The Question Developers Should Be Asking About Federal Historic Tax Credits

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When real estate developers learn that their rehabilitation project may be eligible for the Federal Historic Tax Credit (FHTC), the first question they typically have is “how much are these credits worth?” It’s an important question to answer, but developers inexperienced with the credit tend to ignore the other issue, which is “what is this going to cost me?” The 20% federal credit is not for everyone, and project owners must be comfortable with what they’re giving up to utilize the credit.

There are obvious costs, such as application fees and consulting fees to historic preservationists, but the more significant costs are less familiar to developers new to the credit. Assuming the developer chooses to syndicate the tax credit and not keep the credit to use him or herself, the first cost is the loss of 99% of project ownership for five years or more. This can be structured around with the Master-Lease concept (a blog entry unto itself; contact the author for more information), but in any scenario a developer will give up some project ownership. A developer’s 1% interest always provides for general partner or manager control over the developer and operations. When syndicating the tax benefits to maximize the financial efficiency of the transaction, most investors prefer to maintain the role of silent partner, which they’ll do unless problems arise. Syndication means losing some rights to the property and potentially deprecation benefits for at least five years after the project is placed into service. This time period can extend beyond five years, especially in today’s investor marketplace with the IRS Revenue Procedure 2014-12 (“Rev Proc”) disallowing the use of a call option to guarantee a timely investor exit.

Additionally, the tax credit investor will likely require a cash return for the duration of its interest in the project ownership. This was traditionally a fixed return of 2-3% of the investor’s capital contribution, but the requirements of the Rev Proc has increased this requirement in the eyes of several investors. Developers will sometimes receive very little cash flow while their tax credit investor is still in the project ownership.

There are also the costs of using the credit which are more difficult to quantify. The National Park Service (NPS) has design review over projects utilizing the credit, which often requires restoration beyond what a developer not using the tax credit would undertake. This adds costs and headaches to projects, especially when there is a disagreement with NPS over a historic element of a project, such as windows. Developers unfamiliar with the credit application process can also face timing delays while waiting for approvals from NPS.

The FHTC is a wonderful economic development tool, but project owners expecting to utilize the credit must make sure they understand the costs along with the benefits. To find out more information about the FHTC or marketing the credit to investors, please contact us for more information.