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How Does the Tax Reform Bill Affect the Value of the HTC?
The 10 percent non-historic tax credit is history under the recently passed tax reform act, but perhaps more significant to those in the historic preservation world, the 20 percent historic tax credit (HTC) was retained and altered.
The final version of the legislation, which was signed into law Dec. 22 by President Donald Trump, eliminates the non-historic credit for buildings built before 1936 and requires that the 20 percent HTC be taken over five years, rather than when it was placed in service, as under current law.
There was a measure of relief that the HTC was retained–after all, the House version of the tax reform bill repealed all types of the credit. An amendment by Sen. Bill Cassidy, R-La., essentially saved the credit. Under the final version of the legislation, the credit is allowable ratably over 5 years commencing in the taxable year that the property is placed in service.
The legislation as passed by both houses of Congress and signed by Trump is effective for amounts paid or incurred after Dec. 31, 2017. However, a transition rule provides for qualified rehabilitation expenditures (QREs) (for either a certified historic structure or a pre-1936 building), with respect to any building owned or leased (as provided under present law) by the taxpayer at all times on and after Jan. 1, 2018. Under this transition rule, within 180 days of enactment, a qualifying taxpayer would need to begin their 24-month rehabilitation measuring period. Thus, any QREs incurred for such buildings before Dec. 31, 2020, could be eligible for HTCs. The conference agreement modified the original transition language to add “or the 60-month period selected by the taxpayer” to address questions about whether phased projects as described in IRC Section 47(c)(1)(C)(ii) would qualify for the longer measurement period.
However, even the transitional language as currently drafted raises more questions than it answers. Novogradac & Company is reviewing the transitional rules and will address such requirements in future writings.
So what does this mean for developers that use the HTC? To evaluate this, Novogradac & Company compared–on a net present value basis using after-tax discount rates of 6 percent and 8 percent–the after-tax benefits of a single-tier and lease-pass-through transaction structure under present law as compared to that under the new law as drafted in the conference agreement. To model these effects, the following are the key assumptions used to calculate the nominal after-tax benefits:
Price per credit $0.90
Cash distributions 3 percent annual return on invested capital
Put payment 5 percent of invested capital
Current law 35 percent
New law 21 percent
The first analysis results in the equivalent placed-in-service HTC percentage on a present-value basis ranging from 17.0 percent to 18.6 percent and yields comparable tax credit pricing ranging from 77 to 84 cents as compared to the present-law base case of 90 cents.
For comparison, Novogradac evaluated a similar after-tax benefit using the same assumptions noted above except adding an additional modification–the assumed repeal of the mandatory basis adjustment under IRC 50(c)(1). Those results are shown on the chart below, which results in the equivalent placed-in-service HTC percentage on a present value basis ranging from 18.2 percent to 21.6 percent, which results in comparable tax credit pricing ranging from 82 to 96 cents as compared to the present law base case of 90 cents.
The above analysis incorporates the following tax reform changes: credits are claimed over a five-year period, lower corporate tax rate of 21 percent and election out of business interest limitation which requires the use of the Alternative Depreciation System (ADS) life of 40 years. Similarly, we excluded from depreciation any qualified improvement property, which is certain qualifying non-residential real property that is allowed a 15-year recovery life.
Based on this analysis, one thing is certain: the HTC has lost some value under the conference agreement as compared to current law. However, when the initial tax reform blueprint was unveiled, the industry faced a real possibility that the credit would be eliminated. Thanks to advocacy efforts from the entire industry, there is now greater certainty regarding the implications of tax reform on projects going forward.
As with any new tax legislation, many questions arise regarding the interpretation of new provisions or changes to existing provisions. For example, what does “ratably” mean for the first year? The statute says the five-year period “beginning in the taxable year the property is placed in service,” thus, the initial year could mean it is pro-rated by number of days, number of months or even a full year amount in that first year, all depending on what convention the IRS determines is appropriate. As the bill is drafted, there certainly is not a clear consensus. Another question is how will the basis adjustment work - adjusting each year as the credit is allowable or in the year placed in service? In addition, will single tier and lease pass-through transaction have the same treatment? The statute reads credit “determined” but the regulations read credit “allowed,” therefore, another uncertainty that will require updated regulations to address the question. Next, what are the implications to HTC recapture? Recall that recapture rules are currently tied to the placed-in-service date and have not been modified based on the new legislation that requires the credits to be earned ratably over five years. Again, this is another area of uncertainty going forward. Other matters to consider with the new legislation include depreciation changes and how those will impact projects. One key change for non-residential buildings is the elimination of qualified leasehold improvement property but essentially replacing it with qualified improvement property whose class life has been changed from 39 to 15 years for qualifying property placed in service after Dec. 31, 2017. The impact of this will need to be factored into transactions that are structured under the new legislation. Finally, how does this new legislation affect state historic tax credit programs? Most all state HTC programs follow the federal rules for determining QREs with certain exceptions, but do not necessarily follow federal rules on timing of the credits. A review of the statutory language of each state will be needed to determine how state credits may be affected by this new legislation, if at all.
As 2018 looms, investors will evaluate the impact of the revised HTC and other changes brought about by tax reform on pending transactions. Keeping in mind that this analysis on the impact to the value of the HTC assumes an investor will seek to achieve a similar yield as under present law. Time will tell the impact on HTC pricing as investors evaluate future transactions.