Rehabilitation Tax Credit Guide Glossary
Adjusted Basis
For the purposes of the substantial rehabilitation test, the adjusted basis of the building typically equals the cost of the property, less property cost attributable to land (consult with your accountant to determine this number), plus previously made capital improvements, less depreciation.
Example - Consider a commercial building for which the owner paid $100,000 five years ago. If the property cost attributable to land is $45,000, the owner had previously made $10,000 in improvements, and it has depreciated $2,000 per year, the adjusted basis be calculated in the following manner:
| Original cost of property |
$100,000
|
| Property cost attributable to land |
-45,000
|
| Previously made capital improvements |
+10,000
|
| Depreciation (5 years@ $2,000/yr) |
-10,000
|
| Adjusted Basis |
$55,000
|
Alternative Minimum Tax
Taxpayers who are paying less than the minimum tax rate under the regular tax system may be liable for additional tax under the alternative minimum tax laws. Alternative minimum taxable income is computed from regular taxable income with certain adjustments and the addition of all appropriate tax preference items.
Refer to the AMT for Individuals IRS Form 6251 (pdf, 28 kb) and its instructions (pdf, 60 kb).
At-Risk Rules
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. The amount that a taxpayer is “at-risk” is generally the sum of cash or property contributions to the project plus any borrowed money for which the taxpayer is personally liable, including certain borrowed amounts secured by the property used in the project. In addition, in the case of holding real property, the amount “at-risk” includes qualified non-recourse financing borrowed from certain financial institutions or government entities.
For more information, refer to Passive Activity and At-Risk Rules IRS Publication 925 (pdf file, 234 kb); At-Risk Limitations IRS Form 6198; (pdf file, 19 kb) Instructions for At-Risk Limitations (pdf file, 62 kb).
Building
Any structure or edifice enclosing a space within its walls and usually covered by a roof, the purpose of which is to provide shelter or housing, working, office, parking, display, or sales space. The IRS has ruled that sports stadiums are considered buildings.
Certified Historic Structure
A structure which is either listed individually on the National Register of Historic Places or is a contributing building in a National Register, or State or Local Historic District that has been certified by the Secretary of the Interior. This status is gained by the National Park Service approving Part 1 of the Historic Preservation Certification Application.
Deduction Equivalent Exception to Passive Activity Rules
Individuals (including limited partners) with adjusted gross income (AGI) below $200,000 (phases out for taxpayers with AGI--modified for this purpose--between $200,000 and $250,000) are allowed to offset the deduction equivalent of $25,000 in taxes owed on non-passive income with passive credits such as the rehabilitation tax credit.
Example: A full time dentist purchases and rehabilitates a historic structure, earning a $20,000 passive rehabilitation tax credit in 2003. The dentist's AGI for 2003 is $175,000 (all non-passive income), and his marginal tax bracket is 36 percent. The deduction equivalent exception to passive activity loss limitation allows the dentist to redeem $9,000 ($25,000 * 36 percent = $9,000) in 2003. The remaining $11,000 tax credit can be carried forward to be used in future years.
To determine if you can use this exception. read the Passive Activity and At-Risk Rules IRS Publication 925, (pdf, 234 kb).
Disqualified Lease
Defined by the Internal Revenue Code Section 168(h) as a lease to a tax-exempt entity where: (1) part or all of the property was financed directly or indirectly by an entity that is tax-exempt under Internal Revenue Code Section 103(a) and such entity (or related entity) participated in the financing, or (2) under the lease there is a fixed or determinable purchase price or an option to buy, or (3) the lease term is in excess of 20 years, or (4) the lease occurs after a sale or lease of the property and the lessee used the property before the sale or lease.
Example: Consider a rehabilitated building that is eligible for the 20 percent tax credit and has 50 percent of its space under a disqualified lease. Rehab work done in that space does not qualify for the credit, but work in remaining 50 percent is eligible for credit. For instance, if the rehabilitation costs $2 million, the eligible basis is $1 million, generating a $200,000 tax credit. If there was no disqualified lease, $2 million would be the eligible basis, generating a $400,000 tax credit.
Read the IRS disqualified lease rules.
Facade Easement
A legal agreement granting an easement in perpetuity to a qualified nonprofit organization designed to protect the façade of a certified historic structure. Property owners receive a federal tax deduction equal to the value of the facade easement in exchange for promising to maintain, protect and preserve the façade of a certified historic structure in perpetuity.
Materially Participate
You materially participate in an activity for any tax year that you satisfy one of several tests, including:
- participation in the activity for more than 500 hours during the year;
- where your participation was substantially all of the participation of all individuals in the activity during the year; and
- participation in the activity for more than 100 hours during the year if you participated more than anyone else.
Application of these and the other material participation tests often involves intricate tax analysis. You should contact your tax attorney or accountant if you have any questions about whether you have materially participated in an activity.
