H.R. 1 of the 115th Congress – the “Tax Cuts and Jobs Act” – repeals the Historic Rehabilitation Tax Credit (the “HTC”). That credit is found in section 47 of the current Internal Revenue Code. The effective date of the repeal is the date the Act becomes law. The Republican Leadership wants the Act to become effective on January 1, 2018. So, generally speaking, assuming the Republicans’ dreams come true, any rehabilitation expenditures for a building that is not substantially rehabilitated by December 31, 2017 will not generate HTCs.
The Senate version of the Tax Cuts and Jobs Act (as voted out of the Senate Finance Committee on November 16) does not repeal the HTC. It does, however, change the timing of the credit. Now, the 20% credit is earned in the year the rehabilitated historic building is placed in service. The Senate Bill provides that the credit is earned ratably over the five year period beginning when the historic rehabilitated building is placed in service. Here’s how the credit would work under the Senate bill:
Example
X Corp (a C corporation) acquires Building (an historic structure) on January 1, 2018. During the 24 months beginning January 1, 2018, X Corp incurs $5,000x dollars in qualified rehabilitation expenditures substantially rehabilitating (more on that later) Building. On December 31, 2019, X Corp places Building in service. Assuming X Corp has complied with all requirements for the HTC, then
Current Law
Under current law (assuming the Tax Cuts and Jobs Act is not enacted) X Corp would be entitled to a $1,000x HTC for 2019.
Senate Version of Tax Cuts and Jobs Act
Under the Senate Bill, X Corp would be entitled to a $200x HTC for each of the five tax years beginning 2019 (i.e., 2019, 2020, 2021, 2022, and 2023).
Obviously, the current law HTC is worth more than the HTC under the Senate Bill. As a consequence, if the Senate Bill is enacted, it will be more difficult to finance historic rehabilitation than it is under current law. However, the Senate Bill is much better for historic rehabilitation than the House Bill which repeals the credit altogether.
Transition Rule
Even if some version of the Tax Cuts and Jobs Act repeals or modifies the HTC, some existing projects will earn HTCs under current law, though the projects are placed in service after the Act is enacted. Each version of the Act contains a “transition rule” for existing historic rehabilitation projects. The point of most transition rules is to take account of the fact Congress is changing the rules of the game with very little notice. Without the transition rule, people who made capital commitments in reliance on current law would be harmed.
But, Congress has to set a limit to the harm they’ll address. Otherwise, the exception would swallow the rule. So, Congress drafts the exception with a clear fence around the relief from harm generated by its harmful conduct.
The following is the transition rule for the HTC repeal. Be forewarned. This transition rule will not make any sense to you if you read it quickly. And even if you read it carefully several times, you’ll notice that it does not provide clear guidance to taxpayers about the exception it was drafted to create. In other words, the transition rule needs to be clarified to be understood.
Here’s the text of the transition rule:
In the case of qualified rehabilitation expenditures (within the meaning of section 47 of the Internal Revenue Code of 1986 as in effect before its repeal) with respect to any building –
(A) Owned or leased (as permitted by section 47 of the Internal Revenue Code of 1986 as in effect before its repeal) by the taxpayer at all times after December 31, 2017, and
(B) With respect to which the 24-month period selected by the taxpayer under section 47(c)(1)(C) of such Code begins not later than the end of the 180-day period beginning on the date of the enactment of this Act
the amendments made by this section (3403 of the House Bill) shall apply to such expenditures paid or incurred after the taxable year in which the 24-month period referred to in subparagraph (B) ends.
The Rule – In English
The House Bill repeals the Historic Rehabilitation Tax Credit (the “HTC”) effective 12.31.2017. However, a taxpayer can claim the HTC for qualified rehabilitation expenditures (“QREs”) incurred after 12.31.2017 if the taxpayer satisfies two tests:
(1) the building ownership test, and
(2) the substantially rehabilitated test.
- Building Ownership Test
QREs incurred after 12.31.2017 may produce HTCs only if the taxpayer who incurred the QREs/claims the HTCs owned or leased the building at all times after 12.31.2017.
- Substantial Rehabilitation Test
First, a little background on substantial rehabilitation.
What is Substantial Rehabilitation?
HTCs are only available if the rehabilitated building was “substantially rehabilitated”. A building is substantially rehabilitated if the amount of QREs incurred in any 24-month period selected by a taxpayer is equal to or greater than the adjusted tax basis of the building at the start of that 24-month period.
Example: A owns Building. On July 1, 2015, A’s adjusted tax basis in Building is $500,000. During the 24-month period beginning July 1, 2015, A incurs $750,000 of QREs in rehabilitating Building. A selects that 24-month period as the test period for “substantial rehabilitation”. That 24-month period ends June 30, 2017.
(i) Because A incurred QREs that were greater than A’s basis in Building at the beginning of the test period, Building is “substantially rehabilitated”, and
(ii) Because Building is substantially rehabilitated, A may take HTCs for all QREs incurred through the end of 2017 – the year in which the 24-month period ends.
The Test – Substantial Rehabilitation
The transition rule says that QREs incurred on Building after December 31, 2017 will generate HTCs only if the substantial rehabilitation test period begins within 180 days after the Act is effective. That means, if the Act is effective as of January 1, 2018, the substantial rehabilitation test period should begin before June 30, 2018.
The Result
If a taxpayer satisfies both tests, then all QREs incurred by the end of the year in which the substantial rehabilitation test period ends will generate HTCs for the taxpayer.
Example
A acquires Building on December 31, 2017, the date the Act is effective. On June 1, 2018, A’s adjusted tax basis in Building is $500,000. During the 24-month period beginning June 1, 2018, A incurs $750,000 of QREs in rehabilitating Building. A selects that 24-month period as the test period for “substantial rehabilitation”. That 24-month period ends May 31, 2020.
(i) Because A incurred QREs that were greater than A’s basis in Building at the beginning of the test period, Building is “substantially rehabilitated”, and
(ii) Because Building is substantially rehabilitated, A may take HTCs for all QREs incurred through the end of 2020 – the year in which the 24-month period ends.
The Transition Rule Applied to Partnerships
In the examples above, we assume that A owns Building and is the taxpayer. What if a tax partnership (a limited partnership or an LLC) owns Building? Since many (maybe most) historic rehabilitation projects that generate HTCs are conducted through partnerships, most projects will benefit greatly from a transition rule that addresses tax partnerships.
The Capital Account 