Economic Development: Frequently Asked Questions About Tax Credits

Frequently Asked Questions About Tax Credits

REHABILITATION TAX CREDITS

Historic places connect us to our heritage and enrich the quality of our lives in countless intangible ways and their preservation also provides demonstrable economic benefits. Through the federal and state Rehabilitation Tax Credit Programs, property owners are given substantial incentives for private investment in preservation, resulting in enormous advantages to the public. Since the federal program’s inception in 1976, over 1,600 deteriorated old buildings in Virginia have been returned to productive service, representing a private investment of over $706 million. The state program was initiated in 1997 and has already generated over $63 million of economic activity independent of the federal program. This money represents costs paid into the construction industry, to architects, contractors, craftsmen, and suppliers, with a corresponding increase in local employment. The capital improvement to the buildings results in increases in local property taxes, as well as a general enhancement in commercial activity. The rehabilitated buildings provide desperately needed housing (in many cases, low- and moderate-income housing), and office, retail, and other commercial space. Communities benefit from property improvement, blight removal, and increased occupancy of buildings in historic core neighborhoods.

   This guide describes the state and the federal Rehabilitation Tax Credit Programs. Both programs are administered in Virginia through the Virginia Department of Historic Resources.

   The state tax credits are available for owner-occupied, as well as income-producing, buildings. If your property is income-producing you may also be able to take advantage of the federal tax credits. Please read through this guide carefully for an overview of the programs. Additional information and assistance with projects may be requested from the Richmond office or from the regional office in your area:

Administrative Services
10 Courthouse Avenue
Petersburg, VA 23803
Tel: (804) 863-1624
Fax: (804-862-6196

Capital Region Office
2801 Kensington Avenue
Richmond, VA 23221
Tel: (804) 367-2323
Fax: (804) 367-2391

Portsmouth Region Office
612 Court Street, 3rd Floor
Portsmouth, VA 23704
Tel: (757) 396-6707
Fax: (757) 396-6712

Roanoke Region Office
1030 Penmar Avenue, SE
Roanoke, VA 24013
Tel: (540) 857-7585
Fax: (540) 857-7588

Winchester Region Office
107 N. Kent Street, St. 203
Winchester, VA 22601
Tel: (540) 722-3427
Fax: (540-722-7535

What are the rehabilitation tax credits?
The rehabilitation tax credits are dollar-for-dollar reductions in income tax liability for taxpayers who rehabilitate historic buildings. Credits are available from both the federal government and the State of Virginia.
The amount of the credit is based on total rehabilitation costs. The federal credit is 20% of eligible rehabilitation expenses. The state credit is 25% of eligible rehabilitation expenses. In some cases, taxpayers can qualify under both programs, allowing them to claim credits of 45% of their eligible rehabilitation expenses.

What buildings qualify for the tax credit program?
The credits described above are available only for Certified Historic Structures, which are defined as follows:
Under the federal program, a certified historic structure is one that is either:
•   Individually listed on the National Register of Historic Places, or
•   Certified as contributing to a district that is so listed.
Under the state program, a certified historic structure is one that is:
•   Individually listed on the Virginia Landmarks Register, or
•   Certified as eligible for listing, or
•   Certified as a contributing structure in a district that is so listed.
With a few exceptions, most Virginia properties are listed on both registers. Note, however, that national and Virginia register historic districts may be different from locally designated historic districts. Certification that a building contributes to a listed district, or for purposes of the state credit, is eligible for individual listing, is obtained only by submitting Part 1 of the tax credit application.

What work qualifies for the credits?
   The rehabilitation work for the entire project must meet The Secretary of the Interior’s Standards for Rehabilitation. If the project does not meet these standards, no part of the credit may be claimed. If the work is certified as meeting these standards, the credit is based on all eligible expenses.

   Technically speaking, eligible expenses include any work that is properly chargeable to a building’s capital account in connection with a certified rehabilitation. This means that all work done to structural components of the building will be eligible, as well as certain soft costs such as architectural and engineering fees, construction period interest and taxes, construction management costs, and reasonable developer fees. Acquisition costs, however, and any expenses attributable to additions or enlargements of the building, are not eligible. Under the federal program, site work and landscaping elements are not eligible expenses. Under the state program, certain site work may be eligible. Expenses related to new heating, plumbing, and electrical systems are eligible, as well as expenses related to updating kitchens and bathrooms, compliance with ADA, and fire suppression systems and fire escapes.

How much money do I have to spend?
   Under the federal program, the project must be a “substantial rehabilitation” to qualify the investor for the credit. The Internal Revenue Service defines "substantial" as exceeding the owner's adjusted basis in the building, or $5,000, whichever is greater.   The adjusted basis is generally defined as the purchase price, minus the value of the land, minus any depreciation already claimed, plus the value of any earlier capital improvements.
   The threshold requirements for the state program are different from the federal requirements. In order to qualify for the state credit, the rehabilitation expenses must be:
For owner-occupied structures, at least 25% of the assessed value of the buildings for local real estate tax purposes for the year before the rehabilitation work began.
For all other eligible structures, at least 50% of the assessed value of the buildings for local real estate tax purposes for the year before the rehabilitation work began.

