Have you ever thought of buying an old, historic property, but decided not to because of the high cost of rehabilitation? Well, it is certainly true that the preservation of an historic structure is not an endeavor for the financially fainthearted. However, for those of you who currently own or who may have your eyes set on investment properties in need of some tender love and care, the federal rehabilitation tax credit program may be just the tool you need to “preserve” both the building and the bottom line.

Under the Internal Revenue Code (“IRC”) a taxpayer who rehabilitates any certified historic structure may receive a credit for 20% of the qualified rehabilitation expenditures used in performing this task. A certified historic structure is defined under the IRC as “any building” that “is listed in the National Register [of Historic Places], or is located in a registered historic district and is certified as being of historic significance to the historic district by the Secretary of the Interior.” In order to qualify for the 20% tax credit, an interested taxpayer must first obtain approval for the proposed rehabilitation project and, if the site being rehabilitated is within a registered historic district (but not individually listed on the National Register) a certificate of historic significance. The State Historic Preservation Office within the Department of Environmental Protection is charged with conducting an initial review of all such applications. However, the National Park Service (“NPS”) makes final determinations on proposed rehabilitation projects and requests for certificates of historic significance.

Once a rehabilitation project has been approved, the taxpayer must actually undertake to do the work, which, at a minimum, must be in accordance with the Secretary of the Interior’s Standards for Rehabilitation published in the Code of Federal Regulations. The taxpayer may then proceed to obtain a certification of completed work from the NPS. Upon satisfactory completion of the rehabilitation project and a determination by the NPS that such work is consistent with the historic character of the certified historic structure (or the district in which such structure is located), the NPS will certify the rehabilitation. A copy of this written determination, also known as a “certified rehabilitation” must be included with the taxpayer’s federal income tax return at the time the taxpayer seeks to claim the 20% rehabilitation tax credit.

Other regulatory requirements associated with the 20% rehabilitation tax credit include satisfaction of the IRS’ substantial rehabilitation test, which should not be confused with the NPS’ certification of completed work. A certified historic structure will be treated as “substantially rehabilitated” under the IRC and applicable IRS regulations only if the qualified rehabilitation expenditures incurred during a 24-month period selected by the taxpayer (or 60 months if rehabilitation is completed in phases) exceed the adjusted basis of the structure and its structural components or $5,000.00, whichever is greater. A qualified rehabilitation expenditure is a cost or expense made in connection with rehabilitation, which is “properly chargeable to capital account” for certain classes of depreciable real estate, such as rental housing. Expenditures for improvements to the structural components of a certified historic structure will ordinarily be construed as qualified rehabilitation expenditures. Similarly, amounts incurred for architectural and engineering fees, site survey fees, legal expenses, insurance premiums, development fees and other construction-related costs will also qualify for the 20% rehabilitation tax credit if they are added to the basis of the property for which the credit is being sought. Examples of expenses that would not be counted as qualified rehabilitation expenditures include building acquisition costs and outlays for the installation of parking, sidewalks, landscaping and other similar improvements, which are not related to the rehabilitation of the certified historic structure.

To be eligible for the 20% rehabilitation tax credit, certified historic properties must also have been placed in service (i.e. available for occupancy) prior to the commencement of rehabilitation work.

The right to claim a rehabilitation tax credit originates when the taxpayer who owns a certified historic structure incurs qualified rehabilitation expenditures. This tax credit may be transferred to a purchaser of the certified historic structure provided that: (1) the transferor did not place the structure in service after rehabilitation and prior to the date of acquisition; and (2) no person or entity other than the taxpayer purchasing the certified historic structure has claimed a credit for any qualified rehabilitation expenditures made in connection with the rehabilitation of the structure. A taxpayer/owner may also elect to transfer rehabilitation tax credits to tenants, so long as the transferor is not a tax-exempt entity.

A taxpayer may begin claiming the rehabilitation tax credit for qualified rehabilitation expenditures when the certified historic structure is put back in service, provided that all of the above-referenced conditions have been fully satisfied. A certified historic structure will be construed as having been put back in service on the project completion date irrespective of whether the taxpayer continues to occupy the certified historic structure during the rehabilitation or takes it out of service during such period. The qualified rehabilitation expenditures that a taxpayer may claim a credit for are limited to those incurred before and during (but not after) the taxable year in which the certified historic building (or portion thereof) was placed in service. Significantly, if a taxpayer cannot utilize the entire rehabilitation tax credit in a single taxable year, the excess may be carried back one year and/or carried forward for up to 20 years.

Hopefully, the foregoing brief summary of available federal historic preservation tax incentives has piqued your interest in preserving an historic property. However, given the complexities inherent in federal tax law (and numerous other potentially applicable laws, regulations and ordinances not discussed here) all owners and future purchasers of historic properties would be well advised to seek legal counsel before pursuing their dream of rehabilitating an historic property.