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New IRS Guidelines Provide Additional Tax Planning Strategies to Real Estate Professionals

[fa icon="calendar"] Mar 21, 2014 11:54:00 AM / by Yelena Tsvaygenbaum

Special To Banker & Tradesman

     The Federal Historic Preservation Tax Incentive Program, which was established in 1976, promotes historic preservation by encouraging private entities to rehabilitate historic buildings, turning underutilized or even abandoned buildings to vibrant offices, rental units or retail stores. The tax incentive provides private investors with a tax credit in the amount of 20 percent of qualified expenses incurred rehabilitating historic structures, or 10 percent of expenses rehabilitating structures that are not deemed “historic,” but were built before 1936. According to the National Park Service, which administers the program in partnership with the Internal Revenue Service, tens of thousands of structures have been rehabilitated, representing billions of dollars of private investment.
     Despite the immense success of the program, large corporations have traditionally dominated the pool of investors, which provide the equity investment into real estate partnerships that rehabilitate historic structures. In 2012 and 2013, however, the program saw a significant drop in private investment, following the Third Circuit Court of Appeals, decision in Historic Boardwalk Hall, LLC v. Commissioner. The Third Circuit held that under the specific facts of the case, the private investors’ interest in the success or failure of the partnership that incurred rehabilitation expenses, was insufficiently meaningful to qualify the private investors as partners in the partnership, thus disqualifying the partners from receiving the historic tax credit. The facts of the case were atypical and easily distinguishable from the conventional private investment structure of historic rehabilitation partnerships.
     Still, despite the apparent differences, large corporations, which previously provided significant private investment under the program fell to the sidelines, hesitant to participate in funding the rehabilitation of historic structures. The resulting drop in private funding made it starkly apparent just how influential the large corporations were in the historic rehabilitation industry. Lacking large corporations’ support, the funding for rehabilitating historic structures became increasingly difficult to find.
     In response to the Historic Boardwalk case and the resulting drop in private investment, the IRS and the Treasury provided a revenue procedure to clarify any confusion on how private investors may fund the rehabilitation of historic structures and in turn obtain tax credits. The Revenue Procedure 2014-12 was finalized on Jan. 13, 2014. The procedure is expected to provide seasoned investors the reassurance they need to continue participating in historic rehabilitation.
     Further, the revenue procedure, by providing clear guidelines, provides an opportunity for new private investors, especially real estate professionals, to participate in the program. New investors will benefit from participating in the program, as it provides additional tax planning opportunities, all the while allowing participation in historic preservation in the investors’ local communities. Potential investors that would benefit most from the tax credits under the program are real estate professionals, defined as those who spend more than 750 hours per year on real property trade or business.
     Other investors who would also benefit are those who have a significant amount of passive income, that is income derived from leasing or renting properties, and/or investors who are not subject to the alternative minimum tax. The tax incentives under the program allow for a carry-forward provision – meaning that any tax credits that are not used in one year, may be used in the subsequent 20 years. Such a lengthy period of use provides for greater tax planning to potential investors.
     The procedure requires each investor to receive a stated return proportional to the ownership percentage of the real estate partnership, undiluted by unreasonable fees. The investor may not own more than 99 percent of the partnership; that is a minimum of 1 percent of the partnership must be owned by the principal partner, i.e. the developer. The private investor is required to pay a down payment – a minimum of 20 percent of its total planned contribution as of the date the structure is placed-in-service. The investor may later sell its partnership interest to the developer, so long as its remaining interest is equal to or greater than 5 percent of its initial share of the partnership and the sale price does not exceed the fair market price. In turn, the investor receives a share of the partnership’s profits and tax credits, and in addition may also receive a preferred return. The returns provide an investor an additional revenue stream, and more importantly the tax credits reduces investor’s tax liability, an integral part of tax planning.
     The drop in investment into the historic rehabilitation projects should dissipate as a result of the revenue procedure. Further, the revenue procedure should motivate new investors, such as real estate professionals, to enter the marketplace.

Topics: Historic Rehabilitation Tax Credit, Investment Tax Credit, federal tax credits, IRS Guidelines

Yelena Tsvaygenbaum

Written by Yelena Tsvaygenbaum

Yelena Tsvaygenbaum serves as Corporate Counsel for the Cherrytree Group.

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