How long do I have to complete the rehabilitation?
   The rehabilitation does not have to be completed within any particular period of time. However, the “substantial rehabilitation” test (for the federal program) and the “material rehabilitation” test (for the state program) must be met within a consecutive 24-month period that ends some time during the year in which the credits are claimed. Essentially, this means that for most projects the greatest expenditures must be made within a 2-year period. For phased projects, the time limit is extended to 60 months.

My project has taken longer than I expected, and although I have spent more than my adjusted basis in the building, I have not spent it within a 24-month period. Can I decide to phase my project in order to take advantage of the 60-month measuring period?
   No. In order to use the 60-month measuring period for a phased project, the taxpayer must phase the project from the beginning. This means that a phasing plan, showing what work will be completed during each phase of the project, must be submitted before work begins. For some projects, it may be a good idea to submit a phasing plan at the start of the project, even if there is a possibility the project can be completed within two years. This will “hold open” the 60-month time period, but does not obligate the taxpayer to take that long to complete the project.

If my building is in a historic district that is not yet listed, can I start my rehabilitation anyway?

   Yes, but you do so at the risk that for some reason the district will not be listed. It is a good idea to wait until the listing process is at least well underway and appears to be on track before doing any substantial work. You will not be eligible to claim the credit until the district is actually listed.

When can I claim the credit?
   The credit is claimed in the year the rehabilitation is completed. If you cannot use up the full amount of the credit in the first year, it can be carried forward. The federal credit may be carried forward for up to 20 years, and back for one year. The state credit may be carried forward for up to 10 years. There is no carryback for the state credit.

Can I sell the building after I complete the rehabilitation?
   Under the federal program, if the building is disposed of, or if it loses its income-producing status, within five years after the rehabilitation is completed, the taxpayer will face recapture of the credit. The amount of recapture is reduced by 20% in each succeeding year after the year the rehabilitation is completed — in other words, if the building is sold after one year, there will be recapture of 80% of the credit, if it is sold after two years, there will be recapture of 60% of the credit, and so forth. In addition, the National Park Service reserves the right to inspect a rehabilitated property any time during the five-year period, and to revoke certification if work was not undertaken as presented in the application, or if further unapproved alterations have been made.
   Under the state program there is no continuing ownership requirement following completion of the rehabilitation.

Can I sell the tax credits?
   Technically speaking, no. Credits may be syndicated through the use of limited partnerships, but they may not be directly sold. Syndication is a common tool for bringing investors into a rehabilitation project, but must be carefully thought out at the beginning of the project. Federal credits must be allocated according to percentage of ownership. The state credit, however, may be allocated by agreement among partners.

How can a nonprofit organization take advantage of the tax credits?
   By taking on taxpayers under a limited partnership arrangement and maintaining a minority ownership interest as a general partner, many nonprofit organizations have been able to use the tax credits to their advantage.

How do I apply for the credit?
   Applying for the credit is a three-part process. Part 1 requests certification that the building is historic — i.e. eligible for the program. For properties that are individually listed, Part 1 is not necessary. For all other properties — i.e. those seeking certification that they are contributing structures in a listed historic district or individually eligible for listing — a Part 1 is required. Photographs showing the property in its pre-rehabilitation state must be submitted with Part 1.
   Part 2 requests certification that the proposed rehabilitation work appears to be consistent with the Secretary’s Standards. Part 2 is the most complex part of the application. It requires a description of each significant architectural feature of the property and how it will be treated in the rehabilitation. Many property owners choose to complete Part 2 themselves using the department’s Sample Rehabilitation Proposal as a guide. Others hire a professional consultant to assist them. A list of consultants is available from the department upon request. Additional photographs of the property are sometimes necessary to document Part 2.
   Part 3 requests certification that the completed work is consistent with the Secretary’s Standards. Photographs showing the completed work must accompany Part 3. For the state credit, if the eligible expenses exceed $100,000, a CPA certification is also required.

What are the standards for photographic documentation for the application?
The size and clarity of the photographic images must adequately document the before-and-after conditions of the building. Twenty-four to 36 photographs are generally sufficient for the average project. However, it is better to have more photographs than to have too few. Conventional 35mm color photographs are preferred. Although the popularity of digital photographs has increased, they generally fail to provide adequate resolution of details that are an important source of information. If photographs are judged to be insufficient, the reviewer may place your application on hold and request additional photographs, which could delay your project’s progress.
As noted in the application, photographs must be labeled on their reverse with the following information:
building name and/or address
view (e.g., north side)
description (e.g., plaster damage in dining room, north wall).
Photographs must be numbered and keyed to the description of proposed work.

