Offsetting Passive Income with the Historic Rehabilitation Tax Credit: A Powerful Tax Planning Opportunity for Family Offices

By Bill Sherbert, COO The Sherbert Group bsherbert@sherbertgroup.com

Family offices tend to be very good at generating passive income and comparatively frustrated at sheltering it. Real estate partnerships, operating businesses held through flow-through entities, and syndicated investments throw off K-1 income year after year, and much of it is taxed at the top marginal rate. The usual defensive tools have limits: passive losses are boxed in by their own rules, and most credits an advisor reaches for turn out to be unusable against exactly the kind of income a family office actually has.

The federal Historic Rehabilitation Tax Credit is one of the few tools built to fit that gap. Understanding why it fits requires a short detour into how the tax code sorts income, but the payoff is a credit that can do real work in a family office portfolio.

What the credit actually is

The Historic Rehabilitation Tax Credit, found in Section 47 of the Internal Revenue Code, is a federal income tax credit equal to 20% of the qualified costs of rehabilitating a certified historic building. “Certified historic” generally means the building is listed on the National Register of Historic Places or contributes to a registered historic district, and the rehabilitation work has to meet standards set by the National Park Service.

Two features matter for planning purposes. First, it is a credit, not a deduction — a dollar-for-dollar reduction of tax owed, not merely a reduction of taxable income. A $1 million credit erases $1 million of tax, which is worth far more than a $1 million deduction. Second, since the 2017 Tax Cuts and Jobs Act, the credit is claimed ratably over five years — 4% of qualified costs per year for five years, rather than all at once in the year the building is placed in service.

Why it belongs in a conversation about passive income

Here is the part that trips up even experienced advisors. The tax code divides income into buckets — broadly: active, portfolio, and passive — and it does not let credits and losses flow freely between them.

Under the passive activity rules of Section 469, a credit generated by a passive activity is a passive credit. A passive credit can only offset the tax attributable to passive income. It cannot reduce the tax on wages, and it generally cannot reduce the tax on portfolio income like interest and dividends. For a typical high-earning individual whose income is mostly salary and investment portfolio, a passive credit is stranded — it sits unused and carries forward, delivering no current benefit.

This is precisely why the credit fits family offices better than almost anyone else. Family offices are structurally built around passive income. The whole point of the enterprise is to hold investments that generate returns for family members who are not materially participating in the underlying businesses. That passive income produces passive tax liability — and passive tax liability is the one thing a passive credit is designed to erase.

Put simply: the credit that is useless to most taxpayers is well-matched to the family office because the family office has the right kind of income for it to work against.

The annual limitation on how much credit you can use

Being a passive credit is not the only ceiling. The Historic Rehabilitation Tax Credit is a component of the general business credit, and the general business credit carries its own annual usage cap under Section 38(c). In any given year, the total general business credit a taxpayer can claim is limited to their net income tax reduced by the greater of (a) their tentative minimum tax, or (b) 25% of the portion of their net regular tax liability that exceeds $25,000.

In plain terms, two guardrails apply at once. The passive rules decide which pool of tax the credit is allowed to touch; the Section 38(c) cap then limits how much of the credit can be used in a single year even within that pool. Credit that exceeds the cap is not lost — but it does not disappear into the current return either. It moves into the carryback and carryforward rules below.

Carrying the credit backward and forward

Because the credit is part of the general business credit, unused amounts follow the standard rule of Section 39: a one-year carryback and a twenty-year carryforward. Credit that cannot be used this year is first carried back one tax year and, to the extent still unused, carried forward for up to twenty years.

There is an important wrinkle for advisors working with individual family members rather than C corporations. For an individual, a passive credit that is disallowed under the Section 469 passive rules is suspended under those passive rules — it is held until the taxpayer has enough passive tax liability (or disposes of the passive activity) to release it. That is a different mechanism from the Section 39 carryback and carryforward, which governs credit that is allowed under Section 469 but limited by the Section 38(c) cap. In practice this means two different holding tanks can apply to the same investor: one for credit stranded by a lack of passive income, and one for credit limited by the annual general business credit cap. Modeling both is part of getting the projected benefit right.

A simple illustration

Suppose a family’s investment entities generate $6,000,000 of net passive income in a year. Assume a combined marginal rate on that income of roughly 37%.

Tax attributable to passive income: $6,000,000 × 37% = $2,220,000
The family invests in a historic rehabilitation generating a $2,000,000 credit (20% of $10,000,000 in qualified costs), claimed at $400,000 per year over five years.
Year-one passive credit available: $400,000
Passive tax offset in year one: $2,220,000 − $400,000 = $1,820,000 remaining

The $400,000 each year is applied directly against passive tax, dollar for dollar, until the full $2,000,000 is used. Because the family has more than enough passive tax liability to absorb the credit — and remains within the annual general business credit cap — none of it is stranded. An individual investor without passive income would suspend that same $400,000 with nothing to offset it against.

(Rates and figures are illustrative; actual results depend on the taxpayer’s full facts.)

How family offices access the credit

There are two broad paths. A family office can own and rehabilitate a historic building directly, becoming the developer — which means taking on construction, compliance, and execution risk. Or it can invest alongside a developer through a structured vehicle, contributing capital in exchange for an allocated share of the credit and returns.

Most family offices prefer the second path, because it delivers the tax benefit without the operational burden. This is where Moxie Investments, a subsidiary of The Sherbert Group, comes in. Moxie sponsors and manages Historic Rehabilitation Tax Credit investment vehicles designed for exactly this profile of investor: passive capital seeking a well-structured, compliance-tested credit that offsets passive tax liability. The vehicles are built to align with the federal safe-harbor guidance governing how these investments are structured, so the credit lands where it is supposed to.

The caveats an advisor has to weigh

This is a real estate investment first and a tax strategy second, and it carries real conditions:

Recapture risk. The credit vests over a five-year compliance period. If the building is sold or falls out of qualified use during that window – such as foreclosure or a casualty event like flood or fire – a portion of the credit is clawed back.

The passive limitation cuts both ways. The credit is only as valuable as the passive tax liability available to absorb it. Model the client’s actual passive income before assuming the full benefit is usable in the current year.

The annual general business credit cap. Even with ample passive income, the Section 38(c) limit can defer part of the credit to a carryback or carryforward year.

At-risk and basis rules can further limit how much credit an investor may claim.

Execution matters. Certification and the National Park Service standards are unforgiving; a rehabilitation that fails certification produces no credit at all. This is why it is crucial to have an experienced syndicator, such as Moxie Investments, to help work through the complexities.

The bottom line

For most taxpayers, a passive credit is a frustration. For a family office, it can be a genuine opportunity, because the family office holds the passive income that makes the credit usable in the first place. The Historic Rehabilitation Tax Credit rewards the preservation of historic buildings with a dollar-for-dollar reduction of the exact tax a family office is most likely to owe. Layered thoughtfully — and, where available, alongside a state historic credit that can stack on top of the federal benefit — it becomes one of the more efficient tools an advisor can put in front of a passive-income client.

The strategy is not automatic and not for everyone. But for the right family office, matched to the right project and structured correctly, it converts a routine tax bill into preserved capital and a preserved building.

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Offsetting Passive Income with the Historic Rehabilitation Tax Credit: A Family Office Tax Planning Opportunity