How and Why to Qualify HTC Development as Phased Rehabilitation

Published by John DeJovine on Tuesday, December 7, 2021
Journal Cover Thumb December 2021

Question: How can a historic rehabilitation property qualify as a phased rehabilitation?

Answer: One of the requirements for a property to qualify for the federal historic tax credit (HTC) is for the property to be substantially rehabilitated. Per Internal Revenue Code (IRC) Section 47, a building shall be treated as having been substantially rehabilitated only if the qualified rehabilitation expenditures (QREs) incurred during the 24-month measurement period selected by the taxpayer exceed the greater of the adjusted basis of such building or $5,000. This permits the taxpayer to select a period that includes the maximum amount of QREs during the 24-month measurement period and minimum adjusted basis of the building at the start of the period to ensure the substantial rehabilitation test is met. And once taxpayer meets the substantial rehabilitation test, they can not only earn HTCs on QREs incurred during the measurement period but also on QREs incurred before the measurement period and QREs through Dec. 31 in the year the measurement period ends.

For example, a taxpayer may choose a 24-month measurement period from Jan. 2, 2019, through Jan. 1, 2021, to maximize QREs. This 24-month measurement period would only include all the QREs incurred during 2019 and 2020 to determine if the substantial rehabilitation test is met. If the test is met, this would allow a taxpayer to claim HTCs not only on the QREs incurred during the 24-month measurement period, but also on any QREs incurred before 2019 and in 2021 (outside of the 24-month measurement period).

Projects that may have a longer construction period are expected to be completed in multiple phases and may not meet the substantial rehabilitation test within 24 months are accommodated through a special rule to allow for a phased rehabilitation. IRC Section 47 provides that a phased rehabilitation is a rehabilitation which may reasonably be expected to be completed in phases set forth in architectural plans and specifications completed before the rehabilitation begins, and shall be allowed to use a 60-month measurement period to meet the substantial rehabilitation test.

Treasury Regulation Section 1.48-12(b)(2)(v) explains that a phased rehabilitation must consist of two or more distinct stages of development, which shall be made on the basis of all relevant facts and circumstances. It goes on to note that written plans describing generally all phases of the rehabilitation process shall be treated as written architectural plans and specifications and such written plans are not required to contain detailed working drawings or detailed specifications of the materials to be used. 

Some items to note regarding phased rehabilitation include that there is no requirement that the rehabilitation exceed 24 months, there is no clear definition of what qualifies as a distinct stage of development and there is also no application or approval process for a project to qualify as a phased rehabilitation.

The National Park Service (NPS) Part II application includes the number of phases and a box that can be checked noting the project, “Intends to elect IRS 60-month phased rehabilitation,” but having this does not preclude a project from being considered phased rehabilitation nor does it guarantee that it will be considered a phased rehabilitation upon IRS audit. It is simply a factor in the facts and circumstances noted above. The IRS previously issued private letter ruling 8639026 that noted a property would be considered a phased rehabilitation if it had three phases set forth in architectural plans and specifics completed before the rehabilitation began.

Q: When is it important for a historic rehabilitation project to qualify as a phased rehabilitation?

A: When a project meets the requirements of a phased rehabilitation, it should always consider documenting the phases and treating the project as a phased rehabilitation if only to provide for what the unknown may bring in a rehabilitating a historic project. There are certain circumstances that especially lend themselves to documenting a phased rehabilitation, the most common being a project that will take longer than the standard 24-month period to complete due to the overall size of the project.

Another situation where qualifying as phased rehabilitation is beneficial is if the rehabilitation that does not include the entire building and the developer is planning to rehabilitate distinct portions of the building at separate times. A third situation is if NPS considers multiple buildings to be functionally related historically and treated as a single certified historic structure. In that case, qualifying as a phased rehabilitation can be important for the project to meet the substantial rehabilitation test. In any of these situations, the planning before construction can be the difference in a project earning the HTC, as the requirements for qualifying as a phased rehabilitation require plans before construction and don’t allow a project to select the 60-month substantial rehabilitation test simply because it cannot meet the 24-month substantial rehabilitation test.

Qualifying as a phased rehabilitation has been of increased interest as of late due to the Tax Cuts and Jobs Act passed in December 2017. Previously, the HTC was claimed in full the year the property was placed in service, but under the Tax Cuts and Jobs Act the credit is now claimed over five years. The Tax Cuts and Jobs Act did provide an exception where a project could still qualify for the one-year credit if the building was owned or leased by the same taxpayer since Dec. 31, 2017, and the substantial rehabilitation test measurement period begins no later than June 20, 2018.

Under the 24-month period, this would allow projects using a substantial rehabilitation period of June 20, 2018, through June 19, 2020, to still qualify for the transition rule. On July 30, 2020, the IRS issued Notice 2020-58 to provide COVID-19 relief and permitted projects with a 24-month period ending after April 1, 2020, but before March 31, 2021, to have until March 31, 2021, to meet the substantial rehabilitation test. Notice 2020-58 effectively provides projects that don't qualify as phased the ability to extend the measurement period  more than 24 months but ending no later than March 31, 2021, to meet the transition rule.

For 2022 and 2023, only phased rehabilitations will be able to meet the transition rule and qualify for the one-year HTC. Investors generally pay a higher price per credit for a one-year tax credit and can help provide a project the equity it needs to fill funding shortfalls. After 2023, projects will not be able to meet the transition rule and all projects with have a five-year credit.


Meeting the substantial rehabilitation test is a requirement for a project to qualify for the HTC and meeting the requirements for a phased rehabilitation can provide a project with the time it needs to meet the test. In order to qualify as a phased rehabilitation, proper care must be taken before construction to document the distinct phases of the project.

As we move forward to 2022 and 2023, the only projects that will have the ability to meet the transition rule and qualify for a one-year HTC will be phased rehabilitations.