Novogradac Journal of Tax Credits
February 2017 | Volume VIII - Issue II
By: Bill MacRostie, MacRostie Historic Advisors, LLC
Those who have used historic tax credits (HTCs) know that they can be the make-or- break factor for a rehabilitation project to come to fruition. This factor becomes even more real for developers who are competing for credits in states that limit them. The availability of a meaningful subsidy can dictate the difference between the reuse and neglect of any given historic building. The HTC program in Kentucky is a prime example.
With a $5 million annual aggregate cap and $400,000 per-project cap, Kentucky’s state credit is one of the most limited in the country. The program was part of the 2005 JOBS for Kentucky Tax Modernization Plan under Gov. Ernie Fletcher. Under a tightly structured system, developers must submit applications by April 29 each year to be eligible for apportionment of the $5 million. The state HTC is advertised as a 20 percent credit, but projects rarely receive the full amount. Allocations are distributed proportionally based on applications. As a result, the credit becomes an unreliable source of financing because developers can’t accurately predict their apportionment.
What would happen then if the state HTC were uncapped?
The data exists, thanks to a short-term Enhanced Historic Tax Credit (EHTC) that benefited tax increment finance (TIF) communities and projects that started between July 15, 2014, and July 1, 2015. By targeting TIF areas, the credit sought specifically to stimulate urban areas considered most in need of such a boost. Legislators thought that the one-year program would only apply to a few catalytic projects identified in qualifying areas, but the program ended up attracting the interest of developers outside the state, such as Hudson Holdings, a development firm based in Florida which is responsible for the Starks Building rehabilitation, a major project in downtown Louisville.
The EHTC legislation, HB 445, allowed a 20 percent tax credit for projects with qualified rehabilitation expenditures (QREs) exceeding $15 million, with a per-project cap of $6 million and no aggregate cap on the program. Additionally, developments had to be certified historic structures within the jurisdiction ofa consolidated local government or urban-county gov- ernment and located within a half-mile of a TIF area. With approval of an EHTC Part III Application from the Kentucky Heritage Council (the state historic preserva- tion office), projects received the credit over four years at a rate of 25 percent annually.
A 2016 study by the accounting firm Baker Tilly in collaboration with Preservation Kentucky and the Louisville Downtown Partnership analyzed seven developments that took advantage of the program. The study captured historic rehab starts that qualified for the program, five of which were in Louisville, with two in Lexington. Their findings were published in February 2016 as the Kentucky Historic Tax Credit Impact Analysis.
The Impact Analysis found that before the EHTC in 2014, Kentucky’s HTC program was used on 832 historic rehabilitation projects and accounted for $647 million in project investment since its inception in 2005. The seven properties analyzed in the study had project costs in one year alone of $305 million. For the $33.8 million of estimated tax credits earned by EHTC projects, it is anticipated that there will be a full return on state’s investment by Year 2 of project operations. The compounding economic output and wages of these projects over time estimate that the EHTC will account for $365 million in annual tax growth for Kentucky by Year 20.
Comparing the economic impact numbers of the current capped Kentucky program with other states also helps to understand how the $5 million annual aggregate cap has potentially stunted development. Every year, the National Park Service’s (NPS’s) Technical Preservation Services division, in concert with the National Council of State Historic Preservation Offices and Rutgers University, releases a report on the annual economic impact of the federal HTC. According to the data from 2015, Kentucky benefited from an estimated $7.6 million in federal HTCs with a $6 million impact on the state tax base. Neighboring states Ohio and Virginia averaged more than $84 million in federal funds and estimated $75 million impact on state taxes each. Ohio’s program is also capped, but at $60 million. The comparison illustrates the potential of robust programs to encourage the use of the federal HTC as the gateway to bring increased federal funds that have a tax benefit to the state.
It also illustrates the willingness of developers to invest in historic rehabilitations in states where HTCs are more predictable. Of Kentucky’s seven neighboring states, five have state programs for commercial rehabilitation projects: Illinois, Ohio, Missouri, Virginia and West Virginia. Ohio, Virginia, and Missouri ranked in the top 10 for overall qualified rehabilitation expenses for the federal HTC in 2015. And while the population of Kentucky is much smaller than Virginia and Ohio, experts such as Renee Kuhlman of the National Trust for Historic Preservation (NTHP) agree that the desired outcome of attracting more development is possible with a more competitive program. “A stronger state historic tax credit would give communities like Covington and Middlesboro a fighting chance to lure development dollars to their side of the border,” said Kuhlman.
“A well-thought-out and skillfully drafted tax incentive for historic preservation cannot achieve its objectives if the total amount of credits that can be awarded annually is subject to a statutory limit,” states a 2016 policy report by the NTHP on State Tax Credits for Historic Preservation. Those objectives include encouraging economic development from otherwise underused resources and saving historic buildings. But programs that are unpredictable in terms of funds allocated discourage developers from participating.
“Although the building stock in Kentucky is small, [the EHTC] was successful because we have gotten calls from syndicators, banks and other interests outside the state,” noted Jen Spangler Williamson, State Architect at the Kentucky Heritage Council. “It accomplished getting Kentucky recognized as a potential marketplace.”
Good news may be on the horizon for Kentucky. Republican Gov. Matt Bevin expressed his support for an improved program, according to a questionnaire that statewide historic preservation nonprofit Preservation Kentucky sent to gubernatorial candidates ahead of the 2015 election. Bevin indicated that he would be in strong support of increasing the cap to $10 million for the program. Betsy Hatfield, executive director of Preservation Kentucky, is hopeful that Bevin will maintain his commitment in 2017. “As a businessman, Gov. Bevin gets it; he knows the value and how it facilitates, stimulates and contributes to economic growth,” said Hatfield. “It is my understanding that improvements to our state HTC will be part of the governor’s tax reform, which could roll out this session or later this year.”
As Hatfield points out, it will be important to demonstrate the benefits of the program past the two-year budget for return on investment (ROI) to the state if legislators are to support the measure. This includes the significant investment realized out of the gate when the building is immediately put into service in the construction phase and down the road when developments continue to pay employees, contribute to the local tax base and generate revenue. A similar impact analysis performed for the HTC offered by the state of Wisconsin in 2015 concluded that 40 cents of every $1 in credit was returned to the state during the construction phase alone, demonstrating that these programs begin paying for themselves before credits are even awarded.
Advocates of the program–including Preservation Kentucky, Main Street programs across the state, property owners, developers and legislators who could see their districts benefit from a more robust program– will continue to make the case for an expanded program, using the success of the EHTC as an example. There is a plethora of recent economic impact studies and analysis that supports the facts that HTCs are revenue- positive in the long run and should be included in any state government’s toolkit for economic stimulus and community revitalization. ;
Bill MacRostie is the senior partner of MacRostie Historic Advisors LLC and is located in Washington, D.C. In private practice for more than 30 years, Bill has advised clients nationwide on historic rehabilitation projects of many sizes and types. He can be reached at firstname.lastname@example.org or 202.567.6055. Visit www.macrostiehistoric.com for more information about MHA and our expert team.
This article first appeared in the February 2017 issue of the Novogradac Journal of Tax Credits.
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