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Historic Tax Credits (in 10 minutes or less)

Historic Tax Credits (in 10 minutes or less). Housing Tax Credit Conference 101 October 16, 2008 Boston, MA Presented by Daniel J. Kolodner, Esq., Nixon Peabody LLP. Two Types of Rehabilitation Tax Credits. IRS Code Section 47

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Historic Tax Credits (in 10 minutes or less)

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  1. Historic Tax Credits (in 10 minutes or less) Housing Tax Credit Conference 101 October 16, 2008 Boston, MA Presented by Daniel J. Kolodner, Esq., Nixon Peabody LLP

  2. Two Types of Rehabilitation Tax Credits • IRS Code Section 47 • Older (pre-1936), non-historic and non-residential buildings: 10 percent of qualified rehabilitated expenditures. (not available for housing projects) • Historic buildings: 20 percent of qualified rehabilitation expenditures.

  3. The 20% Rehabilitation Tax CreditFundamentals • Tax Aspects Administered by the IRS. • Preservation aspects jointly administered by NPS and State Historic Pres. Offices (SHPOs). • RTC is the most important (in dollar volume) federal preservation program.

  4. The 20% Rehabilitation Tax CreditStatistics • 1,045 projects approved by NPS in 2007* • In 2007, roughly 45% of HTC projects were for multi-family housing; 21% for office; 27% for commercial* • Top states ranked by Part 3 approvals: MO (189), OH (115), VA (89), NC (51), (FY 2007 statistics) • More than $4.34 billion in private investment leveraged by up to $869 million in tax credits* *Source: Annual Report for Fiscal Year 2007: Federal Tax Incentives for Rehabilitating Historic Buildings National Park Service

  5. Historic Tax Credits and Affordable Housing • In FY’07, HTC projects created 18,006 housing units, of which 36% (6,553) were low/mod units. • In FY’07, 8% of projects claiming HTCs also utilized the LIHTC. • HTC program has financed 76,023 low/mod income units since its inception. Source: Federal Tax Incentives for Rehabilitating Historic Buildings, Statistical Report and Analysis for Fiscal Year 2007

  6. Benefits of using Historic Buildings for Affordable Housing • Smart growth; proximity to work, shopping and transportation. • Rehab is inherently “green”. • Attendant renovation of community landmarks can lessen neighborhood resistance to citing of affordable housing. • Increased building amenities and intangibles associated with culture and heritage. • Relief from zoning; availability of property tax breaks. See: http://nthp.org/housing/Missed_Connection.pdf

  7. Challenges of using Historic Buildings for Affordable Housing • Cost per unit can be higher (particularly as calculated in some QAPs). • Application of 106 standards triggered if federal funds are used; Secretary of the Interior’s standards if HTCs are used. • Requirement to reduce eligible basis for the LIHTC by the amount of the HTCs (in a single entity structure).

  8. What Types of Buildings Qualify?The NPS Rules: Certified Historic Structure Requirement Option #2 Building is located in a registered historic district and certified by the Sec. of the Interior as being of historic significance to the district. Option #1 Building is listed in the National Register of Historic Places.

  9. What Types of Buildings Qualify?The IRS Rules: Depreciable Building Requirement • Must be a “building”. Building is defined as a structure or edifice enclosing a space within its wall and usually covered by a roof. • Building must be depreciable. Depreciable buildings are generally those used for nonresidential (i.e. commercial) or residential rental purposes. (See Section 168(e))

  10. What Types of Rehabilitations Qualify?The IRS Rules:Substantial Rehabilitation Requirement The QREs incurred during any 24-month period** selected by the taxpayer and ending in the taxable year in which the building is placed in service must exceed the greater of: • $5,000, or • The adjusted basis of the building. **A 60-month period may be used where written plans completed before the rehab begins show that the rehab is expected to take place in phases and is reasonably expected to take more than 24 months.

  11. What Types of Rehabilitations Qualify?Definition of QREs • “Qualified Rehabilitation Expenditures” (QREs) is the tax term given to those development costs on which rehabilitation tax credits can be claimed. • QREs are any amounts chargeable to a capital account made in connection with the renovation, restoration or reconstruction of a qualified rehabilitated building (including its structural components), except as provided by law.

