The Internal Revenue Service recently posted a topical tax brief about qualified rehabilitation expenditures (QREs)–that includes information on flood adaptation costs, as well as clarifications about certain renewable energy costs.

QREs are expenditures that are connected with the rehabilitation or restoration of a historic structure certified by the National Park Service. However, not every expenditure associated with a rehabilitation is a QRE that is included in the calculation to receive historic tax credits (HTCs).

The brief identifies costs:

• that generally are QREs,
• that may be QREs in certain circumstances, and
• that generally are not QREs. 

The brief includes a recitation of previously published guidance, but has been expanded to include  a listing of certain other costs that may be QREs if the costs are properly included in the depreciable basis of the qualified rehabilitated building or building improvements, including certain costs associated with flood adaptation. The topical tax brief also confirms that  costs related to solar panels, wind turbines and geothermal systems are five-year property not included in the basis of the building and therefore not QREs.

The IRS brief reiterates three important aspects:

1. Rehabilitation includes renovation, restoration or reconstruction of a building, but does not include an enlargement or new construction.
2. A QRE must be an amount properly chargeable to capital account of depreciable property that is nonresidential real property, residential rental property, real property with a class life of more than 12.5 years, or an addition or improvement to the preceding three types of property, and incurred in connection with the rehabilitation of a qualified rehabilitated building.
3. QREs must be for a building and its structural components. Structural components of a building are components relating to the operation or maintenance of a building.

A building, as defined by Treasury Regulation § 1.48-1(e)(1), is any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purposes of which is, for example, to provide shelter or housing, or to provide working, office, parking, display or sales space.

The following structural components generally qualify as QREs if the costs are properly included in the depreciable basis of the qualified rehabilitated building or building improvements:

• Walls,
• Partitions,
• Floors,
• Ceilings,
• Permanent coverings of walls, partitions, floors and ceilings, such as paneling or tiles,
• Windows and doors,
• Components of central air conditioning or heating systems,
• Plumbing and plumbing fixtures,
• Electrical wiring and lighting fixtures,
• Chimneys,
• Stairs,
• Escalators,
• Elevators,
• Sprinkler systems,
• Fire escapes, and
• Other components to the operation or maintenance of the building.

Costs that may be QREs if the amounts are properly included in the basis of depreciable property include:

• Construction period interest and taxes,
• Architect fees,
• Engineering fees,
• Construction management costs,
• Reasonable arm’s length developer fees, and
• Other fees paid that would normally be charged to a capital account.

Additional costs that are not specifically listed in the Treasury regulations, but also may be QREs include:

• Permanently installed operable floodgates,
• Permanently attached fastening devices to hold floodgates or to attach flood wrapping systems,
• A retaining wall that is part of or connected to the structure of the building,
• A seawall that is part of or connected to the structure of the building,
• The portion of landscaping designed only to protect the building,
• And others (see page 4 of the IRS document).

On the other hand, there are many expenditures that do not qualify as QREs and will not be included in the calculation of HTCs. Those include, but are to limited to:

• Acquisition costs,
• Appliances not either real or residential rental property,
• Office equipment,
• Cabinets,
• Carpeting,
• Decks,
• Porches and porticos,
• Demolition and removal costs,
• Fencing,
• Feasibility studies,
• Financing fees,
• Among others (see page 5 of the IRS’s topical tax brief).

Finally, the cost of solar panels, wind turbines and geothermal systems are also not included in the basis of the building and, therefore, should not qualify for the HTC. Furthermore, the property that is used to claim HTCs can’t also be used to claim renewable energy investment tax credits or production tax credits.

For full lists of expenditures that qualify, may qualify and do not qualify as QREs, review this document. For professional assistance on your historic rehabilitation project, be sure to consult a Novogradac partner.