How Might Tax Reform Affect Historic Tax Credit Equity Pricing?

Published by Michael Novogradac, Thomas Boccia on Thursday, April 13, 2017 - 12:00am

The prospect of comprehensive tax reform poses a number of questions for the historic preservation community, including how a reduction in corporate tax rates would affect the value of historic tax credits (HTCs).

Assuming HTCs survive in their current form after tax reform was passed, Novogradac & Company sought to compare the net benefits of a HTC investment under current law (at a 35 percent top corporate tax rate) to the same HTC investment at lower corporate tax rates. Novogradac & Company also assessed the relative need for the 20 percent HTC under current law as compared to that under the House Republicans’ tax reform “blueprint,” which proposes a 20 percent top corporate tax rate.

Effect of Lower Corporate Tax Rates

Novogradac & Company analyzed the effects of corporate tax rate changes on direct investment structures and on lease pass-through structures with and without IRC Section 50(d) income acceleration.  Novogradac calculated the net present value (NPV) of an HTC investor’s after-tax benefits based on these HTC investment structures using corporate tax rates ranging from the current 35 percent to 15 percent. Novogradac found that for direct and IRC 50(d) accelerated structures, as tax rates decreased, the NPV of the investor’s net benefits increased. That meant the estimated investor equity price per tax credit increased about 2 to 4 cents, depending on the corporate tax rate.  Conversely, for lease pass-through without IRC 50(d) acceleration, as tax rates decreased, the NPV of the investor’s net benefits also decreased. Investor equity price pricing declined about 2 to 3 cents, depending on the corporate tax rate assumed.

House Tax Reform Blueprint

The House tax reform blueprint proposes a corporate tax rate of 20 percent, but also provides full expensing of assets (excluding land) and limits the deductibility of interest expense.  Novogradac’s analysis found that as a rule–under both current law and the House Republican blueprint–the HTC provides significant financial assistance to help offset the cost of historic rehabilitations, but generally doesn’t cover the entire cost.  Interestingly, this analysis found that while the House blueprint provides a significant benefit, the benefit is slightly less than under current law.

Analytic Framework

For simplicity, the analysis outlined on the accompanying chart assumes a $10 million historic rehabilitation financed entirely by HTC investor equity and bank debt.  The analysis assumes 100 percent of project costs qualify for HTCs and the tax credit equity value is $1 per tax credit, resulting in $2 million in tax credit equity. To fund the balance of the project, this analysis assumes $8 million in debt.

A comparable non-historic project is assumed to be financed entirely by debt and cost 30 percent less than the historic rehabilitation, or $7 million.  Each of the three calculations under the current law heading in the schedule examines the $1 million incremental tax basis of the historic rehabilitation ($10 million total, less the 20 percent mandatory basis reduction, less the $7 million basis of non-historic construction).  In addition, the schedule addresses the impact of the $1 million incremental borrowing ($8 million on historic rehabilitation less the $7 million borrowed for non-historic).

 

Blog Chart Analysis of Developer Return - Current Law and Blueprint
Click to Enlarge

 

Federal Historic Tax Credit Equity

In all cases, part of the additional sources for a historic rehabilitation project (compared to the sources for a non-historic project) is the value of the HTCs.  This analysis assumes the same investor equity contribution rate of $1 per tax credit ($2 million total equity) for both current law and blueprint scenarios.

Present Value of Depreciation Deductions for Incremental Costs–Current Law

In addition to the HTC, current law also provides value to building owners from depreciation expense.  Novogradac considered three scenarios that calculated the present value of the incremental basis (the $1 million mentioned above) being depreciated over 15, 27.5 and 39 years, at the current 35 percent corporate tax rate. At a 10 percent discount rate, the present value of tax deductions range from a low of $95,967 for an HTC project with 100 percent 39-year property to a high of $199,177 for an HTC project with 100 percent 15-year property.

Present Value of Building Expensing

Under the House GOP blueprint, asset recovery would switch from depreciation over the asset’s life to full expensing. Novogradac & Company evaluated the potential effects of the House blueprint’s proposal to allow developers to expense 100 percent of development costs.  This analysis calculated the value of the deduction using the 20 percent blueprint tax rate and $1 million of incremental basis, net of the basis adjustment, of a historic rehabilitation, resulting in an incremental benefit of $200,000.

Present Value of Eliminated Interest Deductions

The House blueprint also proposes eliminating the deductibility of interest payments, so Novogradac considered the incremental cost of lost interest deductions for these investments compared to current tax law.  The analysis shows–assuming a 30-year loan, 5 percent interest rate and $1 million in incremental borrowing – eliminating the deductibility of interest payments would result in $148,905 additional cost to the HTC building owner.

Conclusion

The calculations show that under the House blueprint proposals, the HTC provides significant financial assistance to help offset the cost of historic rehabilitations, but generally doesn’t cover the entire costs.  However, the separate analysis of the effect of lower corporate tax rates on tax credit equity suggests that some additional HTC equity may be generated in some HTC financing structures.

These calculations generally confirm the ongoing need in a post-tax -reform world for the HTC to assist in leveling the playing field for HTC developments and non-historic developments. 

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