Rehabilitation Tax Credits for Historic Buildings

Federal rehabilitation tax credits helped spark the return of the Ebert-Dulany House in Hannibal to the appearance of its ca. 1865 construction. Click on image to get a better look...

Since 1976, federal law has provided tax incentives for historic preservation. As of Jan. 1,1998, a state rehabilitation tax credit incentive is available as well. The availability of the federal and state tax credits is a major plus for encouraging investment in historic resources– in urban cores, residential neighborhoods and small towns throughout the state.

According to the National Park Service's FY2004 annual report on tax incentives, the success of Missouri's historic rehab tax credit program "is reflected in the fact that rehabilitation using the federal tax credits doubled" after the introduction of the state tax credits. The report pointed out not only that Missouri's ranking  demonstrates the impact of the existence of the state tax credit on the use of the federal tax credits, but also that it is this winning combination that has enticed developers from other states to join local developers in hiring workers to rehab historic buildings in communities across Missouri!

According to the Park Service's FY 2007 report, Missouri once again ranks

In a recent news release, Department of Natural Resources Director Doyle Childers highlighted the relation between the state and federal historic tax credit programs and the department’s mission, saying: “Rehabbing a historic building conserves energy, helps reduce the amount of construction debris that goes into our landfills and takes advantage of already existing utilities and infrastructure."

A Rutgers University study reveals that the impact of historic preservation tax credits on Missouri's economy extends far beyond the initial investment in buildings and communities. The preservation of Missouri's historic architecture is a major driver for heritage tourism in the state and a major source of new jobs and additional revenue for municipalities, counties, and the state itself.

The Department of Natural Resources’ State Historic Preservation Office (SHPO) works actively with property owners, developers and architects to promote the incentives and provide advice on appropriate rehabilitation. SHPO staff review applications for tax certification and make recommendations for approval.

Below is a summary of the application and review process for state and federal historic rehab tax credit projects. The historic rehab tax credit "grid" PDF, a shorter sketch of the similarities and differences between the two programs, is also available.

TAX CREDITS FOR HISTORIC REHABILITATION
Federal law provides an investment tax credit equal to 20 percent of approved costs for qualified rehabilitation of certain historic buildings for income-producing use. The federal credits are administered by the State Historic Preservation Office in the Missouri Department of Natural Resources and the National Park Service.

Missouri law provides an investment tax credit equal to 25 percent of approved costs associated with qualified rehabilitation made after Jan. 1, 1998. Homeowners as well as commercial developers can qualify for the state credit. The state credits are administered by the Community Development Division in the Missouri Department of Economic Development. The State Historic Preservation Office is responsible for reviewing and approving rehabilitation work for the state credits.

The federal and state credits can be used in combination for the rehabilitation of commercial or income-producing properties. Rehabilitation of non-income producing residential properties qualifies for the state credits only.

 A tax credit lowers the tax owed. A tax credit differs from a tax deduction in that income tax deduction lowers the amount of income subject to taxation while a dollar of tax credits reduces the income tax owed by one dollar.

WHAT BUILDINGS QUALIFY FOR THE CREDITS?
To be eligible for the state or federal credits, a building must be "historic." To qualify as "historic" a building must either:

The federal credits are limited to income-producing, depreciable property only. The property may be either commercial or residential rental property. A taxpayer’s personal residence would not qualify for the federal credit.

The state credits also apply to income-producing property including either commercial or residential rental property. Additionally, a taxpayer’s personal residence can qualify for the state credit if the property is historic and if the minimum investment threshold is met.

MINIMUM INVESTMENT REQUIREMENTS:
The rehabilitation must be "substantial," meaning that a minimum amount must be invested during the rehab. The threshold requirement for the federal program is $5,000 or the adjusted basis of the property, whichever is larger, within a 24-month (60-month, if phased) test period. For the state credits, the threshold requirement is 50 percent of the basis, within the project period defined by the applicant.

