Mr. Tess

Finance & Investment

Historic Tax Credits - The 10% Solution

By John Tess, President & CEO, Heritage Consulting

At the other end of the spectrum, federal tax law allows a 10% investment tax credit for the rehabilitation of a non-historic building placed in service before 1936. To be "non-historic" a building cannot be individually listed on the National Register. A building located within a National Register historic district is presumed to be historic; to use the 10% tax credit, the Park Service must determine that the building in question is not historic.

Like the 20% credit, the 10% applies only to non-residential buildings. It does not apply to ships, bridges or other structures. It also may not be used for single family houses, residential condominiums, and unlike the 20% credit, cannot be used for rental housing. It also does not apply to any building that has been moved since 1935. And the rehabilitation must be "substantial," that is, the work must exceed either $5,000 or the adjusted basis of the property, whichever is greater. The 10% investment tax credit does apply to hotels.

To secure the 10% credit, a project does not need to meet the Secretary of Interior Standards, nor is the work reviewed by the National Park Service. It does however need to meet a specific physical test relating to the retention of external walls and internal structural framework:

• at least 50% of the building's walls existing at the time the rehabilitation began must remain in place as external walls at the work's conclusion, and
• at least 75% of the building's existing external walls must remain in place as either external or internal walls, and
• at least 75% of the building's internal structural framework must remain in place.

10% or 20%

The 10% and 20% investment tax credits are mutually exclusive. On one level, the 10% tax credit is attractive. It is free of the Secretary of Interior Standards for Rehabilitation and National Park Service design review - thereby allowing a greater design freedom and less regulation. That said, while the 20% credit is a gateway to state and local preservation incentives, the 10% is typically an insurmountable barrier to these incentives. And while the 10% does not incur the Park Service design review, most communities will require local design review with many of the same hurdles.

The biggest difference however is the obvious: The lost 10%. For a $1mm project, the lost $100,000 - less the cost of securing the added 10% - may not be a significant amount. However, a $20mm project loses $2 million and a $100mm project loses $10 million. These are amounts that simply cannot be ignored and clearly, for a major project, the 20% tax credit would be preferred.

However, herein lies the pitfalls: A developer who seeks the 20% investment tax credit can easily place the project in a netherworld where neither tax credit is eligible. This situation arises because to be eligible for the 20%, the building must be certified historic and the rehabilitation must be certified. All too often the first hurdle of getting the building listed on the National Register is achieved, only to find that the proposed rehabilitation cannot be certified. This failure to meet the Secretary's Standards may be due to the developer's design preference, but equally it may be due to fire, life safety and seismic codes. It may also be due to the economic realities of the project. But if the building has already been deemed "historic," it is not possible to backtrack to the 10% credit.

The 20% versus 10% decision is complicated as development moves into the 21st century. Design schemes are relatively straightforward in the adaptation of a single office or apartment building. But the 1920s brought an explosion of single use building - retail, fraternal, theaters, churches and civic functions - often with grand interior spaces designed for a particular reason. One example is the downtown department store that in the 1920s focused on destination marketing, enticing customers to a single store with style shows in an upper floor auditorium and a white glove restaurant. Today, department stores are chains located in regional malls that focus marketing on price and selection; the auditorium and restaurant are harbingers of a time past, but for most developers not easily adaptable space. Another example is a public market building; the rise of supermarkets made such buildings extraneous and those that have survived have been adapted and partitioned. Except in rarified circumstances, the original market function no longer is viable. In both instances, the Park Service has shown a tendency to require the interior space to be retained intact - even though there is no viable market use for such space. The same may be said for theaters and fraternal halls.

In this same vein, developers are increasingly looking at collections of buildings that are functionally interconnected. These may be a military base, industrial site, or even housing developments. Often in adapting, the redevelopment scheme requires select demolition of secondary building, or new construction to complement. Or the developer may offer a development scheme that while conservative in some portions is rather aggressive in others. And finally, most such projects require varying landscape treatments from the original hardscape. Yet, the complexities of these redevelopments only increase the potential of running afoul of the Secretary Standards and raise the risk of having the project denied.

The solution lies in properly managing the process. In most instances, a preservation consultant can advise a developer on possible fatal flaws as relates to the Secretary's Standards. The consultant can advise what building elements may be considered character-defining, and reviewing the project at the design development stage indicate what treatments may be problematic and offer alternatives. For a particularly difficult treatment - where say a developer must choose between two bad options - it is also possible to secure a preliminary determination from the State Historic Preservation Office and National Park Service. It is possible to submit both the Part 1 and Part 2 applications simultaneously. The first seeks to establish the building's historic value, while the second seeks to certify the rehabilitation. In most instances, the Park Service will work with applicants to retain their options. Finally, it needs to be recognized that the process for securing individual listing on the National Register usually takes upwards to a year with both an extensive state and federal review. At the state level, there is usually a state advisory committee that, along with state staff, requires technical corrections and supplemental information that must be submitted prior to submission to the National Register staff for final review and listing.

In most instances where a building is not currently listed on the National Register but placed in service before 1936, it is possible to secure at least the 10% investment tax credit and most often the 20% tax credit. Nearly always it is wiser to pursue the 20% investment tax credit, as it is the greater incentive and the gateway to additional state and local preservation incentives. Yet, it is important to manage the process so as to maintain the flexibility of using the 10% as a fail-safe option.

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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