Tax Tips
Rehabilitation Tax Credit - Part II - April 2002
Richard Scrivanich - Partner
In this month's tax tips, we'll wrap up our discussion of the rehabilitation tax credit for certified historical structures by taking a look at how to claim the credit as well as depreciation and other rules applicable to such property.
Claiming the 20% credit.
Generally, the tax credit is claimed on IRS Form 3468 for the tax year in which the rehabilitated building is placed in service. If a building remains in service throughout the rehabilitation, then the credit may be claimed when the substantial rehabilitation test has been met.
The IRS requires that the Park Service certification of completed work be filed with the tax return on which the credit is claimed. If final certification has not been received by the time the taxpayer files the return that claims the credit, a copy of the first page of the certification application (with proof of receipt by the park service or state historic preservation officer) must be filed with the return instead.
If the taxpayer does not receive final certification within 30 months after claiming the credit, the taxpayer must agree to extend the period of assessment. If certification is denied, the credit will be disallowed.
Recapture of the 20% credit.
The owner of the building must hold it for a full five years after completing the rehabilitation, or pay back the credit. If the owner sells the building within a year after it is placed in service, 100% of the credit is recaptured. For properties held between one and five years, the tax credit recapture amount is reduced by 20% a year.
Depreciation.
Rehabilitated property is depreciated using the straight-line method over 27.5 years for residential property and over 39 years for nonresidential property. The depreciable basis of the building must be reduced by the full amount of the tax credit claimed.
10% rehabilitation tax credit.
This credit is available for non-historic building built before 1936. This credit only applies to buildings, and the rehabilitation must be substantial, i.e., exceeding either $5,000 or the adjusted basis of the property, whichever is greater. Furthermore, the property must be depreciable.
This credit applies only to buildings rehabilitated for nonresidential uses. Therefore, rental housing would not qualify, but hotels would. Hotels are considered a commercial, not a residential use for a building.
Projects undertaken for the 10% credit must meet a specific physical test for retention or external wall and internal structural framework.
- At least 50% of the building's walls existing at the time the rehabilitation began must remain in place as external walls at the end of the project.
- At least 75% of the building's existing external walls must remain in place as either external or internal walls, and
- At least 75% of the building's internal structural framework must remain in place.
This credit must be claimed on Form 3468 for the tax year in which the rehabilitated building is placed in service. There is no formal review process for the rehabilitation of non-historical buildings.
Other tax provisions to consider.
Several tax provisions that affect real estate investments generally also affect buildings eligible for these special credits, including the passive activity rule, the alternative minimum tax and the at risk rules.
Passive activity.
The passive activity rule states that losses and credits from a "passive income source" such as real estate limited partnerships, cannot be used to offset a tax liability from "active" sources, such as wages. There are very specific requirements that determine whether an activity is passive or not. The passive activity rules don't apply to most regular corporations or to real estate professionals who materially participate in a real property trade or business. In addition, there is an exception for certified rehabilitations.
Alternative minimum tax.
Nonrefundable credits, such as the rehabilitation tax credit, may not be used to reduce the alternative minimum tax (AMT). If the taxpayer cannot use the credit because of the AMT, it can be carried back or forward to another tax year.
At-risk rules.
These rules state that a taxpayer may deduct losses and obtain credits from a real estate investment only to the extent that the taxpayer is "at-risk" for the investment. This amount is usually the sum of cash or property that the taxpayer contributed towards the project, plus any borrowed funds for which the taxpayer is personally liable, including certain borrowed amounts secured by the property used in the project.
Additional information about the Historic Preservation Tax Incentives Program can be found on the National Park Service Web site at http://www.cr.nps.gov, by selecting the "Find Grants and Assistance" button.
Obviously, please feel free to give me a call as well at (562) 698-9891.
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