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What are the rehabilitation tax credits?
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.
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What buildings qualify for the tax credit program?
The credits described above are available only for Certified Historic Structures,
defined as follows.
Under the federal program, a certified historic structure is one that
is either:
Under the state program, a certified historic structure is one that is:
With a few exceptions, a Virginia property that is listed on one of these registers
is listed on the other.
Please note, however, that historic districts listed in the national and Virginia
registers 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.
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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. Essentially,
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.
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. 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.
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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:
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.
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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.
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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.
Generally speaking, 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. If you complete your project
before the district is listed, you will not be able to claim the credit at all unless the
listing is completed within a year after your completion date.
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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 twenty years, and back for one year. The state credit may be carried
forward for up to ten years. There is no carryback for the state credit.
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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.
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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.
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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.
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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 – e.g. 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.
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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. 24 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
with the following information: building name and/or address, view (e.g., north side),
and description (e.g., plaster damage in dining room, north wall). Photographs must be
numbered and keyed to the description of proposed work.
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What should I photograph?
For most buildings, the following features should be photographed in order to allow
for proper evaluation:
I began rehabilitating a historic building last year, but I have just learned
about this program. Can I still qualify for the credits?
Possibly. It is much more difficult to qualify for the credits if you don’t submit
Parts 1 and 2 before beginning work, but in some cases it may be possible. You must have
good photographs showing the building before the rehabilitation work began,
as described in the preceding question. If you do not have this documentation, you probably
cannot qualify for the credits. Additionally, the work which you have already
completed must meet the
Secretary’s Standards.
If you have already completed your rehabilitation work, and your building is not
individually listed on the National Register, you cannot qualify for the federal credit.
The IRS has taken a strong position that if the Part 1 has not been submitted before
the building is placed in service, it is not a certified historic building and the
credit is not available. Failure to submit the Part 1 before completing work is not
necessarily fatal to the state credit, provided that all other requirements of the
program are met. However, the deadline for application for the state credit is one
year after your completion date. You must submit a complete, fully documented application
by this date in order to qualify for the state credit.
See this
advisory on projects already started.
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How do I claim the credit?
The federal credit is claimed on 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.
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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:
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.
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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.
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How can I get additional information?
For additional information on the federal program, check out the
National Park Service’s website.
To speak to a DHR tax credit staff member or to make an appointment, please call (804) 367-2323.
