Key Attributes of State Historic Tax Credit Programs
Published by John Dejovine and Nick Gerhardt on Wednesday, September 8, 2021
Today, 38 states have their own historic tax credit (HTC) incentive. State tax incentives have been a vital resource used by developers to fill financing gaps for historic rehabilitation projects because of the higher overall development costs of historic rehabilitation as compared to new construction. Historic preservation has also proven to be extremely beneficial to states in terms of job creation, increased property values and the generation of new state and local tax revenue.
Given the value that the HTC incentive can provide, it is important to be aware of the distinguishing characteristics and variations that are found in the various state HTC programs. This article will discuss some of the key elements incorporated in state HTC programs that should be carefully considered by prospective developers, syndicators and investors.
Allocated Versus Certificated Credit
One of the key differentiating factors in state HTC programs is whether the credit is allocated or certificated. Allocated credits are similar to the federal HTC whereby the investor will participate in the transaction via some form of partnership. Unlike the federal credit, many allocated state HTCs allow for disproportionate allocations of the state HTC among the partners. So it is common to see a state HTC investor with a 1% ownership being allocated 100% of the state HTCs.
A certificated credit, by contrast, can be sold directly to an investor without requiring the buyer of the state HTC to be an owner, which is required when the state HTC is an allocated credit. Therefore certificated credits typically allow for a more efficient transaction, with a simple purchase agreement connecting the state HTC investor to the developer. This eliminates the entanglement of some form of partnership between the developer and the state HTC investor.
While some state certificates can only be transferred once, other states allow the credits to be transferred multiple times. Connecticut, for example, allows the state HTC to be transferred up to three times, whereas Pennsylvania only permits the credits to be sold or assigned once. States that permit multiple transfers often have larger investor pools and increased competition for credits, which often leads to higher tax credit equity pricing and more equity for historic preservation.
Annual Program Caps and Individual Project Caps
Another important aspect of state HTC is annual program caps and individual project caps. States often impose annual program caps to provide budgetary control of their programs. When demand for credits exceeds the amount allowable by a state that imposes an annual program cap, applicants must compete for the credits or participate in an award process prescribed by the state. The process for a state to award the credits is sometime a detailed scoring process and in other cases is awarded on a first-come, first-served basis. It’s important for developers to be cognizant of how programs with annual program caps award credits to best position their project to be successful.
Recognizing the importance of increasing cap amounts, Arkansas Gov. Asa Hutchinson signed legislation
earlier this year to extend the state HTC for 10 years and double the annual statewide cap from $4 million to $8 million starting in 2022. Other states have implemented much larger caps, such as Louisiana, which has an annual program cap of $125 million.
Additionally, many states have imposed caps on the amount of credits that can be awarded to individual projects. State HTC programs’ project caps can range from under $1 million to $10 million while other states do not have any individual project caps, such as Texas.
Types of Taxes a State’s HTC may Offset and Eligible Claimants
State tax credits are valuable only to the extent that the credit can be used to offset the underlying taxpayer’s tax liability in that state. State HTCs are often used to offset a state’s income tax liability; however, in some states, entities such as insurance companies, banks and public utility companies are not taxed under the state’s income tax law but are instead subject to a different set of tax laws specific to their industries. Additionally, some states do not have a state income tax but can still offer an HTC against other taxes. Texas, for example, has no state income tax, but it does have state franchise tax and insurance premium tax, which the Texas HTC can be used against that liability. Other states, such as Massachusetts, allow their credit to offset all state income taxes, which creates the opportunity for individuals as well as corporations to participate in the incentive.
Also of note, some states, like Kansas and Colorado for example, allow nonprofit entities to participate in their state HTC program, which the federal program does not allow. While nonprofits don’t typically have state tax to offset, they can benefit from transferring the credit to an entity that does have state tax.
Carryforward Provisions and Refundability
The majority of states allow credits to be carried forward to future years in instances where the amount of credits allocated to or acquired by a taxpayer exceeds their current state tax liability. For example, Missouri’s HTC program allows unused tax credits to be carried back up to three years. Similarly, New Jersey’s HTC program allows for a nine-year credit carryforward but does not allow for a carryback of unused credits.
Tax credits may also be refundable, whereby any amount not used to offset current-year taxes is paid in cash to the holder of the credit. Nine states offer refunds to taxpayers that are issued credits in excess of their tax liability, including Alabama, Iowa, Minnesota and Ohio.
This year, Mississippi Gov. Tate Reeves also signed legislation reinstating the refundability of the state HTC, a provision that was removed last year in legislation that extended the credit through 2030. Mississippi’s HTC is for 25% of qualified rehabilitation expenditures (QREs) and H.B. 1296 allows a rebate of up to 75% of the state HTC if the amount of the credit exceeds the taxpayer’s tax liability.
States also prescribe different time periods over which the credits are realized. Many programs allow the credit to be fully realized in the year placed in service. Others follow the federal HTC program that allows projects that meet the requirements of the transition rule to realize the full credit in the year placed in service while those that do not meet those requirements must realize the credit over a five-year period. And some states have their own time period, such as Maine which is realized over a four-year period. Furthermore, some states limit the amount of credits that can be claimed by a taxpayer in any one year.
Geographic Distribution and Targeting State Priorities
Several states have included geographical set-asides for rural areas or limits on the percentage of credits that can be claimed for metropolitan areas in order to avoid disproportionate allocation across the state. Another strategy used by states involves restricting the use of credits to areas of physical deterioration and economic distress.
For example, Illinois Gov. J.B. Pritzker signed legislation this year to implement the state budget that includes provisions to extend the sunset date for the state’s River Edge HTC. The River Edge Redevelopment Zone Program (RERZ) helps revive and redevelop environmentally challenged properties adjacent to rivers in Illinois. The credit is for 25% of QREs in the River Edge Redevelopment Zone that meet four other qualifications.
Historic buildings are frequently rehabilitated for housing and states use HTCs to encourage this adaptive reuse. Maine and Pennsylvania, for example, offer increased percentage rates for the development of affordable housing. Massachusetts sets aside 25% of its credits for those projects that include a housing component.
State HTCs have proven to be the key financing source in helping countless historic buildings be rehabilitated. Being aware of these key aspects in a projects specific state can help developers secure and maximize the benefit of the state HTC. Understanding the specific rules and regulations of a particular state HTC program is critical for a property owner in order to maximize the financial benefits that can be realized by the state HTC.