What should I photograph?
   For most buildings, the following features should be photographed in order to allow for proper evaluation:
•   Site and surrounding environment. Streetscape photographs are recommended for urban buildings.
•   All exterior elevations. Where elevations are partially blocked by adjacent buildings or trees, it may be necessary to take several photographs from different angles to show the whole elevation.
•   Typical exterior features: siding, window sash, foundations, roofing, shutters.
•   Details of deteriorated exterior features: peeling paint, failed mortar joints, deteriorated sash.
•   Exterior areas where major rehabilitation work is proposed.
•   Outbuildings: garages, barns, dependencies.
•   Major interior spaces: hallways, stairways, parlors, and principle rooms. Wide-angle photographs are strongly recommended.
•   Typical interior spaces, including all areas to be affected by the rehabilitation.
•   Major interior features: staircases, mantelpieces, woodwork, etc.
•   Representative interior finishes: peeling paint, failed plaster, rotten woodwork, previously altered features.
Interior areas where major rehabilitation work is proposed.

How do I claim the credit?
The federal credit is claimed on Internal Revenue Service (IRS) Form 3468. The IRS requires information related to the substantial rehabilitation test and a copy of the certification of the completed work by the Secretary of the Interior. To claim the state credit, the taxpayer must complete the state Schedule CR and attach a copy of the certification of the completed work by the Department of Historic Resources.

What is the 10% credit?
The federal government allows a 10% rehabilitation tax credit for buildings which were constructed before 1936, but are not certified historic structures. If the building is listed on the National Register, it is automatically a certified historic structure, and is not eligible for the 10% credit. If it is located within a listed historic district, it is eligible for the 10% credit only if it is certified (through the submission of a Part 1) as not contributing to the district. The building must also meet the following conditions:
Is used for non-residential rental purposes;
Has not been physically moved; and
Meets the external and internal wall retention tests set forth under federal regulations.
Property owners are not required to follow the Secretary’s Standards in order to claim the 10% credit.

There is no corresponding state credit for rehabilitation of buildings that are not certified historic structures.

Where can I find the regulations governing these programs?
The federal regulations governing the National Park Service’s review of tax credit applications are found at 36 CFR 67. The regulations governing the use of the tax credit itself (the IRS regulations) are found at 26 CFR 1.48-12.

The Virginia legislation authorizing the state tax credit is found at Virginia Code. §58.1-339.2. Department of Historic Resources is currently operating under draft regulations. They are expected to be final by the end of 2003.

How can I get additional information?
Department of Historic Resources website: www.dhr.state.va.us
The Virginia Department of Historic Resources is the State Historic Preservation Office. Applications for both federal and state tax credits are submitted to the Department. DHR staff members review the federal applications and forward them to the National Park Service with a recommendation regarding approval. Final decisions about the federal credits are made by the Park Service. Decisions about state credits are made by the Department. For information about both the state and federal programs, click on the URL above, and follow the links for Incentives and Grants, then Rehabilitation Tax Credits. State application forms can be downloaded from the website in PDF format, or requested by e-mail in Word. Information on other state preservation programs is also available through the Department’s website.

To speak to a representative or to make an appointment please call (804) 367-2323.

National Park Service website: www.cr.nps.gov/hps/tps
This URL goes to the section of the National Park Service’s website that deals with the federal Rehabilitation Tax Credit program. From here you can view basic information about the program, download application forms, check the status of an ongoing project, or click on the IRS Connection link for tax-related information. You can also view and download the Park Service’s Preservation Briefs, a series of over 40 guidance documents to assist property owners with technical preservation issues.

For information on other NPS programs, including the National Register of Historic Places, click on www.cr.nps.gov

Secretary of the Interior’s Standards for Rehabilitation: www.cr.nps.gov/hps/tps/tax/rhb/stand.htm
In order to qualify for either the federal or state tax credit, all rehabilitation work must be consistent with the Secretary’s Standards. Look here for a copy of the standards for rehabilitation as well as the other Standards for the Treatment of Historic Properties (standards for preservation, restoration, and reconstruction).

IRS Connection: www2.cr.nps.gov/tps/tax/IRS
The National Park Service reviews projects for designation as “certified rehabilitations.” It is the IRS, however, that administers the use of the credit that can be claimed when a project is so designated. Check this URL for a list of frequently asked questions about the credit, as well as topical tax briefs and a link to the IRS Code and Treasury Regulations governing the use of the credit.

Other resources:
APVA Preservation Virginia: www.apva.org
Virginia Main Street Program: www.dhcd.virginia.gov/mainstreet
National Trust for Historic Preservation: www.nationaltrust.org
HUD Virginia: www.hud.gov/local/ric
National Housing and Rehabilitation Association: www.housingonline.com
Partners for Sacred Places: www.sacredplaces.org