  12. What Types of Rehabilitations Qualify?Definition of QREs QREs include costs related to: • walls, partitions, floors, ceilings; • permanent coverings such as paneling or tiling; • windows and doors; • air conditioning or heating systems, plumbing and plumbing fixtures; • chimneys, stairs, elevators, sprinkling systems, fire escapes;

  13. What Types of Rehabilitations Qualify?Definition of QREs (cont’d) QREs include costs related to: • construction period interest and taxes; • architect fees, engineering fees, construction management costs; • reasonable developer fees Note: The calculation of Eligible Basis for LIHTC purposes is not the same as the calculation of QREs

  14. What Types of Rehabilitations Qualify? Definition of QREs • Costs EXCLUDED from QREs: • Land and building acquisition; • Enlargements that expand total volume (cf. remodeling that increases FMR); • Personal property (furnitureand appliances, cabinets andmovable partitions, tacked carpeting); • New building construction; • Sitework (demolition, fencing,parking lots, sidewalks, landscaping)

  15. The 20% Rehabilitation Tax CreditCalculating the Allowable Credit • Credit equals 20% of all QREs incurred: • Prior to the start of the 24-month period selected (so long as they were incurred “in connection with” the rehab process that resulted in the substantial rehabilitation of the building); • During the 24-month period; and • After the last day of the 24-month period but before the last day of the tax year in which the measuring period ends.

  16. The 20% Rehabilitation Tax CreditWhen is the Credit Allowed? • Credit is generally allowed in the year in which the building is placed in service (provided substantial rehabilitation test has been met). • “Placement in Service” means that the all or identifiable portions of the building is placed in a condition or state of readiness and availability for a specifically assigned function. • Progress Expenditure Election available for properties with a “normal” construction period of 2 years or more

  17. The 20% Rehabilitation Tax CreditRecapture • Credit previously allowed is recaptured if any portion of the project which includes QREs is disposed of prior to the fifth anniversary of placement in service. • Amount subject to recapture decreases by 20% during each year of the five year period.

  18. The 20% Rehabilitation Tax CreditRecapture • Disposition includes any sale, exchange, transfer, gift or casualty. Subsequent rehabs that do not comply with the Secretary’s Standards can trigger recapture. • Reduction of a partners interest can be deemed a disposition (33% rule).

  19. Parting Thoughts: • Availability of State Historic Tax Credits • Importance of Placed-in-Service deadlines (differences between LIHTC and HTC) • Importance of a team familiar with Historic Tax Credits from the beginning of the transaction • Structuring (Single Entity vs Lease/Pass-Through)

  20. Single Entity Structure Tenants Tax Credit Investor LLC Tax Credit Investor Managing Member (Developer Affiliate) Tax CreditEquity 99.99% Credits, Profits & Losses and Cash Flow .01% Credits, Profits & Losses, Fees andCash Flow DeveloperEquity Tax Credit, LLC (Property Owner) Developer Dev.Fee DebtServicePayments RentalPayments LoanProceeds Construction/Perm Lender

  21. Impact of HTC Basis Reduction on Equity RaisedSample Transaction Assumptions • $1,000,000 Qualified Basis (Eligible Basis x Applicable Fraction) • $950,000 Qualified Rehabilitation Expenditures (QREs) • LIHTC Pricing: $.75 per $1 of LIHTC • Historic Tax Credit Pricing: $.90 per $1 of HTC • LIHTC Credit Percentage: 8% (in each of 10 years) • HTC Credit Percentage: 20% (in year of placement in service)

  22. Impact of HTC Basis Reduction on Equity RaisedLIHTC–Only Transaction • $1,000,000 x .08 x 10 x .75 = $600,000

  23. Impact of HTC Basis Reduction on Equity RaisedHTC–Only Transaction • $950,000 x .20 x .90 = $171,000

  24. Impact of HTC Basis Reduction on Equity RaisedTwinned LIHTC/HTC Transaction • HTC Equity: $950,000 x .20 = $190,000; $190,000 x .90 = $171,000 • LIHTC Equity: $810,000 ($1,000,000 - $190,000 ) x .08 x 10 x .75 = 486,000; • Aggregate Twinned LIHTC/HTC Equity = $486,000 + $171,000 = $657,000 (compare $600,000)

  25. Impact of HTC Basis Reduction on Equity RaisedLIHTC-Only Transaction in QCT/DDA • LIHTC Equity: $1,000,000 x 130% x .08 x 10 x .75 = $780,000

  26. Impact of HTC Basis Reduction on Equity RaisedTwinnedLIHTC/HTCTransaction in QCT/DDA • HTC Equity: $950,000 x .20 = $190,000; $190,000 x .90 = $171,000 • LIHTC Equity: $810,000 ($1,000,000 - $190,000 ) x 130% x .08 x 10 x .75 = $631,800 • Aggregate Twinned Equity = $631,800 + $171,000 = $802,800 (compare $780,000)

  27. More Information? Daniel Kolodner, Esq. dkolodner@nixonpeabody.com 617-345-1053

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