Real Estate Strategies Update – Tax Incentives for Real Estate Projects
As a result of the downturn in the economy, more businesses are using tax incentives to subsidize financing of real estate construction and renovation projects. Incorporating tax incentives into a project’s plan of finance requires upfront, detailed strategic planning taking into consideration the mechanics of the tax incentive program and, in the case of syndicated tax credits, the requirements of potential tax credit investors. This article provides a brief introduction to three syndicated real estate tax credits and a commonly available tax deduction for green building expenditures.
Federal Historic Rehabilitation Tax Credits (HTC) are available in the amount of (a) 20% of qualified rehabilitation costs for projects listed in the National Register of Historic Places or located in a registered historic district and certified by the Secretary of Interior as being of historic significance or (b) 10% for buildings first placed in service prior to 1936. An additional Virginia HTC is available in the amount of twenty-five percent of qualified eligible expenses. HTC equity contribution pay-ins are not generally made until the completion of the project unless the project qualifies for phased completion for tax purposes or the credit strength of the project owner and guarantors mitigates the investor’s pre-completion funding risks.
New Markets Tax Credits (NMTC) can be used to finance most commercial and mixed-use real estate projects, though residential projects without a commercial component that generates at least 80% of the project revenues do not qualify for NMTCs. The credit is equal to 39% of a qualified equity investment and is claimed over a seven year allowance period. In a NMTC real estate transaction, a NMTC investor makes a qualified equity investment into a Certified Community Development Entity (CDE) that in turn uses the investment proceeds to make a loan to a qualified active low-income business (the owner’s project entity) for a project located in a qualified low income community. The loan is typically fully funded to an escrow account controlled by the CDE and disbursed during construction. All or a portion of the loan is required to be repaid after seven years, with interest-only payments during the loan term.
Low Income Housing Tax Credits (LIHTC) are available over a ten year credit period for eligible projects based on approximately 9% of a project’s qualified basis if the project is allocated credits from a competitive pool or approximately 4% of a project’s qualified basis if at least 50% of the project is financed with tax-exempt bonds. Projects eligible for LIHTCs include new construction, rehabilitation and acquisition and rehabilitation of projects for which either (a) 20% or more of the residential units in the project are both rent-restricted and occupied by individuals whose income is 50% or less of area median gross income or (b) 40% or more of the residential units in the project are both rent restricted and occupied by individuals whose income is 60% or less of area median gross income. Projects receiving LIHTCs are required to comply with the LIHTC program requirements (including rent and income restrictions) for 30 years. LIHTCs are generally funded in four or five phases upon meeting certain construction completion benchmarks with the final funding upon achievement by the project of debt service coverage ratios and lease up requirements.
Because the current economic climate has resulted in a buyer’s market for the tax credit investors, developers pursuing NMTC, HTC or LIHTC must do their homework before approaching a tax credit investor. At the onset, developers need to target tax credit investors with project investment criteria that align with the owner’s proposed project in terms of geographic location, type of project and desired community benefits. Moreover, developers approaching tax credit investors also need to be mindful that tax credit investors choosing between real estate projects are looking for investment efficiency (smaller projects are less likely to attract investors), developers with a strong credit history, strong guarantors with liquid assets, a fully vetted development plan, including costs and construction schedule, detailed project finance models demonstrating project feasibility based on reasonable market assumptions, identification of financing sources and demonstration of the project’s tax compliance. Accordingly, developers must work in concert with consultants, attorneys, accountants, architects and contractors experienced in tax credit transactions.
In certain instances, business owners can reduce building renovation and construction costs by taking advantage of green tax incentives. The most commonly available green tax incentive for business owners is the Energy Efficient Commercial Buildings Deduction (EECBD) which establishes a tax deduction for expenses incurred for certain energy efficient building expenditures. The EECBD is available primarily to building owners, although tenants may be eligible if they make construction expenditures. In the case of energy efficient systems installed on or in government property, the EECBD can be allocated to the person primarily responsible for the systems’ design. The EECBD is available for new buildings or existing commercial buildings that save at least 50% of the heating and cooling energy of a building that meets the minimum requirements set by ASHRAE Standard 90.1-2001. The deduction is equal to the amount of energy-efficient property expenditures, capped at an amount equal to $1.80 per square foot of the building for which such expenditures are made. Partial deductions of up to $0.60 per square foot can be taken for measures affecting any one of three building systems: the building envelope, lighting, or heating and cooling systems. The EECBD is taken in the year when construction is completed.
For more information regarding NMTC, HTC, LIHTC and EECBD tax incentives or to sign-up for an invitation to attend Kaufman & Canoles’ upcoming Tax Credit Forum, please contact Saundra R. Hirth.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.