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Senior Managing Director | The Opes Group LLC

Historic Tax Credits

Alexi Harding, Philosophy, Finance

Pictured above is the philosophy department at Columbia University, a renowned project that utilized Historic Tax Credit funding.

It takes vision to bring a real estate project to fruition. Sometimes a developer needs to be able to look at empty land and imagine the possibilities. They generally need to build something that is not only physically supported by the geography of the area but a structure that is simultaneously attractive and functional. It can be a herculean effort to shepherd all the parties needed to design and build the magnificent towers that surround us in everyday life.

What remains unseen to the lay person is the equally enormous task of arranging the financing for these real estate projects. It is rare to see a simple capital structure with one lender providing a giant senior loan buttressed by common equity. Instead, there can be several lenders, mezzanine slices, PIK structures, varying levels of equity, and funding arranged through a multitude of tax credits or other government programs. Developers must familiarize themselves with all these tools if they are to optimize their cost of funds. One such tool that I would like to discuss today is historic tax credits.

Historic Tax Credits breathe new life into older communities by “encouraging the flow of private funds to facilitate the rehabilitation of historic buildings.” Essentially, a portion of the rehabilitation costs of a certified building is transferred to a third party investor or bank that funds the project without taking direct risk to the cash flows of the project.

This very large and often forgotten area of real estate finance was established in 1976 by the government and has since allowed for the renovation of more than 39,600 buildings nationally, raised more than $109 billion in private funds, and created more than 2.41 million jobs. In fact, in just 2013, Historic Tax Credits were responsible for 800 projects and 63,000 jobs. The program is jointly overseen by the US Departments of the Interior and the Treasury. More specifically, The National Park Service acts on behalf of the Secretary of the Interior while the IRS acts on behalf of the Secretary of the Treasury.

In general, the Historic Tax Credit program “encourages the rehabilitation, restructure, and reconstruction of certified historic buildings through the provision of tax credits to property owners equal to 20 percent of the qualified rehabilitation expenditures.” Yet, if the building is of a certain age, then the tax credit is only ten percent of the cost of rehab. These credits are available to properties that have been rehabilitated for commercial, industrial, agricultural, or residential rental reasons. That said, the properties must be depreciable, revenue generating, and utilized for business. It should further be noted that projects can also receive state and federal tax credits.

As noted above developers often sell the tax credits to a third party investor and this is where structuring the transaction can get a little tricky. The financing needs to be arranged such that the tax credit investor is considered the owner of the project in order to receive the tax credit but the developer also wants to be the owner in order to receive the majority of the project’s cashflow; yes, once the IRS is involved nothing is easy. And as we all know the IRS is loath to give a free lunch so they have created conditions under which the credits can be recaptured! The project is not home free on closing.

Despite the labyrinth of rules, it is still worth every developer’s time to explore these funding options as they ultimately typically cost less than equity. That being said, the developer must be prepared to educate those who come to a transaction late and it can certainly be a headache. I was working with a client last week to refinance a building that was acquired using historic tax credit financing and the potential lender walked away from the transaction because they thought the tax credit rules prevented refinancing. That was not at all the case but ignorance about these programs can frustrate a lender’s ability to leverage their real estate portfolio.

Fortunately, my firm takes the time to navigate these structured offerings and help developers take advantage of these programs as well as clearly communicate the internal workings of a project to all of a transaction’s participants. As we’ve said before, we look for patient capital……let’s just say that once in a while the patience of Job is needed.