Rehabilitation Tax Credits and the Certification Steps

The federal rehabilitation credit pays a portion of the cost of putting an old income-producing building back into use. It is generous enough to change whether a project happens at all, and conditional enough that a single design decision can eliminate it. Two of the three qualifying tests are financial and mechanical. The third is a judgment about how the work treats the building.

The credit and the property it reaches

Section 47 allows a credit equal to twenty percent of the qualified rehabilitation expenditures with respect to a certified historic structure. The credit is taken ratably over a five-year period beginning with the taxable year in which the building is placed in service, so it arrives in installments rather than at once, a feature that materially affects how it is syndicated.

The word building does real work in the statute. The credit reaches buildings, not structures generally, so bridges, dams, grain elevators and similar works that are not buildings fall outside it however historic they are. A registered historic district for this purpose is one listed in the National Register, or a district designated under a state or local statute that has been certified by the Secretary of the Interior as substantially meeting the requirements for listing.

A certified historic structure is a building listed individually in the National Register, or located in a registered historic district and certified by the Secretary of the Interior as being of historic significance to that district. The building must also be depreciable, which excludes personal residences. Whether a building is listed is a question answered by the process described in the National Register criteria and nomination route.

The substantial rehabilitation test

A building qualifies only if the rehabilitation is substantial. The test compares qualified rehabilitation expenditures during a twenty-four month measuring period against the greater of the adjusted basis of the building or five thousand dollars. Where the rehabilitation is completed in phases under architectural plans and specifications completed before the work begins, a sixty-month period may be used instead.

The measuring period is selected by the taxpayer and it ends on a chosen date, so the timing of spending can decide whether the test is met. Adjusted basis is measured at the beginning of that period, which means an acquisition that allocates a large share of price to the building rather than to land raises the bar the project has to clear. Allocation between land and improvements is therefore a decision with consequences well beyond depreciation.

Qualified expenditures are the amounts chargeable to capital account for the structure itself. They exclude the cost of acquiring the building, the cost of enlargement, site work such as parking and landscaping, furnishings and personal property. Projects routinely fail the test not because they spent too little but because a large share of the spending fell outside the definition.

The three-part certification

Part 67 of Title 36 governs certification. The first application evaluates significance and establishes that a building in a registered historic district contributes to that district; a building already listed individually does not need it. The second describes the proposed rehabilitation and is reviewed against the Secretary of the Interior's Standards for Rehabilitation. The third requests certification of the completed work and is reviewed against what the second application approved.

The standards applied at the second stage are the Secretary of the Interior's Standards for Rehabilitation, a short set of principles addressing retention of historic character, avoidance of false historical appearance, preservation of distinctive features, repair rather than replacement of deteriorated features, and compatibility of new additions. They are principles rather than a specification, which is why reviewers reach different conclusions on similar work and why applicants who submit vague drawings get vague answers. Detailed window schedules, wall sections and finish specifications produce reviewable submissions.

All three are submitted through the State Historic Preservation Officer, which reviews and forwards them with a recommendation to the National Park Service. The federal decision is the operative one. Certifications can be conditioned, and a certification of completed work can be denied where the executed project departs from the approved description.

Recapture and what happens afterward

The credit is not final when it is claimed. Under section 50 of the Internal Revenue Code, disposition of the property or a cessation of its qualifying use within five years after it is placed in service triggers recapture of a portion of the credit, decreasing by one fifth for each full year the property was held. Partnership arrangements are drafted around this period, because a transfer of an interest can be treated as a disposition.

Certification can also be revoked where the Park Service determines the certification was obtained on the basis of a misrepresentation, or where work inconsistent with the approved description is performed. Owners who intend to hold the building long term often layer a recorded restriction on top of the credit, an instrument described in preservation easements and how long they bind. Where the same rehabilitation is also under municipal review, the standards can differ in emphasis even where the text is identical, as noted in local designation and certificates of appropriateness. None of this changes the baseline position set out in what listing does and does not restrict: the credit is a benefit an owner elects, and with it come conditions the owner accepted.