Historic Tax Credits (in 10 minutes or less)

1
Historic Tax Credits (in 10 minutes or less)

• Housing Tax Credit Conference 101
• October 16, 2008
• Boston, MA
• Presented by
• Daniel J. Kolodner, Esq., Nixon Peabody LLP

2
Two Types of Rehabilitation Tax Credits

• IRS Code Section 47
• Older (pre-1936), non-historic and
  non-residential buildings 10 percent of
  qualified rehabilitated expenditures. (not
  available for housing projects)
• Historic buildings 20 percent of qualified
  rehabilitation expenditures.

3
The 20 Rehabilitation Tax CreditFundamentals

• Tax Aspects Administered by the IRS.
• Preservation aspects jointly administered by NPS
  and State Historic Pres. Offices (SHPOs).
• RTC is the most important (in dollar volume)
  federal preservation program.

4
The 20 Rehabilitation Tax CreditStatistics

• 1,045 projects approved by NPS in 2007
• In 2007, roughly 45 of HTC projects were for
  multi-family housing 21 for office 27 for
  commercial
• Top states ranked by Part 3 approvals MO (189),
  OH (115), VA (89), NC (51), (FY 2007 statistics)
• More than 4.34 billion in private investment
  leveraged by up to 869 million in tax credits
• Source Annual Report for Fiscal Year 2007
  Federal Tax Incentives for Rehabilitating
  Historic Buildings National Park Service

5
Historic Tax Credits and Affordable Housing

• In FY07, HTC projects created 18,006 housing
  units, of which 36 (6,553) were low/mod units.
• In FY07, 8 of projects claiming HTCs also
  utilized the LIHTC.
• HTC program has financed 76,023 low/mod income
  units since its inception.
• Source Federal Tax Incentives for Rehabilitating
  Historic Buildings, Statistical Report and
  Analysis for Fiscal Year 2007

6
Benefits of using Historic Buildings for
Affordable Housing

• Smart growth proximity to work, shopping and
  transportation.
• Rehab is inherently green.
• Attendant renovation of community landmarks can
  lessen neighborhood resistance to citing of
  affordable housing.
• Increased building amenities and intangibles
  associated with culture and heritage.
• Relief from zoning availability of property tax
  breaks.
• See http//nthp.org/housing/Missed_Connection.pd
  f

7
Challenges of using Historic Buildings for
Affordable Housing

• Cost per unit can be higher (particularly as
  calculated in some QAPs).
• Application of 106 standards triggered if federal
  funds are used Secretary of the Interiors
  standards if HTCs are used.
• Requirement to reduce eligible basis for the
  LIHTC by the amount of the HTCs (in a single
  entity structure).

8
What Types of Buildings Qualify?The NPS Rules
Certified Historic Structure Requirement
Option 1 Building is listed in the National
Register of Historic Places.

• Option 2
• Building is located in a registered historic
  district and certified by the Sec. of the
  Interior as being of historic significance to
  the district.

9
What Types of Buildings Qualify?The IRS Rules
Depreciable Building Requirement

• Must be a building. Building is defined as a
  structure or edifice enclosing a space within its
  wall and usually covered by a roof.
• Building must be depreciable. Depreciable
  buildings are generally those used for
  nonresidential (i.e. commercial) or residential
  rental purposes. (See Section 168(e))

10
What Types of Rehabilitations Qualify?The IRS
RulesSubstantial Rehabilitation Requirement

• The QREs incurred during any 24-month period
  selected by the taxpayer and ending in the
  taxable year in which the building is placed in
  service must exceed the greater of
• 5,000, or
• The adjusted basis of the building.
• A 60-month period may be used where written
  plans completed before the rehab begins show that
  the rehab is expected to take place in phases and
  is reasonably expected to take more than 24
  months.

11
What Types of Rehabilitations Qualify?Definition
of QREs

• Qualified Rehabilitation Expenditures (QREs) is
  the tax term given to those development costs on
  which rehabilitation tax credits can be claimed.
• QREs are any amounts chargeable to a capital
  account made in connection with the renovation,
  restoration or reconstruction of a qualified
  rehabilitated building (including its structural
  components), except as provided by law.

