Worth the trouble if you know how to get them
First in a series
One of the most powerful financial tools in the preservation toolkit is the federal Historic Rehabilitation Investment Tax Credit (ITC). Qualifying a project for an ITC can be difficult, but the reward is recovering 20% of your building improvement costs in the form of income tax credits. This article will give an overview of the rules, benefits and liabilities of attempting a certified rehabilitation. In later articles I will address the process in more detail, and review some of the common pitfalls to watch out for that could derail an otherwise worthy project from being certified.
As a disclaimer, I’m an architect who has been doing preservation projects for 30 years, so I have been around ITCs for some time. But I’m not a CPA and I’m not an attorney; if after reading what I have to say about the ITC you are inspired to do a certified rehabilitation, you’ll need advice from those professionals as well.
The Historic Preservation ITC provides for direct tax credit of 20% of the investment in a certified historic building undergoing a substantial, certified rehabilitation. In essence, if you plow a million dollars into fixing up a building that’s eligible for the National Register of Historic Places, you can recover $200,000 in forgiven taxes – using just this one incentive.
Of course, there are strings attached – and a process that many find to be daunting and incomprehensible. But with a little foresight and the right team, you can cover any increased costs many times over.
What kind or project is eligible? In short, the project must involve a registered historic building that undergoes a “substantial rehabilitation” that conforms to the Secretary of the Interior’s Standards for Rehabilitation. Let’s address each part of those requirements in more detail.
Any income-producing, commercial building that is listed in, or eligible for, the National Register of Historic Places could be a candidate for the ITC. The building doesn’t have to look like much, or even be individually listed; it could just be a contributor to an historic district. Most local governments and the State Historic Preservation Office (SHPO) keep track of what’s already listed and have surveys of places that are eligible, but not listed yet. There are also lots of other buildings around that could be eligible, waiting for someone to come along and do the research and paperwork necessary to get listed. The same governmental entities can usually render an informed opinion if there is any doubt. A good consultant can also advise you with some degree of assurance.
The ITC is intended to encourage re-investment in historic buildings that are currently underutilized. So, to qualify, the project must be a “substantial rehabilitation,” in which the investment in improvements is worth at least as much as the value of the building (not including land) before rehabilitation (technically, the “adjusted basis”). This requirement tends to exclude small projects like tenant improvements and quick fix-and-flips. What they really want to see is a project that is transformational – that reverse years of deterioration and neglect and put the building back into service.
The standards that must be met in order to be named a “certified rehabilitation” are what many developers and their architects find to be hardest to understand. The
Secretary of the Interior’s Standards for Rehabilitation can be thought of as the “ten commandments” of the historic preservation approach. The intended affect of the Standards is to allow certain kinds of changes and updates to be made in order to keep (or return) a building in service, while still protecting the very qualities that make it qualify as an historic building in the first place. If you have an eligible historic building and you follow the standards, it will still be eligible after you have completed the work.
Rehabilitations are certified using a 3-part process that I will cover in more detail in a later article. In the first step, you establish that the building itself is eligible for the program. In the second step, you document what you plan to do, and in the last step you show that you did it. Each of these steps is reviewed by the SHPO (largely advisory) and then by the National Park Service (which actually decides if you have met the bar).
The obvious benefit of a certified rehabilitation is the tax credit itself. That credit can be carried back one year, and best of all, can be carried forward 20 years. And if the ownership entity does not pay enough in income tax to make a 20% credit worthwhile, or doesn’t want to wait that long to recover the funds spent out of pocket, it’s good to know that there is a secondary market for these credits and that they are transferrable. Even nonprofit entities that don’t pay any income tax at all can take advantage of the ITC by partnering with for-profit investors to whom the credits can be assigned.
There is some risk of failure, particularly if your project needs to stick to a tight schedule and you have to proceed with construction before you have received approval from NPS. At a minimum, you will have spent some money on consultants to register the building and to do the paperwork to apply for the credit. You may have compromised the function or size of the project in an attempt to make it “certifiable,” and you may have incurred significant additional construction costs in preserving things that would have been cheaper to replace (or demolish). For these reasons, it’s always best to get your project certified before it is built.
If you have incurred some of these sunk costs and then are denied certification, all is not necessarily lost. If the reasons for NPS denying certification are minor, then it may be worth re-doing the part of the design that they object to. If not, then there is also a back-up plan: the 10% rehabilitation ITC. A 10% credit is available to ANY rehabilitation of a non-residential building constructed before 1936 – the building does not have to be certified historic, and the rehabilitation does not have to be certified by NPS.
Knowledge is power and the risks of embarking on a project using the Historic Rehabilitation ITC can be controlled. Make sure that you fully understand the requirements of the program, and hire an architect and contractor that “get it” and won’t do something that will disqualify the project. If your architect doesn’t have the in-house expertise to get your building listed as historic, apply preservation standards, and guide you through the ITC process, there are preservation consultants who can fill this gap in the team.