Question: What would cause recapture of federal rehabilitation (historic tax) credits and how would recapture be calculated?

Answer: A historic building that has been subject to a “qualified rehabilitation” may be required to recapture all or a portion of the rehabilitation credits claimed if a recapture event occurs. The following are recapture events:

• the building is sold,
• the building ceases to be “business-use property,”
• a partner disposes greater than two-thirds of its interest,
• the National Park Services removes the building from the National Register,
• the National Park Service determines the building no longer contributes to a Registered Historic District, or,
• the building is destroyed by a casualty.

Certain circumstances would not trigger recapture. They include a simple transfers between spouses or where there is a spousal transfer due to a divorce; a transfer due to death; a transfer due to certain tax-free corporate reorganizations (see IRC §381(a) and IRC §50(a)(4)); or where there is a change in the form of the business entity, but only if the property retains the same trade or business status.

If a recapture event occurs, the amount of the recapture is 20 percent of the rehabilitation credit claimed for each year remaining in the five-year recapture period. If the recapture occurs before the end of the first tax year, the recapture is 100 percent of the credit claimed. If the recapture occurs before the end of the second tax year, the recapture percent is 80 percent of the credit claimed, and so forth until the end of the fifth tax year. The recapture provisions are contained in IRC §50(a) as well as Treasury Reg. 1.48-12(f)(3). Recapture is reported on Form 4255.

If a building ceases to be “business-use property,” a recapture event will have occurred. In order to claim the credit, the property must be an income producing property. This provision excludes personal residences, churches, fraternal halls or any other non-income producing use. If an income producing property were converted to a church for example, then a recapture event will have occurred. The business use property designation also covers the issue of tax-exempt use which is the subject of another article.

If a building is held in a partnership (or LLC electing to be treated as a partnership), then a change in the ownership percentage of partner may trigger recapture of the credits claimed by that partner. If a partner’s interest falls below two-thirds of what it was when the credits were claimed, then a proportionate amount of credits would be recaptured. So for example, if a partner owned 45 percent of a partnership which held a property which had been the subject of a qualified rehabilitation, and that partner sells or transfer more than 30 percent of its interest, that partner will be required to recapture a portion of the credits it has taken. If that occurs before the end of year two, the amount of the recapture would be 80 percent (see above) times the two thirds of the interest given up. 

For example if a partner claimed $75,000 in tax credits and reduced its ownership from 45 percent to 10 percent in year two, the recaptured calculation would be done as follows:

45 percent - 10 percent = 35 percent interest disposed of, 
35 percent/45 percent = 77.77 percent reduction
$75,000 x 77.77 percent = $58,333, potential recapture
$58,333 x 80 percent = $46,667 recaptured in year two.

The next two recapture events on the list above have to do not with the ownership structure, but with the standing of the building itself and its historic nature.
Lastly, a casualty loss (destruction or partial destruction) would result in recapture. Unlike the low-income housing tax credit, with which many of you are familiar, there is no ‘reasonable time’ to restore property after a casualty has occurred. You cannot replace a qualified rehabilitation once it is destroyed and avoid recapture. The credit is recaptured using the same 20 percent declining recapture calculation discussed above.

If you have additional questions about recapture events, or how your historic rehabilitation may be impacted, please contact me at [email protected] or 617-330-1920 x116.