Overview of the Virginia Historic Rehabilitation Credit Process
The following is an executive Summary of the Virginia State Rehabilitation Tax Credit Program and how it is effectively implemented by those who are not able to take advantage individually of all tax credits generated on a project under the program.
Creation of Virginia Rehabilitation Tax Credits.
Virginia offers tax credits that can be applied to Virginia state tax liability for a portion of eligible expenses incurred on qualifying projects to restore historic properties within the Commonwealth. The program is administered by the Virginia Department of Historic Resources, or “DHR." The tax credit is granted is equal to 25% of the eligible expenses on such a project.
A qualified project is the rehabilitation of a certified historic property where eligible expenses amount to at least 50% of the locally-assessed value of the structure being rehabilitated, unless the structure is a personal residence, in which case the eligible expenses must equal at least 25% of such value. Note that the value of other structures or the underlying real estate are not included in making these calculations. Unless a project is “phased" from the outset (where the project can take as much as 60 months to complete), the material “rehabilitation test" within a 24 month period ending in the year in which the tax credits are first claimed.
A certified historic property is one of the following:
• Individually listed on the Virginia Landmarks Register, or
• Certified as eligible for listing, or
• Certified as a contributing structure in a district that is so listed.
Generally speaking “eligible expenses" are those that are considered capital expenses incurred on a project that satisfies the U.S. Secretary of the Interior’s Standards for Rehabilitation. Unused Virginia tax credits can be carried forward for up to ten years.
Examples; $200,000 of eligible expenses incurred on a project to rehabilitate a structure on the Virginia Landmarks Register that has a local assessment value of $350,000 will generate a Virginia tax credit of $50,000. Eligible expenses of $100,000 on the same project would not generate any Virginia tax credits unless the structure were a personal residence, in which case the Virginia tax credit generated would be $25,000. Eligible expenses of $75,000 on such a project would generate no Virginia tax credit even if the project were the rehabilitation of a personal residence.
Transfer of Virginia Rehabilitation Tax Credits.
Unlike other state tax credits that benefit from express code provisions that permit the outright and straight-forward transfer, or sale, of tax credits to unrelated parties, the provisions of the Virginia Code related to Rehabilitation only allow for the sharing of credits between partners. Accordingly, those who earn credits but cannot take advantage of them personally must enter into a unique financial transaction that will allow them to realize a return on their on their unused credits.
A typical transaction is structured as follows: The credit holder and the party interested in acquiring the credits (the “Investor") for a limited liability company. The credit holder contributes the subject tax credits to the capital of the LLC and the Investor contributes cash equal to the amount of the “purchase price" to the capital of the LLC. The LLC then enters into a five-year lease with the owner of the structure that has been rehabilitated (the credit-holder) under which the rental amount (the amount of the purchase price) is paid to the owner in advance. Under the terms of the LLC’s operation agreement all remaining capital is allocated to the Investor. Thus the tax credits are allocated and distributed to the Investor who can them use them on his or her individual Virginia tax return. The next year, the credit holder redeems the interest of the Investor for nominal consideration and become the sole remaining member of the LLC. The cost of preparing the legal documents necessary for such a transaction is invariably incurred by the party seeking to sell his or her credits.
Because of the complexity of the transaction and the fact that Rehabilitation Tax Credits distributed through such a transaction are useful to fewer individuals than other Virginia tax credits, the market for transferred Rehab Tax Credits is only a fraction of the market for other Virginia tax credits. Investors for such transactions are generally found through a state credit tax credit broker who is likely to be a Virginia attorney or CPA with experience in the creation and transfer of these specialized tax credits. Such “listing" brokers customarily charge a commission equal to 10% of the credit value being transferred with one half of the commission being shared with the broker who produces the Investor.
The actual purchase price for the credits reflects a discount for transaction risk and fluctuates with other market conditions. In the past few years, “purchasers," more accurately described as “investors," have paid between 75 cents and 82.5 cents per credit dollar “purchased," netting the seller 65 cents to 72.5 cents per credit dollar sold (before legal fees).
Special Note: The Taxability of the Transaction.
As the financial transaction that effectuates the transfer of the credits results in the payment of rent to the “seller," such proceeds may be deemed taxable income to the party transferring the credits. Taxpayers, particularly nonprofit organizations, are well advised to consult their tax advisors to determine if any exemptions or deductions may be available to offset or minimize the taxability of proceeds from the transaction.