12
What Types of Rehabilitations Qualify?
Definition of QREs

• QREs include costs related to
• walls, partitions, floors, ceilings
• permanent coverings such as paneling or tiling
• windows and doors
• air conditioning or heating systems, plumbing and
  plumbing fixtures
• chimneys, stairs, elevators, sprinkling systems,
  fire escapes

13
What Types of Rehabilitations Qualify?
Definition of QREs (contd)

• QREs include costs related to
• construction period interest and taxes
• architect fees, engineering fees, construction
  management costs
• reasonable developer fees
• Note The calculation of Eligible Basis for LIHTC
  purposes is not the same as the calculation of
  QREs

14
What Types of Rehabilitations Qualify?
Definition of QREs

• Costs EXCLUDED from QREs
• Land and building acquisition
• Enlargements that expand total volume (cf.
  remodeling that increases FMR)
• Personal property (furnitureand appliances,
  cabinets andmovable partitions, tacked
  carpeting)
• New building construction
• Sitework (demolition, fencing,parking lots,
  sidewalks, landscaping)

15
The 20 Rehabilitation Tax CreditCalculating the
Allowable Credit

• Credit equals 20 of all QREs incurred
• Prior to the start of the 24-month period
  selected (so long as they were incurred in
  connection with the rehab process that resulted
  in the substantial rehabilitation of the
  building)
• During the 24-month period and
• After the last day of the 24-month period but
  before the last day of the tax year in which the
  measuring period ends.

16
The 20 Rehabilitation Tax CreditWhen is the
Credit Allowed?

• Credit is generally allowed in the year in which
  the building is placed in service (provided
  substantial rehabilitation test has been met).
• Placement in Service means that the all or
  identifiable portions of the building is placed
  in a condition or state of readiness and
  availability for a specifically assigned
  function.
• Progress Expenditure Election available for
  properties with a normal construction period of
  2 years or more

17
The 20 Rehabilitation Tax CreditRecapture

• Credit previously allowed is recaptured if any
  portion of the project which includes QREs is
  disposed of prior to the fifth anniversary of
  placement in service.
• Amount subject to recapture decreases by 20
  during each year of the five year period.

18
The 20 Rehabilitation Tax CreditRecapture

• Disposition includes any sale, exchange,
  transfer, gift or casualty. Subsequent rehabs
  that do not comply with the Secretarys Standards
  can trigger recapture.
• Reduction of a partners interest can be deemed a
  disposition (33 rule).

19
Parting Thoughts

• Availability of State Historic Tax Credits
• Importance of Placed-in-Service deadlines
  (differences between LIHTC and HTC)
• Importance of a team familiar with Historic Tax
  Credits from the beginning of the transaction
• Structuring (Single Entity vs Lease/Pass-Through)

20
Single Entity Structure
Tax Credit Investor LLC
Tax Credit Investor
Managing Member (Developer Affiliate)
Tax CreditEquity
99.99 Credits, Profits Losses and Cash Flow
.01 Credits, Profits Losses, Fees andCash Flow
DeveloperEquity
Tax Credit, LLC (Property Owner)
Developer
Dev.Fee
DebtServicePayments
RentalPayments
LoanProceeds
Construction/Perm Lender
21
Impact of HTC Basis Reduction on Equity
RaisedSample Transaction Assumptions

• 1,000,000 Qualified Basis (Eligible Basis x
  Applicable Fraction)
• 950,000 Qualified Rehabilitation Expenditures
  (QREs)
• LIHTC Pricing .75 per 1 of LIHTC
• Historic Tax Credit Pricing .90 per 1 of HTC
• LIHTC Credit Percentage 8 (in each of 10
  years)
• HTC Credit Percentage 20 (in year of placement
  in service)

22
Impact of HTC Basis Reduction on Equity
RaisedLIHTCOnly Transaction

• 1,000,000 x .08 x 10 x .75 600,000

23
Impact of HTC Basis Reduction on Equity
RaisedHTCOnly Transaction

• 950,000 x .20 x .90 171,000

24
Impact of HTC Basis Reduction on Equity
RaisedTwinned LIHTC/HTC Transaction

• HTC Equity 950,000 x .20 190,000 190,000
  x .90 171,000
• LIHTC Equity 810,000 (1,000,000 - 190,000 ) x
  .08 x 10 x .75 486,000
• Aggregate Twinned LIHTC/HTC Equity 486,000
  171,000 657,000 (compare 600,000)

25
Impact of HTC Basis Reduction on Equity
RaisedLIHTC-Only Transaction in QCT/DDA

• LIHTC Equity 1,000,000 x 130 x .08 x 10 x .75
  780,000

26
Impact of HTC Basis Reduction on Equity
RaisedTwinned LIHTC/HTCTransaction in QCT/DDA

• HTC Equity 950,000 x .20 190,000 190,000
  x .90 171,000
• LIHTC Equity 810,000 (1,000,000 - 190,000 ) x
  130 x .08 x 10 x .75 631,800
• Aggregate Twinned Equity 631,800 171,000
  802,800 (compare 780,000)

27
More Information?

• Daniel Kolodner, Esq.
• dkolodner_at_nixonpeabody.com
• 617-345-1053