Substantial Rehabilitation Test: Qualify for 20% Historic Tax Credit
By Frank Perdue, Audit Manager, Sherbert CPA, PC
To qualify for the 20% Federal Historic Tax Credit, commonly referred to as the historic preservation tax credit or Historic Tax Credit (HTC), a building must, among other things, be “substantially rehabilitated”. This article discusses the Internal Revenue Service (IRS) two-part test, Qualified Rehabilitation Expenditures (QREs) and phased project rules to secure historic preservation tax credits.
Key Terms to Understand
- Adjusted Basis – In general, equal to purchase price (excluding cost of land), plus cost of capital improvements made since purchase, minus depreciation taken on the property.
- QREs – Costs for construction, architectural fees, etc. that improve the building. However, this does not include buying the building, expansion costs, or landscaping.
- Section 47 Tax Credit – IRS establishes requirements for HTCs under Section 47 of the Internal Revenue Code (IRC).
Rehab Tax Credit Eligibility
Section 47 of the IRC generally requires that you have QREs for a qualified rehabilitated building, which includes any building and its structural components that:
- Has been substantially rehabilitated as defined in IRC 47(c)(1)(B) and Treas. Reg. 1.48-12, which is discussed further in the Two-Part Test section below
- Was placed in service as a building before the beginning of the rehabilitation
- Is a certified historic structure under IRC 47(c)(3) and Treas. Reg. 1.48-12(d)(1)
- Has allowable depreciation
The National Park Service (NPS) lists the eligibility requirements that must be met under the IRC and associated Regulations.
The HTC application is submitted to NPS in 3 parts: Part 1 presents information about the significance and appearance of the building; Part 2 describes the condition of the building and the planned rehabilitation work; and Part 3 is submitted after the project is complete and documents that the work was completed as proposed. NPS approval of the Part 3 certifies that the project meets the Standards and is a “certified rehabilitation”.
Two-Part Test for HTC Eligibility
The IRS sets a clear test under Section 47 of the IRC with two main rules that must both be met within a 24-month measuring period (60-month measuring period for phased projects). Phased projects are discussed in the next section of this article.
- Substantial Cost – Total QREs must exceed the greater of the building’s Adjusted Basis or $5,000.
- Test Done in 24 Months – All the spending that counts toward the test must happen within a 24-month measuring period that you choose (60-month measuring period if the project is phased). In order to claim credits in a given year, you must pass the test with a window that ends at some point during that year.
Phased Project
If the whole rehabilitation is planned as one big project split into logical phases, the 24-month measuring period in the two-part test described above can be extended to a 60-month measuring period (for all phases combined, not per phase). A phased project is any rehabilitation that may reasonably be expected to be completed in phases (if it consists of two or more distinct stages of development).
For phased projects, Treasury Regulations Section 1.48-12(b)(2)(v) and IRC Section 47(c)(1)(B)(ii) require that written architectural plans and specifications be completed before the physical work on the rehabilitation begins. The determination of whether a rehabilitation consists of distinct stages and therefore may reasonably be expected to be completed in phases shall be made on the basis of all the relevant facts and circumstances in existence before physical work on the rehabilitation begins.
Total spending in all 60 months must still exceed the Adjusted Basis. All phases together are one HTC project. You can’t just do the easy phases and skip the hard ones.
A Simple 24-Month Example
Facts: A historic building is purchased for $300,000 with a land value of $50,000 as an adaptive reuse project. $400,000 is spent on rehabilitation within the chosen two-year measurement period.
Conclusion: The building’s Adjusted Basis is $250,000 (purchase price of $300,000 – land cost of $50,000). QREs are $400,000 (given in facts above). Two-Part Test is passed (QREs exceed the larger of Adjusted Basis or $5,000). The building qualifies for an HTC of $80,000 ($400,000 x 20%), recognized over a 5-year period beginning with the taxable year that the QREs are placed in service.
Phased projects qualify under a 60-month measurement period.
Contact Us
The Sherbert Group is a great resource to help you navigate the requirements of historic building renovation incentives like the HTC, state historic tax credits, and other tax credits/tax incentives.
To contact the reporter on this story: Frank Perdue at fperdue@sherbertcpa.com.
To discuss this or any other upcoming tax changes with the Sherbert Group, Contact: Bill Sherbert at bsherbert@sherbertgroup.com.