Note that the federal credits use the "adjusted basis" while the state credits use the "basis" for determining if the threshold has been met. "Basis" is the cost, or fair market value, of the property at the time of acquisition, or as otherwise defined in the U.S. Internal Revenue Code. The "adjusted basis" of a building is essentially the current book value of the building. It is determined by taking the purchase price of the building and subtracting the value of the land (which does not depreciate). Any previously claimed depreciation is subtracted from this figure and the value of any improvements made up to the beginning of the 24-month (60-month, if phased) test period is added to the figure.

Applicants considering the federal tax credits should consult a qualified tax professional for information on determining the basis of a property, the 24-month test period for meeting the threshold, and the impact of phasing a project.

For a taxpayer seeking both federal and state credits, it is possible that the project might meet one but not the other of the threshold requirements.

WHAT REHABILITATION WORK QUALIFIES FOR THE CREDIT?
Qualified work for the federal credits includes costs associated with work undertaken on the historic building, as well as architectural and engineering fees, legal expenses, development fees, and other construction-related costs, if such costs are added to the basis of the property and are determined to be reasonable and related to the services performed.

For the state credits, total costs incurred on rehabilitation shall include but not be limited to qualified rehabilitation expenditures as defined under section 47(c)(2)(A) of the Internal Revenue Code of 1986, as amended.

Acquisition costs, furnishing costs, new additions that expand the building, new building construction, parking lots, sidewalks and landscaping are not allowed under the federal and state programs.

REHABILITATION STANDARDS
In order to qualify for the federal or state credits, the rehabilitation project must follow the Secretary of the Interior’s Standards for Rehabilitation. The same standards are followed for both the state and federal programs. A rehabilitation project approved by the National Park Service as meeting the Secretary of the Interior’s Standards will be approved at the state level.

Copies of the Secretary of the Interior’s Standards are included in both the federal and state tax credit application packets. Additional information on the standards can be obtained by contacting the Historic Preservation Program or the National Park Service or by following these links:

WHAT IF A BUILDING IS NOT CURRENTLY LISTED IN THE NATIONAL REGISTER?
Under the federal tax credit program, owners of buildings that are not yet listed in the National Register may use the Historic Preservation Certification Application, Part 1, to request a preliminary determination of significance from the National Park Service. Such a determination allows the owner to proceed with the rehabilitation while the process of nominating a building or district continues. Preliminary determinations, however, are not binding and become final only when the building or district is listed in the National Register.

Owners may submit their state tax project for review prior to a property being listed in the National Register. State credits will not be awarded, however, until the property is formally listed in the register. An owner may begin rehabilitation work prior to a property being listed, but they do so at their own risk.

WHO REVIEWS THE PROPOSED WORK TO ENSURE THAT THE SECRETARY OF THE INTERIOR'S STANDARDS ARE FOLLOWED?
For the federal credits, the taxpayer submits a Part 2 application outlining proposed rehabilitation work. This is reviewed initially by the State Historic Preservation Office in the Department of Natural Resources. The application is then submitted to the National Park Service for final certification. The State Historic Preservation Office and the National Park Service are permitted to inspect a property within the five-year recapture period and the certificate can be revoked if it is found that work was not carried out as certified.

To obtain the state credits, the taxpayer submits to the Department of Economic Development the Part 1B of the state application outlining the proposed rehabilitation work. To ensure that the proposed work meets the Secretary of the Interior’s Standards, the State Historic Preservation Office in the Department of Natural Resources reviews the application.

RECAPTURE PROVISIONS
For federal projects, a property owner must maintain ownership for a period of five years after the credit is issued. If the owner sells the property within that five-year period, 20 percent of the credit will be recaptured for each year remaining.

There are no recapture provisions for the state credits.

CAN THE CREDITS BE CARRIED OVER?
The federal tax credits can be carried back one year and forward 20 years or until the credit is exhausted. The state tax credits can be carried back three years and forward 10 years. The credits are to be claimed against the taxes imposed pursuant to §§ 143 and 148 RSMo, except for §§ 143.191 to 143.265, RSMo.

HOW DOES A PERSON OBTAIN AN APPLICATION PACKET?
Follow these links for

WHAT IS THE PROCESS FOR OBTAINING THE CREDITS?
To obtain the federal credit, a taxpayer must submit a Preservation Certification Application to the State Historic Preservation Office. The application is a three-part form. Part 1 is used to determine if a property is historic. Part 2 outlines in detail the proposed rehabilitation work. Part 3 is submitted once the rehabilitation work is completed.

