Mr. Tess

Architecture & Design

The Potential of Using Historic Tax Credits When Updating Older Hotel Properties

By John Tess, President & CEO, Heritage Consulting

Tax credits need to be distinguished from tax deductions. An income tax deduction lowers the amount of income subject to taxation. A tax credit, however, lowers the amount of the tax owed. In general, a dollar of tax credit reduces the amount of income tax owed by one dollar.

The federal government offers tax credits for the rehabilitation of older buildings. There are two levels of credits, 10% and 20%. The 10% is for non-historic buildings constructed prior to 1936. The 20% is for historic structures rehabilitated using the Secretary of Interior's Standards for Rehabilitation. The percentage is of the "qualified rehabilitation expenditures."

Many think the qualifying costs are amounts spent on "restoring" the building. The term however is defined much more broadly: Qualified rehabilitation expenditures are capitalized costs associated with the work undertaken on the building, as well as direct soft costs. These costs include updated finishes, but also include upgrades for elevators, plumbing, mechanical, HVAC, electrical, fire & life safety and other less visible expenses. It also includes professional services related to the project, including architectural, engineering, legal and other fees. Qualifying expenses however do not include acquisition costs, FF&E costs, landscaping or site development costs.

There is an expenditure threshold necessary to qualify: Depending on how the rehabilitation is phased, over a 24 or 60 month period, the owner must spent the greater of $5,000 or the adjusted basis of the property on the renovation of the property. The adjusted basis is the original cost of the property reduced by depreciation and increased by capital expenditures.

Thus under the right circumstances, a hotel that is "freshened" with moderate repairs, new paint, and upgraded mechanicals can qualify for the tax credits. For a property that has been under the same ownership for several years without significant capital improvements, the threshold can be rather low.

So which is more appropriate, the 10% or 20% credit?

A building listed on the National Register of Historic Places, or located in a certified federal, state or local historic district, can only take the 20% credit. This process requires that the building be a certified historic structure and that the rehabilitation be certified. If the building is individually listed on the National Register, it is automatically considered a certified historic structure. If the building is in a certified district, it is necessary to have the individual structure certified as contributing to the district. This process involves filing "Part 1 of the Historic Preservation Certification Application - Evaluation of Significance" with the State Historic Preservation Office. Ultimately, this application is reviewed by the National Park Service. To have the rehabilitation certified, an owner must file "Part 2 of the Historic Preservation Application - Description of Rehabilitation" again with the State Historic Preservation Office. And again, this application is reviewed by the National Park Service. The Part 2 review is based on the Secretary of Interior Standards of Rehabilitation and essentially represents design review by the Park Service on the exterior and interior of the building.

It is important to note, however, that the tax credit process is a rehabilitation process controlled by the owner. There is no obligation to undertake work that otherwise would not be required. There is not restoration work required. There is no obligation to put back missing architectural elements. The owner defines the scope of the work; the state and federal review evaluates only the impact of that work on the building. Again, there is no obligation to put back missing elements, or to give the property a "period" look.

For a property built before 1936, where the project does not intend to significantly modify interior or exterior walls, the simplest approach is the 10% tax credit. There is no review process for the proposed work and the credit is claimed on IRS form 3468 for the tax year in which the rehabilitated building is placed in service. An important consideration however is that the building not be historic. This means that it cannot be listed on the National Register of Historic Places or a contributing structure in a certified federal, state or local historic district. If the building is in a historic district, there is a review process to determine whether the building is or is not contributing.

But for a pre-1936 building, the simplest approach is not always the best. The difference between the 10% and 20% tax credit on a $1 million renovation is $100,000. If the project does not involve wholesale changes to the building where it might be unrecognizable in its prior form, the 20% tax credit may be viable.

The challenge of course would be getting the building certified. That process involves submitting the "Evaluation of Significance" to the State Historic Preservation Office. But to be deemed historic, a building need not be an architectural masterpiece or associated with a notable person. Buildings may be locally significant and may be considered important as a building type contributing to the context of the area. For example, a hotel may be considered notable as it relates to the impact of transportation improvements or the rise of a local tourism industry.

What about a building built after 1936?

Only the 20% historic preservation tax credit is available. There is nothing presently comparable to the 10% credit where the building is not historic. That said, owners interested in exploring tax credits should not hesitate because they do not think their building is historically or architectural significant. To be listed on the National Register, a building typically needs to be 50-years old. This time frame then makes buildings built before 1955 eligible. And again, as discussed under the pre-1936 structures, the basis for historic significance can be local and broadly defined. In this sense, even the National Register's 50-year timeframe can be bent on occasion. The 1950s and 1960s saw the transformation of hotel types with the rise of the motel, both in-town and roadside, the rise of destination resorts, and the rise of new forms of in-town "new town" downtown properties.

How often can I apply for the tax credits?

It is often thought that a property may only apply for tax credits once. In fact, the credits can be sought as often as the property qualifies.

At the end of the day, to be successful, it is imperative that hotels keep abreast of market demands for a clean, attractive and modern facility. And one important, and often overlooked financial tool is the federal investment tax credits. A 20% credit is available for historic and potentially historic buildings, and a 10% credit is available for non-historic buildings built before 1936. The work does not require restoration, is determined by the property owner and can include system upgrades such as mechanicals and HVAC. To qualify, the work must cost more than the greater of $5,000 or the adjusted basis for the property. And a property owner may apply as often as qualifying.

While the use of the credit it is not always applicable, it is certainly worth exploring when doing a hotel rehabilitation or renovation. Regarding the use of the credit the National Park Service reports that since 1996 some 197 projects totaling 1.6 billion dollars in project costs have made use of the historic credit for historic buildings. This represents over 320 million dollars in tax credits that have been made available to owners of historic hotels. This tax savings does not include projects making use of the 10% credit which is not tracked.

John M. Tess is President of Heritage Consulting Group, a firm that assists property owners, attorneys, accountants, financial institutions and investors maximize the value of historic real estate assets through the use of federal tax incentives and other tools. Heritage has represented projects totaling more than $1 billion. Heritage specializes in linking developers with corporate and institutional investors active in historic tax credits. Heritage Consulting Group is headquartered in Portland, with offices in San Francisco and Washington, D.C. Mr. Tess can be contacted at 503-228-0272 or jmtess@heritage-consulting.com Extended Bio...

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