Consider Tax Incentives on Historic Preservation ProjectsAugust 02, 2016
Are you a developer who transforms historic buildings into office, retail, hotel or residential spaces? There may be a valuable tax credit for you.
With its wealth of distinctive buildings, the New England area is fertile ground for historic preservation projects. Developers who transform these buildings into attractive office, retail, hotel or residential spaces often take advantage of the federal historic tax credit to improve their cash flow and attract investors. In addition, many states offer their own tax incentives to developers who help preserve historic sites.
Evaluate State Tax Credits
State credits can be valuable. You should evaluate each state’s Historic Preservation Tax Credit program before starting a historic preservation project. In some cases, they can mean the difference between a successful project and an unsuccessful one.
For example, developers in Massachusetts may claim a historic rehabilitation credit of up to 20% of qualified expenditures to preserve a historic property. In Rhode Island, the credit increases to up to 25% of qualified expenditures for certain properties. Connecticut, Maine and Vermont offer similar tax incentive programs for historic preservation.
Monetize Credits to Boost Operating Cash Flow
State historic tax credits are relatively straightforward, unless you decide to “monetize” them to generate extra cash. Then things can get complicated. Here’s why the extra legwork may be worthwhile and how to execute a monetization strategy to maximize its benefits and minimize potential pitfalls.
How does monetizing credits work exactly? Typically, developers can’t use all of their historic tax credits in the year a building is placed in service. But they can carry forward these credits to offset taxable income in future tax years. To improve operating cash flow, some developers monetize the credits by either:
- Selling them to third parties (if permitted by state law), or
- Allocating them to investors through complex partnership structures.
What happens if the plan isn’t executed properly? Unfortunately, a significant portion of the state tax incentive can be lost to federal income taxes if the plan isn’t executed carefully. In general, selling tax credits generates taxable income. Allocating credits to a partner may also trigger federal tax consequences. However, the use of a tax-exempt entity (TEE) may reduce or eliminate federal taxes on the allocation or sale of state tax credits.
Although the use of a TEE can be beneficial, any transaction involving a TEE must be executed properly. You want to make sure the transaction will pass IRS scrutiny if examined.
Don’t Go It Alone
Careful planning with the help of experienced tax professionals can minimize these risks. Our tax specialists can help you evaluate your options and design tax credit structures that maximize your benefits and reduce the risk of an IRS challenge.