Texas HTC to Help Revitalize Real Estate Industry

Novogradac Journal of Tax Credits
February 2015 | Volume VI, Issue II

By: Bill MacRostie

For the past three decades, Texas has been the poster child for suburban sprawl more than any other state. In metropolitan areas such as Austin, Dallas and Houston, it’s not uncommon to find individuals who have round-trip commutes that top three hours. That’s more than a month spent in the car each year just driving to and from work. It’s easy to see why: As urban buildings fell into disrepair, the prospect of cheaper, new construction lured developers farther and farther away from city centers. And who could blame them? What incentive was there to rehabilitate older, more costly buildings?

Over the years, there have been attempts to revitalize these downtown areas, but ultimately, viable ways to recoup project expenses couldn’t be realized and the projects remained in limbo–or abandoned altogether. Now that is changing. In 2013, the Texas Legislature decided to follow what 33 other states have done: institute a state historic tax credit (HTC) program, speciἀcally the Texas Historic Preservation Tax Credit (THPTC). When coupled with the federal HTC, Texas now has an economically feasible way to bring more office space and affordable and market-rate housing to its major cities–setting the Texas real estate industry up for the early stages of an economic boom.

Texas Historic Preservation Tax Credit
The THPTC equals 25 percent of the eligible costs and expenses incurred in a certified rehabilitation that totals more than $5,000. This includes all eligible costs and expenses incurred before Sept. 1, 2013, if the property was placed in service on or after that date.

Updated Regulations
In September 2014, the Texas Historical Commission adopted a series of regulations implementing the program and clarifying an opinion issued by Texas Attorney General Greg Abbott. Among the more unusual of these regulations is 1 TAC §20.64, which states that any debt forgiveness of a loan and settlement of a debt must be reported as an in-kind political contribution, unless the loan was paid off through usual business practice of the industry, free of any particular unfair treatment of political or nonpolitical persons. A complete set of the updated regulations can be found at the Texas Historical Commission website.

Application Process
Those wishing to take advantage of the THPTC program will need to complete a three-part application to receive a certificate of eligibility, which establishes that the building is a “certified historic structure” and the rehabilitation is a “certified rehabilitation,” meaning it follows the Secretary of the Interior’s Standards for Rehabilitation (the Standards) and “is consistent with the historic character of the building, and where applicable, with the district in which it is located.”

Parts A and B of the application must be submitted before work on the building is completed and ideally before any construction is started.

Part A: evaluates the building to ensure that it is a historic property eligible for state credits. Eligible buildings will be those listed on the National Register of Historic Places (National Register), designated as a Recorded Texas Historic Landmark or that contribute to a registered historic district. If a building doesn’t have any of these formal designations, building owners can still request a preliminary designation to fulfill the Part A application.

Part B: describes the intended rehabilitation, both interior and exterior work, to certify that the project complies with the Standards. The Texas Historical Commission offers preliminary consultations for complex projects where meeting the Standards might be unclear. Completing these first two steps before work begins helps ensure the project is compliant and won’t jeopardize eligibility for the tax credits.

Part C: should be completed after work has been completed to formally certify the rehabilitation work. In some cases, an authorized representative of the Texas Historical Commission will need to inspect the project to determine it meets the Standards. Each of these steps will take approximately 30 days for review, so plan appropriately when submitting each part of the application. A complete explanation and requirements for each step are available at the THPTC webpage at www.thc.state.tx.us/.

Comparing Other State HTC Programs
As previously noted, 33 other states have implemented similar HTC programs  and while all have benefited their respective economies by rehabilitating underutilized historic assets, not all state HTC programs are created equal. Some programs, such as the Virginia Historic Tax Credit program and the New York Historic Tax Credit program, limit the number of tax credit investors for a project. Both Virginia and New York require the tax credit investors be admitted into the transaction structure to allow the tax credits to be allocated through a partnership in order for the investor to use the tax credits. New York takes it a step further by not allowing the state tax credit investor to be decoupled from the federal HTC investor.

Unlike the Virginia and New York allocated credit programs, what makes the THPTC so attractive to investors and developers is the ability to directly transfer the tax credits to the investor and more efficiently include the tax credit equity as part of the project’s capital stack. Scot Butcher of Tax Incentive Finance LLC is already involved in several THPTC transactions. “The transferability of the Texas credit allows the developer to raise additional capital through a sale of the credits or they have to option to bring the state tax credit investor into the transaction as a partner and, among other advantages, it reduces upfront legal and accounting costs to the deal,” he says.

While there are many different state HTC programs, the THPTC should be highly desirable due to the simplicity of the expected transfer process and the strong demand for state tax credits in a market where there are no other tax credits that can be purchased or sold. Butcher also points out that the THPTC has a basis test of only $5,000, which means that a project need only spend $5,000 of eligible costs to qualify for the credit. This contrasts the federal HTC program, which requires 100 percent of the tax basis of the building be exceeded in order to qualify.

Projects to Watch
Even though Texas’ program has only been in place for a short time, some high-profile projects are already teed up to take advantage of the new program.

One such project is the redevelopment of 500 South Ervay Street, a 103-year-old property adjacent to Dallas City Hall. This project languished through a series of failed redevelopment prospects dating back to 2006, all the while, the building remained vacant or underutilized. With the enactment of the 25 percent tax credit, construction on an $85 million rehabilitation project is moving forward. Plans include a 270-room hotel, market rate housing, restaurant and retail space, with construction slated to begin during the first quarter of this year.

Another building of a significantly different aesthetic–mid-Century modern–is the Dallas Statler Hilton. Similarly, the building went from an architectural icon to derelict eyesore over the years and has seen a series of deals promising rejuvenation collapse. Construction on an extensive rehabilitation is expected to start early this year, partially funded through the new state HTCs.Comparing these two buildings brings up a good question–what’s considered historic in Texas? According to the THPTC guidelines, any building 50 years or older may qualify as long as there is some architectural or historic signiἀcance associated with the building. Our constant advice to clients is to think outside the box in terms of what may qualify as historic. Remember, buildings built in the mid-1960s are now turning 50.

Urban revitalization starts with viable redevelopment projects that bring affordable office space and housing back to downtown areas. States such as Texas that have enacted HTC programs have seen formerly depressed properties and neighborhoods transformed, and for investors and developers, these areas also provide a sea of opportunity. Only time will tell the true impact of Texas’ program, but if the projects already queued up are any indicators, the coming years will be an exciting time for the Lone Star State.

This article first appeared in the February 2015 issue of the Novogradac Journal of Tax Credits. 

© Novogradac & Company LLP 2015 - All Rights Reserved

Notice pursuant to IRS regulations: Any U.S. federal tax advice contained in this article is not intended to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties under the Internal Revenue Code; nor is any such advice intended to be used to support the promotion or marketing of a transaction. Any advice expressed in this article is limited to the federal tax issues addressed in it. Additional issues may exist outside the limited scope of any advice provided – any such advice does not consider or provide a conclusion with respect to any additional issues. Taxpayers contemplating undertaking a transaction should seek advice based on their particular circumstances. 

This editorial material is for informational purposes only and should not be construed otherwise. Advice and interpretation regarding property compliance or any other material covered in this article can only be obtained from your tax advisor. For further information visit www.novoco.com.