After the State Historic Preservation Office reviews Part 3, it is forwarded to the National Park Service. The National Park Service issues the final certification, which is filed with the taxpayer’s federal income tax return.

To obtain the state credit, the applicant submits Part 1a and 1b to the Department of Economic Development prior to the start of a project. Once the project has been approved and work is completed, the applicant submits a Part 2. The Department of Economic Development will provide the taxpayer with the documentation to be submitted with the taxpayer’s state income tax return.

It is recommended that an owner seeking BOTH federal and state credits apply to obtain the federal credits first. Once a project has been reviewed and approved at the federal level, no subsequent state review of the scope of work is required.

WHEN IS THE TAX CREDIT CLAIMED?
Generally, the federal tax credit is claimed on IRS form 3468 for the tax year in which the rehabilitated building is placed in service.

Generally, the state tax credits are claimed on Missouri form MO-TC for the year in which the rehabilitated building is placed in service.

TIME FRAME FOR REVIEW
Federal tax act projects are allowed 30 days for review at the state level and 45 days for review at the federal level

The period for review of projects seeking only the state credit is 30 working days. This permits time for initial processing at the Department of Economic Development, review of proposed work by the State Historic Preservation Office and final processing by the Department of Economic Development for final processing. If a project is seeking both credits and has been approved at the federal level, this time frame will be significantly reduced.

These time frames assume that all adequate information has been supplied in the application. Should it be necessary to request clarification or additional information from the applicant, the clock would stop at that point and be started again once adequate information is supplied for review.

CAN A PROJECT HAVE MULTIPLE INVESTORS? ARE THERE LIMITATIONS IN THE USE OF CREDITS?
Federal projects can have multiple investors; however passive loss restrictions for federal projects would apply. Note that federal credits cannot be sold. The "Housing and Economic Recovery Act of 2008" (P.L. 110-289 Sec. 3022) repeals the Alternative Minimum Tax limitations on the Federal rehabilitation tax credit "to the extent attributable to qualified rehabilitation expenditures properly taken into account for periods after December 31, 2007." For the implications of this change, please consult a a qualified tax professional.

State law permits distribution of credits to investors based on a pro-rata basis or an executed agreement among the investors. Effective Aug. 28, 1998, state credits can be sold. Involvement by not-for-profits in the sale of state credits is not allowed.

It is recommended that the advice of a qualified tax professional be sought before proceeding with any project involving multiple investors!

IS THERE AN APPLICATION FEE FOR PROJECTS SEEKING THE CREDITS?
The National Park Service (NPS) charges a fee for review of federal tax projects. The fee is based on the anticipated cost of the project. The fee must be paid before the NPS will review the application. Fees range from $500 for projects costing between $20,000 to $99,000 to $2,500 for projects costing $1,000,000 or more. The NPS handles billing for the federal project review.

Effective Sept. 7, 2005, the Department of Economic Development will collect a fee of 2.5 percent of the value of the tax credit issued for deposit into that department's Economic Development Advancement Fund. The amount will be determined and the fee required after final certification, but prior to the issuance of the tax credit.

ARE THERE OTHER THINGS TO KEEP IN MIND WHEN UNDERTAKING A TAX CREDIT REHABILITATION?
Apply as soon as possible--preferably BEFORE beginning work. Consult with the State Historic Preservation Office for the federal credits or the Department of Economic Development for the state credits as soon as you can. Read the program applications thoroughly and follow instructions carefully.

Photograph your building inside and out BEFORE beginning work. Before photographs are especially important. Without them, it may be impossible to review a project. A photo-documentation instruction sheet is included in the guidelines for the state tax credit.

Read and follow the "Secretary of the Interior’s Standards for Rehabilitation." Consult with the State Historic Preservation Office for information on interpreting the standards.

Seek the advice of a qualified tax professional before proceeding with any tax credit rehabilitation project!

Helpful Links:

SHPO Home Page