Rehabilitation of income-producing properties that are either historic landmarks or within a historic district may present a favorable real estate investment opportunity.
The 1976 Federal Tax Reform Act opened the investment doors by making such rehabilitation a favored tax shelter investment. Investors of qualifying properties can now either write off their investments over five years or take accelerated depreciation (at double declining rates) on the whole property.
Washington is prime for investment because of the rebounding vitality of many of its older, historic areas.
For instance, take a building with an initial depreciable basis of $1,000,000 and additional qualifying rehabilitation expenditures of $500,000. Prior to the 1976 Federal Tax Reform Act, 1 the investor could only realize $75,000 in depreciable benefits. Under the new five-year alternative, the investor can amortize $100,000 in each of the first five years in addition to taking the ordinary depreciation attributable to the $1,000,000 basis. Under the accelerated depreciation basis alternative (assume a 25-year life for the building), the investor can depreciate up to $125,000 in the first year.
Few investors used these provisions, even though Congress had dramatically cut back on almost all other tax shelters. The basic tax flaw was corrected in 1978 when Congress changed the "recapture" provisions enforced at time of sale of the rehabilitated properties. Previously what the investor saved in tax sheltering amortization was fully taxed at ordinary income rates at time of sale. Sale proceeds are now subject to the same gains treatment as other real estate investments.
The multi-tiered processing of applications to quality investments has also slowed the process. An investor must submit applications through the State Historic Preservation Officer to the Historic Conservation Recreation Service (HCRS) of the Department of the Interior. In addition, the investor must submit materials to the Internal Revenue Service (IRS) when filing tax returns. While HCRS and IRS have sought to simplify the procedure, these steps require additional work.
The review process is designed to assure that tax benefits go to properties rehabilitated consistent with their historic character. HCRS has set up review standards. Investors are required to perform alterations that are consistent with the original use of the property although the reuse need not be the same. Distinguishing original qualities or character of the building or its site are not to be destroyed. Changes are to be based upon the historical context of the property. Where possible, deteriorating archectectural features are to be restored, not destroyed. The investor is advised to seek the assistance of qualified architectural historians.
Only income-producing properties listed on the National Register of Historic Places or within a district on the National Register for favorable tax treatment. A property may also be qualified if located within a locally designeated district if the local ordinance has been approved by HCRS and the district certified as substantially meeting the criteria for designating a district for the Register.
The District's ordinance has not yet been submitted for approval. Thus, properties in the Dupont or Capitol Hill historic districts, for example, are eligible, but not properties in the Massachusetts Avenue district.
However, owners of historic properties, which would qualify for favorable tax treatment, face unfavorable tax treatment if they demolish or rehabilitate their properties inconsistent with the HCRS standards. These treatments involve the loss of demolition expense deductions and use of accelerated depreciation. Owners should seek tax advice if they are uncertain about the status of their properties and the tax consequences of proposed actions. *tThe writer is a federally employed attorney with an interest in historic preservation.