National Register of Historic Places
The National Register of Historic Places is the nation's official list of cultural resources worthy of preservation. Authorized under the National Historic Preservation Act of 1966, the National Register is part of a national program to coordinate and support public and private efforts to identify, evaluate, and protect our historic and archeological resources. Properties listed in the Register include districts, sites, buildings, structures, and objects that are significant in American history, architecture, archeology, engineering, and culture. The National Register is administered by the National Park Service, which is part of the U.S. Department of the Interior. Visit the Park Service's web site for more information.
Non-Contributing Historic Structure
A structure that is neither listed individually on the National Register of Historic Places nor a contributing building in a National Register, or State or Local Historic District that has been certified by the Secretary of the Interior.
Part 1
Part 1 of the Historic Preservation Certification Application is the Evaluation of Significance by the National Park Service (NPS). It usually contains a narrative describing the history of the building so the NPS can determine if the building contributes to the historic district within which it is located. Buildings individually listed on the National Register are automatically certified historic structures and no Part 1 is neeed. It must be submitted to the NPS via the state historic preservation office (SHPO). The NPS must also deem a building a non-certified historic structure in order to be eligible for the 10 percent Rehabilitation Tax Credit.
Part 2
Part 2 of the Historic Preservation Certification Application is the Description of the Rehabilitation. It must be submitted to the National Park Service (NPS) via the state historic preservation office (SHPO). The Department of the Interior reviews the description and makes the decision as to whether it conforms to the Secretary of the Interior's Standards for Rehabilitation. The ruling is conveyed through NPS. While the rehabilitation may involve repair or alteration of a historic property, it may not destroy or damage the interior and exterior material and features that define the building's historic character. A conditional approval may be granted which is contingent upon certain adjustments to the rehabilitation plan. The Part 2 application may be submitted to NPS at any time during the course of the rehabilitation, yet it is advisable to do so before work commences in case modifications are ordered. Any alteration to the original work plan during construction must be submitted as an amendment to the NPS for their review.
Part 3
Part 3 of the Historic Preservation Certification Application is the Request for Certification of Completed Work. It must be submitted to National Park Service (NPS) via the state historic preservation office (SHPO) after the rehabilitation is completed. The application must be accompanied by photographs documenting the completed project. The NPS issues an approval if the completed rehabilitation conforms to the Secretary's Standards.
Passive Activities
Passive activities are those activities in which the taxpayer is not involved on a regular, continuous and substantial basis. Limited partner investors in rehabilitation projects are presumed to be involved in a passive activity. In addition, rental activities, including the rental of rehabilitated buildings are considered passive activities. Non-passive activities income includes wages and portfolio income such as stock dividends, stock capital gains, and interest on bank accounts.
Placed-in-service
Placed-in-service means that the appropriate work has been completed which would allow for occupancy of either the entire building, or some identifiable portion of the building. An occupancy permit issued by the local government authority or a certificate of substantial completion issued by the project inspecting architect often serves as evidence the building is placed-in-service.
Portfolio Income
Dividends, interest, annuities and royalties not earned in the conduct of a trade or business, together with gains from the disposition of property that produces this type of income or from property otherwise held for investment.
Qualified Rehabilitation Expenditures (QREs)
Expenditures that are connected with the rehabilitation or restoration of the qualifying structure. Examples of qualified rehabilitation expenditures (QREs) include: construction costs, construction interest and taxes, architectural and engineering fees, legal costs, developer's fees, general and administrative fees and other construction-related expenditures if such costs are added to the basis of the property and are determined to be reasonable and related to the services performed. The cost of other work, such as additions to the structure, does not qualify as a qualified rehabilitation expenditure. Examples of costs that do not count as qualified rehabilitation expenditures include: acquisition costs, enlargement (addition) costs, furnishings, acquisition interest and taxes, realtor's fees, paving and landscaping costs, sales and marketing costs.
Real Estate Professional
Generally, a taxpayer who spends more than half of their professional services in the real property business (property development, construction, acquisition, conversion, rental, management, leasing, or brokering) and more than 750 hours a year in real property trade or business.
Secretary of the Interior's Standards for Rehabilitation
A set of 10 rehabilitation standards against which the Department of Interior reviews all rehabilitations.
Substantial Rehabilitation
A rehabilitation in which the qualified rehabilitation expenditures (QREs) (over a 24-month period selected by the taxpayer) exceed the greater of $5,000 or the adjusted basis of the building. The adjusted basis is to be calculated as of the first day of the 24-month period.
Example - A property owner spends $20,000 in QREs rehabilitating a historic structure. The adjusted basis of the building as of the first day of the 24-month measuring period was $8,000. The substantial rehabilitation hurdle for this project is therefore $8,000 ($8,000 > $5,000). Because the owner spent $20,000, which exceeds the $8,000 hurdle, the rehabilitation satisfies the substantial rehabilitation test.
Wall Retention Requirement
The rehabilitation must retain a significant portion of the building's original structure. The following three tests must be satisfied in order to meet this requirement:
- At least 75 percent of the external walls must be retained either as external or internal walls;
- At least 50 percent of the external walls must be retained as external walls;
- At least 75 percent of the internal structural framework must be retained.