By Robert Steeg
With an abundance of historic properties throughout the city and dilapidated properties and parcels of land in low-income neighborhoods ripe for rehabilitation, many developers in New Orleans have been successfully using Historic and New Markets Tax Credits as a partial source of financing for their projects. For others, pursuing the use of tax credits can seem daunting and overly complex.
This article features the basics of the Historic and New Markets Tax Credits Programs for those who are considering exploring this option of financing for the first time.
What is the Historic Tax Credit Program?
The Historic Tax Credit Program (the HTC Program) encourages the rehabilitation of certain buildings through a tax credit equal to either 10% or 20% of the qualified renovation expenditures (QREs). The 10% credit applies only to non-historic buildings first placed into service before 1936 and rehabilitated for non-residential use. The 20% credit applies only to certified historic structures and may include buildings, which are built after 1936. The two credits are mutually exclusive.
Which Agencies Administer the HTC Program?
The U.S. Department of the Interior and the U.S. Department of the Treasury jointly administer the HTC Program. The National Park Service (NPS) represents the Secretary of the Interior in partnership with the State Historic Preservation Officer (SHPO) in each state. The Internal Revenue Service (IRS) represents the Secretary of the Treasury.
10% Historic Tax Credit – The Basics for Developers
- The 10 percent credit is available for the rehabilitation of non-historic, non-residential buildings that were built before 1936. Therefore, buildings listed in the National Register of Historic Places are not eligible for the 10 percent credit.
- In order to qualify for the 10 percent credit, there are three physical criteria which must be met: at least 50% of the existing external walls must remain in place as external walls; at least 75% of the existing external walls must remain in place as either external or internal walls; and at least 75% of the internal structural framework must remain in place.
- The owner must hold the building for a full five years after completing the rehabilitation or risk recapture of the credits.
- If the owner ceases to hold the building within a year of it being placed in service, 100% of the credit will be recaptured. For properties held between one and five years, the tax credit recapture amount is reduced by 20% for each year.
- A building owner generates the credits upon completion of a certified rehabilitation on a qualified rehabilitated building.
20% Historic Tax Credit – The Basics for Developers
- The 20 percent credit only applies to certified historic structures – buildings that are listed individually in the National Register of Historic Places or a building that is located in a registered historic district.
- The NPS certifies structures as historic.
- The credit is not available for properties used exclusively as the owner’s private residence.
- Not all expenses associated with the rehabilitation of the property can be contributed toward the calculation of the 20% credit. Generally, only those costs that are directly related to the repair or the improvement of the structural or architectural features of the historic building will qualify.
- The credits are only available to properties that will be used for a business or some other income producing purpose.
- The cost of rehabilitation must exceed the adjusted tax basis of the building.
What is the New Markets Tax Credit Program?
Created in 2000 as part of the Community Renewal Tax Relief Act, the New Markets Tax Credit Program (the NTMC Program) was promulgated to attract new or increased investment in commercial, industrial, community, and mixed-real estate real estate projects and operating businesses located in low-income communities.
Which Agencies Administer the NMTC Program?
The NTMC Program is administered by the Community Development Financial Institutions Fund (CDFI) division of the United States Treasury, which allocates New Market Tax Credits to a Community Development Entity (CDE), an organization that is certified by the CDFI. The CDEs use the New Market Tax Credits to provide subsidized financing to projects.
How Does the NMTC Program Work?
- In order to take advantage of the New Markets Tax Credits, the applicant project must obtain financing from a CDE and the project must meet the Federal definition of a Qualified Active Low-Income Community Business (“QALICB”) in order to be eligible.
- QALICBs are businesses that are located in or that provide services to Low-Income Communities (“LIC”).
- LICs are identified by income and poverty statistics from the Census. LICs are defined as U.S. census tracts with at least a 20 percent poverty rate or household median incomes at or below 80 percent of the area or statewide median, whichever is greater.
The NMTC Program – The Role of the Investor
CDEs obtain funds to invest in QALICBs through private investors.
- The NMTC Program compensates the investors with Federal income tax credits based on their Qualified Equity Investment (“QEI”) made in the CDEs and the investors receive a tax credit for 39% of a QEI, which can be claimed over a seven-year period.
- A QEI must be invested in the CDE for the full seven-year period in order for the investor to satisfy the Program’s requirements.
- Investors claim tax credits as a percentage of the QEI amount over the seven years.
Note: It is uncommon that the investor will finance the entire project. Therefore, the remaining QEI must be sourced from other investments. These other sources may include leverage loans from banks, affiliates of the QALICB, state agencies, city agencies, and other funding sources.
The NTMC Program – The Basics for Developers
- The capital funds that a CDE provides to a project are known as Qualified Low-Income Community Investment (“QLICI”).
- QLICIs are structured as interest-only loans for a period of seven years to comply with the Program’s requirements for QEIs.
- The NTMC Program allows small and medium-sized businesses to obtain and utilize flexible and affordable financing for their projects.
- The investment determinations are made at a community level with a reported 90-97% of NMTC business and real estate investments involving more favorable terms and conditions than the market would otherwise offer, including lower interest rates, subordinated debt, lower origination fees, and longer maturity.
Historic and New Markets Tax Credits – The Takeaway
The value of Historic and New Market Tax Credits as a dollar for dollar reduction on the amount of taxes owed can be of great utility for Steeg Law clients. Due to the highly technical and complex nature of these tax credits, it is imperative that all procedures are strictly complied with. The credits can be combined through a process called “twinning.” Twinning the Historic and New Market Tax Credits can raise additional equity and leverage equity in different ways to the project.