Rehabilitation tax credit projects are on the rise.

Take a random walk through any urban metropolis and a person can expect to find at least one historic or pre-World War II building that is undergoing a major restoration. These rehabilitation projects cover the spectrum of possible uses, such as the rehab conversion of a vacant warehouse into spacious rental residential lofts, the restoration of a historic hotel to its original grandeur coupled with all the conveniences of contemporary culture, or the upgrade of an office building to luxury Class A office or apartment space. These historic and pre-World War II buildings that were once the centerpieces of sprawling city environments are being restored through adaptive re-use, thereby rejuvenating many urban communities which had temporarily lost their way.

In addition to the traditional forms of conventional and subsidized financing, and recently fueled by the anticipation of further tightening by debt lenders, the federal rehabilitation tax credit is rapidly becoming a popular supplemental financing source for "substantial rehabilitations" of both historic and pre-World War II buildings. The federal rehabilitation tax credit, a dollar-for-dollar reduction of federal income tax liability, is calculated as a percentage of the eligible rehabilitation expenditures. Federal tax law offers a 20 percent tax credit for rehabilitations of certified historic buildings, and a 10 percent tax credit for rehabilitations of non-historic, non-residential buildings built before 1936.

To qualify for the rehabilitation tax credit, the project must constitute a "substantial rehabilitation," whereby the rehabilitation expenditures exceed the "adjusted basis" of the building. Generally, a building's adjusted basis is equal to its purchase price less land value, plus capital improvements made, less depreciation taken.

In most instances, any building listed on the National Register of Historic Places or located in a National Register Historic District will qualify for the 20 percent historic rehabilitation tax credit as long as the rehabilitation work is approved by the National Park Service, a division of the U.S. Department of the Interior. Rehabilitation of a non-historic building built before 1936 can qualify for a 10 percent rehabilitation tax credit, provided that the adaptive reuse is non-residential. Rehabilitation tax credits are not available for homes, condominiums or apartments occupied by owners.

The rehabilitation tax credits can be either used to offset the owner's tax liability or sold to a tax credit investor in exchange for additional equity capital that can be utilized for long-term financing of the project. Because the Passive Activity Rules and Alternative Minimum Tax Regulations severely limit, and sometimes prohibit the use of tax credits, most owners syndicate the tax credits to a third party corporate investor. Typically, to transfer the tax credits, the corporate investor is admitted into a limited partnership (or similar legal ownership structure) prior to issuance of the certificate of occupancy and the official "in service" date.

Fortunately, developers of historic rehabilitations can find expert assistance with the tax credit syndication process. Sovereign Capital Resources (SCR) is a boutique real estate consulting firm that specializes in the syndication of tax credits to institutional investors and provides related advisory services to historic property and low-income housing developers and investors throughout the country. To date, SCR's team has facilitated over $600 million of equity investments into tax credit projects across the country, with development budgets ranging from $5 million to $180 million.

Though varied in nature and scope, each SCR engagement poses similar objectives: to ensure project feasibility and profitability through optimization of the equity structure; and to successfully navigate threshold regulatory requirements affecting tax credit eligibility. As financial advisors working on the developer's behalf, SCR evaluates the project's financial building blocks, determines the eligibility and potential qualifying basis for rehabilitation tax credits, refines the equity structure, prepares offering materials including financial spreadsheet analysis, and directs communications with the top national equity investors.

Sovereign Capital Resources maintains a national presence through its corporate headquarters in El Segundo, CA, and regional office in Princeton, NJ.

Robert Plotka, Acquisitions Manager, Sovereign Capital Resources, LLC