Rehabilitating a historic property requires strict compliance with more building regulations than would be necessary for ground-up construction. Although a historic rehabilitation involves increased costs, a developer can secure both state and federal tax credits that, when combined, can recover up to forty percent (40%) of the construction budget. So, how can you use these incentives to aid your next financial project?
A look at the statistics over more than a decade demonstrates the impact of the historic rehabilitation tax credit in Massachusetts.
On July 1, 2105, the Massachusetts Department of Revenue (“DOR”) issued Working Draft TIR 15-XX relating to transferring historic rehabilitation tax credit awards in single or phased projects, or recapture of historic rehabilitation tax credits.
Have you ever thought about investing in federal tax credits but weren’t sure how it works?
The fact that you even are familiar with tax credits and know that they can be an investment opportunity puts you ahead of the curve. Perhaps the biggest barrier to entry with regards to investing in federal tax credits is lack of industry knowledge about tax credits and how strong an investment they can be.
To get started, let’s go over the tax credit basics.
A tax credit is a dollar for dollar credit against taxes owed to the federal government. As a tax credit can be used to offset (or pay) your federal taxes, as if you had written a check to the federal government, a tax credit has a value of $1.00 per tax credit.
Historical buildings lend themselves very well to multifamily residential use.
When performing an adaptive reuse of a historic building, in addition to the possibility of utilizing historic tax credits (HTC's), if a certain number of the residential units are designated as affordable there may be a possibility to secure low-income housing tax credits (LIHTC's). In such a project, there will need to be a twinning of the two different types of tax credits, and successful completion of the project will hinge on the attention needed to be paid to the structuring of the transaction, the coordination between the requirements of each program, as well as the specific protections needed by the tax equity provider(s) and/or the lender(s).
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State, Federal Offsets Help Recover Costs In Tight Times
Many developers tend to think “traditional” when it comes to commercial real estate financing sources, resulting in a scramble to obtain the funds necessary to finance a project. Without knowledge of how to secure available federal and state tax credits specific to projects, developers unwittingly “leave money on the table.”
Tax credits allow a dollar-for-dollar offset against taxes due. As such, they act as a form of tax payment. Tax credits are not to be confused with a tax deduction, which reduces adjusted gross income and can lessen the tax due. Tax credit recipients can use the credit to offset taxes, or can sell the credit in order to gain income. Restrictions, limitations, recapture risk, compliance obligations and transferability of the tax credit are dependent on the type of tax credit issued.
A variety of tax credits exist, including those for historical remediation, low-income housing, renewable energy and brownfields projects.
Historic rehabilitation tax credits promote the rehabilitation of historic buildings by the private sector. This is one of the nations’ most successful and cost-effective community revitalization programs, as historic renovations – which are extremely expensive – may not otherwise be undertaken without this tax credit.
State and federal historical rehabilitation tax credits together can offset as much as 40 percent of a construction project’s budget and they can make or break the feasibility of resurrecting a building with significant community value. With these credits, preservation efforts are more economically appealing than replacement costs. Likewise, being designated as a historic place may increase property values, thereby enhancing the property’s economic bottom line.
The market for tax credits allows for the completion of often essential projects that might not otherwise see the light of day due to the difficulty of financing through traditional funding avenues.
It is important to note that the process of applying for, securing and monetizing tax credit awards is an information and document sensitive process which is enhanced by using a consultant, a broker or a syndicator, and at times a lawyer to complete the paperwork.
Energy Credit Revenue
There are two significant tax credits for renewable energy projects – investment tax credits (ITC) from capital investments in the technology and/or the facility that creates renewable energy; and renewable energy credits (RECs) that are generated as a result of the production of renewable energy.
ITCs amount to 30 percent of the project capital costs, whereas the REC formula is organic – for each megawatt hour of electricity a renewable energy project generates, the owner receives one REC. These RECs can then be sold, allowing the producer of the renewable energy to reap revenue from the credit.
RECs can be purchased from companies that supply power, natural gas, biomass, and energy products, or from any producer of renewable energy. This source of revenue subsidizes the operating costs of a renewable energy facility, which is necessary to allow said facilities to remain financially feasible. A REC is retired once it is sold, ensuring that the credit is used but once.
Increasingly, businesses are investing in RECs as a means to implement more eco-conscious practices. Purchasing RECs allows a company to support renewable energy development, even when it does not produce renewable energy and is not directly utilizing renewable energy for its consumption needs. RECs are designed to encourage the development and distribution of renewable energy technology and the production of renewable energy.
Recovering Cleanup Costs
Finally, mention needs to be made of the Massachusetts Brownfields Tax Credit. Although some commercial property owners will go out of their way to avoid brownfields sites, others recognize the benefits inherent in the brownfields tax credit, which is intended to encourage the reclamation of polluted property as well as to enhance economic growth by fostering the rehabilitation of abandoned properties.
If the property qualifies for the credit, costs related directly to the environmental clean-up – such as outlays to determine, contain or remove contamination – will apply toward the issuance of credit. By monetizing the credit, often a brownfields property owner that cannot or does not desire to use the tax credit can recover up to 50 percent of the eligible costs of cleaning up the site.
The tax credits outlined above illustrate a sound approach to attracting new investment and financial activity during a challenging economic climate.
The following is part II of an article written by Warren Kirshenbaum published in Area Development Online. To read the entire article now, click here.
Developers, owners, and managers require innovative financing solutions to fill gaps in project funding. State and federal tax credits, together with depreciation and other available grants, can offset as much as 45% of a construction project’s budget, and they can make or break the feasibility of rehabilitating a historic building that has significant community value.
The historic rehabilitation tax credit program is one of the nation's most successful and cost-effective community revitalization programs to date. Tax credits encourage private-sector rehabilitation of historic buildings. But the benefits of these tax credits go beyond urban renewal. They can help fund a project that might not otherwise get off the ground, and they can create new construction jobs for the community (which builds further goodwill in the process). In addition, being designated as an historic place may increase surrounding property values, enhancing the economic viability of an entire neighborhood.
In addition to historic rehabilitation tax credits, there are other tax credits worth mentioning that may be applicable. These tax credits may be used together for the same project. Brownfields tax credits (for remediating contamination) and renewable energy tax credits (for investing in or producing renewable energy) are two tax credits, in particular, that may provide an added benefit.
Both the federal and most state governments recognize that encouraging the rehabilitation of historical properties is beneficial to our communities. Through tax incentives such as the historic rehabilitation tax credit, they offer a solution that manages some of the inherent challenges in preserving an historical building, and potentially provide added financial incentives as well. The value of such credits goes far beyond monetary figures.
The process of applying for and securing historic preservation tax credits, grants, or any other applicable tax credits can be complicated and requires certain specialists, such as an architect, lawyer, consultant, and a syndicator. Seeking out information about this process before the project commences is critical in allowing for the developer to factor the potential tax credit equity into a proposed budget or development pro-forma, which can lead to more control over financing costs.
The Cherrytree Group can deliver our menu of services to provide maximum efficiency and cost effectiveness to our clients. We offer a value-added component to our clients' businesses or projects that results in a scaling of costs, a reduction in project time and expense, and a lower opportunity cost of capital for our clients, leading to their achieving greater productivity and profit.