If there is anything real estate developers understand, it’s adaptation. There are many elements to juggle in any transaction. They must manage the rising costs of raw materials, while also working with harder to find skilled labor, and at the same time, they must adjust to many rapid changes in real estate demand. There isn’t just one solution or a one-size-fits-all plan. However, there is one technique that helps lessen the hard blows that come from a struggling economy. That is taking advantage of the available federal tax credits.
What is the New Markets Tax Credit?
The NMTC (New Market Tax Credit) originated in 2000, but it continues for now. The goal of the tax credit was to create jobs and encourage investment in the nation’s low-income communities.
Benefits for Developers
For developers investing in qualifying communities, the federal government is offering a tax credit of up to 39% of the development costs. The credit is awarded over a period of seven years. But it comes in specific increments with the first 5% of the investment awarded over each of the first three years. Then, 6% of the investment is awarded for the last four years.
Developers need to apply with the CDFI or Treasury’s Community Development Financial Institutions Fund to be eligible. After approved, developers may claim the NMTC for their qualifying equity investments. Applying for CDFI funding can be difficult, especially for smaller developers. For this reason, many choose to go through an intermediary, Community Development Entity.
What is a CDE (Community Development Entity)?
A CDE is an intermediary that helps developers, as well as individual investors, claim the New Market Tax Credit. CDEs handle the application for funding and initiate investments for qualifying communities. Once the CDEs are awarded the credits for investments, they sell them to investors and developers. CDEs are not free, but some developers prefer using CDEs just because of how they simplify the credit approval processes. In the long run, a CDE may be a more cost-effective option for developers rather than trying to do it themselves. CDEs sometimes apply to public subsidy programs as well as state and local tax incentive programs that help increase tax savings for investors.
Even though the NMTC is a popular program, it is set to be phased out by the end of 2025. However, there are a couple of bills that have been introduced to Congress that would make it a permanent fixture. So far, neither bill has made it very far, but at least Congress is making some sort of attempt to help make it more permanent in the future.
What is the Historic Rehabilitation Tax Credit Program?
The rehabilitation tax credit is designed for developers who restore historic buildings. The tax credit is worth 20% of the restoration costs. The credit is disbursed over a five-year period starting the year the building was placed in service. There is a three-step application process to qualify for the credit.
Step 1: Evaluation of Significance
The first part of the application process makes sure the building qualifies as a historic structure. There are three ways to determine this:
- A building listed in the National Register of Historic Places automatically becomes classified and certified as a historic structure.
- Buildings located in a (registered) historic district are classified as historic structures if the taxpayer gets the NPS (National Parks Service) to certify that the building is a contributory factor of the historic character of the region or district.
- A building located outside a historic district can receive a preliminary NPS determination that the building has historical significance. After that, completing step two certifies the building as a historic structure.
Step 2: Description of the Rehabilitation
After a historic structure obtains certification, the developers need to state their rehabilitation plans to the NPS. The plans must be consistent with the historical character of the property. The NPS will check the plans and make sure they meet the Standards for Rehabilitation provided by the Secretary of the Interior.
Step 3: Request for Completed Work Certification
After developers complete the work, they can finish the third part of the application. This final step certifies the completed work as proposed.
There are several other requirements for the rehabilitation program, including:
- The building has to be depreciable.
- The structure cannot be the primary residence of the owner.
- Rehabilitation costs should be more than $5,000 or the adjusted basis of the structure.
- A building placed back in service must produce income for a minimum of five years.
- Developers must show “before” and “after” photos to the NPS to ensure their work is complete.
What is the Low-Income Housing Tax Credit?
The LIHTC (Low-Income Housing Tax Credit) encourages developers and investors to invest in the acquisition, rehabilitation, or construction of low-income housing. Investors who make long-term investments in low-income rental housing can get a credit somewhere between 4 and 9% of their capital investments.
How Developers Qualify for LIHTC
To qualify for this tax credit, investors or developers have to either:
- Rent at least 40 percent of the units to tenants whose income is 60 percent of the median income in the region, or
- Rent at least 20 percent of the units to tenants who have incomes at 50% or lower than the region’s median income.
In addition, rent amounts must remain lower than 30% of the renter’s maximum eligible income as determined by HUD (the US Department of Housing and Urban Development).
Other Important Facts About the Low-Income Housing Tax Credit
Here are some important facts to know about obtaining this tax credit:
- The tax credit is a percentage based on the cost of the project used to house tenants who meet the income tests. For the largest credits, most developers who apply for low-income housing tax credits look for most of their tenants to qualify under low-income standards.
- Taxpayers can claim this credit every year for up to 10 years starting with the year they put their low-income housing projects into service.
- The LIHTC only benefits taxpayers who have taxable income. For this reason, some developers sell credits to corporations.
- LIHTC is worth considering since it is a permanent tax credit. That makes it a realistic and reliable tax strategy for real estate developers.
Tax Planning for Real Estate Developers
Real estate developers and investors can benefit from tax planning using these types of tax credits, but they need to know how to stay in compliance with the programs’ guidelines and requirements. Taxpayers should consult with tax professionals and CPAs to ensure they understand how each program works and to ensure full compliance with the program requirements.