Q&A: How Would a Natural Disaster Affect Your Historic Tax Credits?

Published by Frank Buss on Monday, July 1, 2013
Journal thumb July 2013

Question: What are the tax implications if a historic tax credit (HTC)-financed building is destroyed by a natural disaster?

Answer: If an HTC-financed building is destroyed by natural disaster, it is probable that a tax credit recapture event has occurred. According to Internal Revenue Code (IRC) Section 50(a), a recapture event of a qualified rehabilitated building occurs when one of the following takes place:

the building is sold;

  • the building ceases to be “business use property;”
  • a partner disposes of greater than two-thirds of its interest;
  • the National Park Service (NPS) removes the building from the National Register;
  • the NPS determines that the building no longer contributes to a Registered Historic District; or
  • the building is destroyed by a casualty (such as a hurricane, flood, tornado or earthquake).

For the purposes of this article, we will focus on when a building is destroyed by a casualty and the resulting tax implications. HTC recapture rules provide that recapture is equal to 100 percent of the credit claimed and used to reduce tax if the recapture event occurs before the first anniversary of the respective qualified rehabilitation expenditures (QREs) placed-in-service date. The recapture percentage is then reduced 20 percent for each subsequent year.

For example, the recapture amount is 80 percent of the originally claimed credit for the year from the first anniversary date to the day before the second anniversary date, 60 percent from second anniversary to the day preceding the third anniversary date, 40 percent from third anniversary to the day preceding the fourth anniversary date and 20 percent from fourth anniversary to the day preceding the fifth anniversary date. After five years, there is no recapture.

The recapture timeframe begins on the date the QREs are placed in service. Thus, additional QREs placed in service after the initial placed-in-service date would have a separate anniversary date for determining potential recapture.

Casualty loss
When a building that qualified for the HTC is destroyed by casualty, within five years of first claiming the credit, the recapture provisions of IRC section 50(a) apply. The casualty loss, either a partial or full destruction of the building would result in a recapture event. Unlike the low-income housing tax credit (LIHTC), there is no provision to restore the property in a full destruction of the building. If the qualified rehabilitated building has been completely destroyed, the property cannot be replaced and the HTC recapture is calculated using the 20 percent declining calculation as noted above.

If the qualified rehabilitated building is partially destroyed, HTC recapture can be avoided if the building is restored in accordance with the standards previously established by the NPS and the state housing preservation office (SHPO). Partially damaged property would not trigger recapture if the owner makes the necessary repairs and places the property back in service within a reasonable time.

Often, special tax provisions are enacted during times of significant natural disaster that affect a large geographic area. An example of a special provision includes the Gulf Opportunity Zone Act of 2005 and related Internal Revenue Service notices that allowed a provision relative to recapture of any rehabilitation tax credits jeopardized as a result of damage by hurricanes Katrina, Rita and Wilma. These provisions are often enacted by Congress in the wake of natural disasters and should be considered in addition to the regulations discussed herein.

If historic property in which the HTC was claimed is destroyed and it is beyond the recapture period (five years from when building was placed in service), no recapture of the HTC would be required.

Basis Adjustment upon Recapture
Treasury Regulation section 1.48-12(e) requires that the basis of rehabilitated buildings, including certified historic structures, must be reduced by 100 percent of the HTC earned regardless of whether the HTC is used or carried forward. If the rehabilitated property is disposed of or ceases to be business use property within the five-year recapture period, the amount of the recaptured HTC is added back to the building’s basis.

However, the taxpayer also is allowed to restate the depreciable basis of the property for the previously required reduction by the HTC amount, therefore allowing more depreciation deductions. Any returns that have been filed for years subsequent to the return on which the HTC was first claimed must be amended to receive the increased depreciation benefit.

Conclusion
Unfortunately, each year buildings across the country are destroyed by natural events such as tornadoes, floods, hurricanes and earthquakes. As a result, investors in and developers of historic rehabilitation projects should know the recapture risks that natural disasters can pose to their HTC project.

Once a historic building is completely destroyed there is no provision to rebuild the historic structure and avoid recapture. Sadly with this type of event, the historic nature of the building is lost forever in the destruction. There are, however, provisions for a partially destroyed building to avoid recapture, by taking the proper steps to repair the damage and place the building back into service. If these types of events have damaged your historic project please discuss the options and remedies with your professional advisors and your SHPO.