Here are select FAQs based on feedback from Vicinity users. This is not intended to be comprehensive and other specific IRS rules may apply to your individual situation. Sources for this information are the IRS site here, and South Carolina Dept. of Archives and History here. Please consult a tax specialist to review the details and personal impact of any tax credit investments.
1. What is an income tax credit?
The federal and state tax credits reduce the amount of income taxes owed. In general, a dollar of tax credit earned reduces the amount of income taxes owed by one dollar. Each tax situation is different, however, and we advise you to check with a tax specialist to determine how the credits would affect your tax liability.
2. How do I use the credits?
Consult with an attorney or tax specialist to advise you on the tax aspects of the programs and to help you determine the effect of the credits on your tax liability. While the goal of the programs is to preserve historic buildings, they are also income tax programs and must meet Internal Revenue Service (IRS) and South Carolina Department of Revenue (DOR) requirements. The IRS website includes Rehabilitation Tax Credit – Real Estate Tax Tips. See also the NPS page IRS Info.
3. Who can claim the tax credit?
The rehabilitation credit is an investment credit and part of the general business credit that a taxpayer can claim against the income tax. Taxpayers that own an interest in the building directly or through a passthrough entity are among those who are eligible.
There are restrictions in the Internal Revenue Code which could limit or suspend the use of a tax credit against income not derived from the activity giving rise to the tax credit. Potential investors should discuss the applicability of these rules and their ability to use tax credits with their investors prior to making an investment.
4. When can a taxpayer claim the credit?
The credit is generally first allowed in the taxable year the qualified building is “placed in service” (meaning when the property is placed in a condition or state or readiness and available for a specifically assigned function).
5. How is the credit claimed on a tax return?
Taxpayers claim the rehabilitation credit on Form 3468, Investment Credit.
The individual investor’s credit amount should show on the K-1 received from the Issuer.
6. How do recapture rules apply (e.g., how would the credits be lost)?
The rehabilitation credit is recaptured if the property is disposed of or otherwise ceases to be investment credit property during the 5-year recapture period.
The recapture percentage is 100 percent for property that ceases to be investment credit property within one full year after it is placed in service, reduced by 20 percentage points for each year held during the 5-year recapture period.
7. Can the credit be carried back and forward?
The rehabilitation credit is an investment credit that is part of the general business credit that a taxpayer can claim against the income tax.
A taxpayer is generally allowed to carry back one year and carry forward 20 years unused portions of the general business credit.
8. When can I claim the credits?
You can claim the federal credit in 20% installments over five years on Internal Revenue Service (IRS) form 3468 beginning in the tax year in which the rehabilitated building is placed in service (that is, returned to use). There are also provisions for claiming the credit for phased projects.
Please note: The state credit must be claimed in equal installments beginning with the year in which the property is placed in service. If placed in service after June 9, 2015, the installment equals 33% of the credit amount. If the tax credit installment exceeds your tax liability you may carry the credit installment forward for up to 5 more years. You will claim the credit by submitting South Carolina Department of Revenue (DOR) form SC SCH TC-21 with a copy of your federal income tax return showing the credit claimed. The form is available on the DOR website.
The Franklin Reg CF investment offering is a current example of a project planning both state and historic tax credits as a material component of an investor’s returns.
As a demonstration of how these credits may be distributed to an individual investor/entity:
Key assumptions from the budget and distributions plan(subject to change): (1) investor equity of $893,588 and sponsor equity of $99,288; (2) tax credit basis for the project of $1,247,760; (3) 20% Fed HTC of $249,552; (4) 25% State HTC of $311,940.
An investment of $50,000 would represent 5% of the total equity.
This investor would receive 5% of the Federal and State HTCs in the amounts of $12,567 and $15,708, respectively.
The Federal credit could be claimed in 20% installments over 5 years ($2,513.40) and the State credit could be claimed in 33% installments ($5,183.64).
Note: this assumes final numbers match the Issuer’s pro forma and budget and the building is placed in service for at least the 5-year recapture period. Please consult a tax specialist for any personal implications, limitations, or specific risks to you that would be associated with these credits.
Tax credits can be a valuable component of a real estate investing opportunity. We hope this article helps to break down some of the most popular questions when evaluating a historic tax credit opportunity.
Interested in learning more? Contact us today! We look forward to helping you build your local portfolio.