Novogradac Journal of Tax Credits
February 2018 | Volume IX - Issue II
The federal historic tax credit (HTC) survived tax reform at 20 percent. That is good news. But just how disruptive might the change from a one-year credit to a five-year credit be? Speculation about how this will affect the value of the HTC varies and the forecast is uncertain.
According to experts such as Renee Kuhlman with the National Trust for Historic Preservation, state HTC programs that are also distributed over multiple years, such as those in Maine and South Carolina, may shed some light on the new structure.
The Maine HTC, a credit taken over four years, began in 2008. The program started just as the Great Recession was beginning to impact the national economy, so real estate development was sparse. The impact of the recession can clearly be seen in the change in construction jobs during this period: unemployment in the construction sector in Maine rose from 6.5 percent to 14.2 percent between 2007 and 2009. Yet, a 2011 economic impact report sponsored by Maine Preservation reported that historic rehabilitation activity in the state increased from $7 million in 2007 to $40 million in 2011–against the odds–with the help of the new credit.
Likewise, South Carolina’s HTC structure requires that owners claim the credit over three years. (Before 2015 that period was five years.) This applies to both HTC options for owners of income-producing properties. Like Maine, taking the credit over multiple years does not seem to be a deterrent to historic property developers and the South Carolina program continues to grow: the state historic preservation office reporting a 36 percent increase in reviews from 2016 to 2017.
While a multiyear credit does not seem to deter the use of the program, what effect does it have on the dollar value of the credit? And what can that tell us, if anything, about the changes in the federal program?
Some industry experts have made early predictions that the federal HTC pricing could go as low as 75 cents on the dollar as a result of the new law. Greg Paxton, executive director of Maine Preservation, estimates that his state’s credit is trading at 83 cents on the dollar. He points out that even though this value may not seem as robust as other states–Massachusetts HTCs can all be taken in one year, are freely transferable and trade in the 85- to 90-cent range. Ultimately the state credit in Maine is worth less than transferable credits in other states. For instance, transferable credits like those in Rhode Island and Connecticut also trade higher than Maine–also around 90 cents–but even if the difference in pricing can all be attributed to the multiyear program, it represents less than a 7 percent difference. “If our 25 percent state credit and the 20 percent federal credit make the project close to being feasible,” Paxton says, “then any loss in value can be made up with other subsidies like local TIFs or other incentives.”
Indeed, other incentives may be key to stabilizing the value of the federal HTC in the future. Both Maine and South Carolina have specialized incentives aimed at attracting development to special sectors and spurring economic growth. South Carolina offers tax credits for the rehabilitation of both abandoned textile buildings and other historic abandoned buildings, both of which must also be taken equally over three years. Stack either of these additional credits with the state and federal HTC and an ownership group can receive subsidy of 55 percent of qualified costs. In Maine, historic rehab developers can earn an extra 7 percent credit for affordable housing projects up to the annual $5 million project cap. There may be a lower value on these individual state credits, but they are no less effective at subsidizing historic rehabilitations.
This approach of stacking, or “twinning,” tax credits has long been employed on the federal level as well. With the 2018 federal changes, there may be a need to look at other sources of equity for developments to make up any gap due to changes in pricing strategy. In particular, low-income housing tax credits (LIHTCs), which fared well in the tax reform exercise despite some uncertainty, will continue to be an important companion program for historic building redevelopment and may tip the scale toward affordable housing use in some cases where that is a feasible option.
While additional incentives help to sustain value for equal installment credits, the slow-release credit structure also helps to assuage concerns of state lawmakers who believe uncapped credit programs negatively impact budgets. Every year there are a handful of state HTC programs on the chopping block because a few legislators believe the program is too costly to their state’s tax base. The benefit of HTC programs, however, is that most of the investment is made before the impact of the tax credit is incurred by the state. Well-used credit programs that require longer redemption periods for the credit can accumulate just as much as those redeemed in the one year, but their long-term tax effect back into the state treasury is more predictable and the impact is spread out. It also makes it more difficult for legislators to repeal HTC legislation when credits have been committed to projects that have a multiyear lifecycle in the program. (For developments in the new federal program, many will require seven years from application to fulfillment.) Many states are already looking at ways to enhance their state programs to address the impact the changes in the federal tax code, not just from the HTC, may have on their economy.
Other approaches to addressing legislative concerns about HTCs are more detrimental to their usefulness. Insufficient aggregate program caps and low per-project caps can greatly devalue the incentive. Most recently, Wisconsin Gov. Scott Walker’s line-item veto to impose a low $500,000 per-project cap has led many HTC investors in the state to look elsewhere. This type of change truly threatens many large projects’ feasibility and two bills have been introduced to increase the cap in order to avoid negative impacts to Wisconsin communities. The change in the federal HTC rules will not have as adverse an effect as this type of approach.
As noted above, there are downfalls to equal installment credits. The time-value-of-money principle stipulates that money earned five years from now will not be as valuable as money earned today, so naturally there may be some change in pricing. For the federal HTC, there is also the added issue of the reduction in the corporate income tax substantially lowering the total corporate tax liability. But state programs, which have historically had lower corporate rates than the federal rate, also prove that lower tax rates still benefit from tax incentives like HTCs.
It is too early to tell what impact changes to the federal HTC will have on pricing. There is also not enough room in the article to discuss all of the other aspects of tax reform that could affect investors’ appetites for the credits. What is clear, from our review of Maine and South Carolina, is that even with an equal installment program there is still a significant need and appetite for HTCs as a financing tool, that the use of HTCs continues to grow and that developers will find a way to make the programs work.