A Guide to Claiming the Historic Tax Credit
January 03, 2022
By King Cheng
The Federal Historic Preservation Tax Incentive program is the largest federal program related to the rehabilitation and re-use of historic buildings. It is administered by the National Park Service (“NPS”) and IRS in partnership with the respective State Historic Preservation Offices (“SHPO”). Every year, approximately 1,200 projects are approved, leveraging nearly $6 billion of private investments in historic preservation and community revitalization.
Commonly known as the historic tax credit, the rehabilitation credit is an investment credit and part of the general business credit. The amount of credit equals 20% of qualified rehabilitation expenditures (“QRE”). The credit is available to be claimed ratably over a five-year period beginning in the taxable year that the qualified rehabilitated building is placed in service.
The Tax Cuts and Jobs Act repeals a 10% credit previously available for rehabilitation of non-historic buildings placed in service before 1936. The legislation provides transition rules to claim the rehabilitation credit under provisions that existed prior to January 1, 2018.
Taxpayers that own an interest in the building directly or through a pass-through entity are eligible to claim the credit. A lessee of a building (or portion of a building) is also eligible, if the lessor that owns the building elects to treat the lessee as the building owner solely for the purpose of the credit. A lessee of a long-term lease can claim the credit without the lessor’s election if certain requirements are met.
Qualified Buildings and Expenditures
To qualify for the credit, the taxpayer must have qualified rehabilitation expenditures with respect to a qualified rehabilitated building.
Some key definitions of qualified rehabilitated building are:
- The building must be a certified historic structure, either individually listed or as a contributing building on the National Register; or be a contributing building to a state and local certified historic district.
- Depreciation is allowable with respect to the building, and it was placed in service as a “building” before the beginning of rehabilitation.
- The rehabilitation work must be undertaken according to the Secretary of the Interior’s Standards of Rehabilitation. The building must be substantially rehabilitated during a 24-month measuring period where the rehabilitation costs exceed $5,000 or the adjusted basis of the building and its structural components, whichever is greater. The 24-month measuring period is selected by the taxpayer and it can be substituted by a 60-month measuring period if certain requirements are met.
- The building must be owned by the same owner and continue to be operated as an income-producing property for five years after rehabilitation.
In general, costs directly related to the repair and improvement of the structural and architectural features of the historic building will qualify. In addition to hard costs, some soft costs qualify, including construction period interest and taxes, architect and engineering fees, construction management costs, and developer fees. The expenditures should be incurred by the taxpayer.
Expenditures not qualified as QRE include:
- Acquisition costs, including interest incurred on indebtedness that is attributable to the acquisition.
- Enlargement costs where the total volume of the building is increased. Increase in floor space resulting from interior remodeling, however, is not considered an enlargement.
- Expenditures attributed to work done to facilities related to the building (for example, sidewalks and parking lots).
For property used for both business and non-business purposes, an allocation of the QRE must be made, generally based on a square footage percentage.
Application of Certified Rehabilitation
As part of the process to qualify for the credit, the property owner must complete the appropriate part or parts of the Historic Preservation Certification Application, NPS Form 10-168. It is a three-part application:
- Part 1, Evaluation of Significance. Document the building is a certified historic structure and is eligible for the credit.
- Part 2, Description of Rehabilitation. Explain the scope of rehabilitation and provide drawings to show the existing conditions and the proposed rehabilitation work.
- Part 3, Request for Certification of Completed Work. Document the completed work and substantiate the application by “before and after” photographs and architectural plans.
Part 1 and 2 of the application may be submitted together or separately. Applicants should submit the application of Part 2 and receive approval from the NPS prior to the start of construction. Applicants are advised to consult the SHPO early and throughout the application process for technical assistance.
Completed applications are submitted to the SHPO, where SHPO reviews and forwards the applications to the NPS with its recommendations. NPS makes the final certification decisions and once approved, it certifies Part 3 (“Certification”).
Claiming the Credit
Generally, the rehabilitation credit is first allowed in the taxable year that the certification is issued and the qualified rehabilitated building is placed in service.
A property is placed in service when it is ready and available for a specifically assigned function. If a building remains in service (or partially in service) during the rehabilitation, the property that is attributable to QRE is considered as placed in service when the building (where the property is a part) meets the definition of a qualified rehabilitated building.
To claim the credit, taxpayers file Form 3468, Investment Credit. The form requires the NPS project number and the date of certification. Taxpayers must attach the form to the return for each year that the credit is claimed. Entities that do not claim the credit but pass through QRE file the form too. Eligible lessees also file Form 3468 where the lessor, on its return, will attach a copy of the election pursuant to Treasury Regulation Section 1.48-4(a)(1).
Guidelines are available for situations that the certification has not yet issued at the time of tax filing for the year that the credit is claimed.
Depreciation and Basis
In general, the rehabilitation credit is available only if the taxpayer uses the straight-line method of depreciation on the qualified rehabilitated building. One of the implications is that cost segregation study, which aims to identify components for accelerated depreciation, may be counterproductive as it reduces QRE and hence the credit.
Basis of the property is reduced by the full amount of the credit. If there is credit recapture in a taxable year, the basis is increased by the recapture amount. Different rule applies to a lessee who claims the credit. Instead of basis adjustment, the lessee must include in gross income, over the recovery period of the property, an amount equal to the credit. There is no basis adjustment for the lessor.
The rehabilitation credit is recaptured if the property is disposed of, ceases to be investment credit property, or is destroyed by casualty during the five-year period. Partially damaged property will not trigger recapture if the owner makes necessary repairs and places the property back in service. The recapture percentage is 100% within one full year after the property is placed in service; reduced by 20% points for each year held during the five-year period.
Recapture also occurs when a partner’s interest in a partnership is reduced by more than one-third. The reduction is treated as a proportional disposition of the property.
As an investment credit, the taxpayer’s ability to claim the rehabilitation credit may be limited by other tax provisions in a given taxable year. Examples of limitation include passive activity loss rules, at-risk rules, and general business credit rules. Generally, the taxpayer is allowed to carryback one year and carryforward twenty years unused portion of the general business credit.
The rehabilitation credit can be used in conjunction with the low-income housing tax credit and façade easement contribution.
Thirty-nine states have their own historic tax credits that can be used in tandem with the federal credit. Most of them mirror the federal program with different credit percentages and transaction caps.
IRS – Rehabilitation Credit FAQs
IRS – Rehabilitation Credit Real Estate Tax Tips