms such as “owned,” “leased,” and “continuously owned.”
Why Five Years?
In a welcome bit of parliamentary Ju-Jitsu, last fall Senator Bill Cassidy (R-LA) and other Finance Committee Senators reversed the dimming fate of the federal HTC by changing not only the percentage but the terms. While the “Cassidy Amendment” restored the HTC to 20%, it also provided that it be taken over five years—a timeline that pushed some of the payments out of the 10-year budget window that every bill works on, thus becoming a cost-saving measure versus the federal budget.
More Historic Tax Credit Resources
National Trust for Historic Preservation
Historic Preservation advocacy
Novogradac & Company LLP
Accountants and consultants with specialization in and reports on historic tax credit developments
National Park Service
Info on the federal tax incentives program
Historic Tax Credit Coalition
Historic Tax Credit advocacy