Historic Rehab Projects at Risk From State Credit Lapse, Pillar 2

By: Chandra Wallace

The expiration of Minnesota’s historic tax credit puts historic building rehabilitation projects there at risk, and similar projects nationwide may face head winds if proposed global minimum tax rules remove incentives for investors to help fund them, industry professionals say.

State and federal historic tax credits are often used in tandem to facilitate funding for renovations to revitalize or repurpose historic buildings while preserving their historic character. If those tax credits aren’t available — either because programs expire or because investors can’t claim credits without incurring additional global tax liability — some historic rehabilitation projects just won’t happen.

“If current investors cannot invest, it will absolutely have an effect on the number of projects that can get done. And it will be significant,” according to Patrick Robertson, executive director of the Historic Tax Credit Coalition.

Minnesota’s version of the historic tax credit lapsed June 30, prompting a flurry of activity to obtain necessary approvals before that date and a pause in the development of current and future projects not yet approved. Projects that were counting on the Minnesota state credit will face a significant funding gap in its absence, Robertson said.

At the same time, proposed global minimum tax rules under pillar 2 of the OECD plan could jeopardize investment in historic building rehabilitation projects nationwide if the tax credits used to finance them reduce companies’ effective U.S. tax rates below 15 percent. Industry estimates show that at least 48 percent of the equity investment in these tax credits — and possibly more — could be from taxpayers that fall within the scope of the pillar 2 rules.

Minnesota Projects at Risk

The Minnesota historic structure rehabilitation tax credit expired June 30 when the state legislature adjourned without passing its omnibus tax bill, which included the extension of the credit. Pending projects that had received necessary approvals by June 30 are still eligible for the tax credits, but many more in the pre-planning and early pipeline stages must wait and hope that credits will be extended in a special session before the end of 2022, Meghan Elliott of New History building consultants in Minneapolis told Tax Notes.

“That’s a lost-opportunity situation that’s really hard to quantify” at this stage, according to Erin Hanafin Berg of the Rethos Policy Institute. Still, the industry hopes the credit will be extended as soon as the legislature is back in session, she said.

Just before the credit’s expiration, on June 29, Sherman Associates Inc. announced that an $80 million project at the Landmark Towers in St. Paul would be paused indefinitely because critical funding was unavailable in the absence of the state credit.

The Sherman project is one of several that may be jeopardized by the credit’s lapse. According to RevitalizeMN, a coalition of nonprofits and businesses that supports extension of the credit, the projects at risk also include the McKnight Building in Minneapolis, the Sandstone School in Sandstone, the Dock Cinema in Excelsior, the Anderson Hotel in Wabasha, and the Kasson School in Kasson.

Projects will be abandoned and blight will worsen in the absence of the Minnesota historic rehabilitation tax credits, Elliott said. There are 38 other states with similar tax credit programs, and Elliott expects that if Minnesota isn’t able to renew its credits, investors will move their money to projects in those states.

Many historic rehabilitation projects rely on both federal and state credits for the financing to proceed, so states without credit programs are at a disadvantage, Elliott said.

Pillar 2 Effect

Industry professionals have also worried about the effect of the emerging global minimum tax rules on historic building rehabilitation project investment.

“If corporate investors are going to have to pay a minimum amount of tax, perhaps that changes their appetite for credits, and so we’re not completely insulated from these types of global changes,” Elizabeth Young of Nixon Peabody LLC said June 16 at a conference on historic tax credits sponsored by the Institute for Professional and Executive Development.

“If you are a U.S. taxpayer and you invest in tax credits and tax-exempt bonds, you’re actually reducing your effective tax rate through the tax incentives that are built into [the U.S. tax code] to encourage economic development, community development, historic preservation,” Merrill Hoopengardner of the National Trust Community Investment Corp. said at the same conference.

But if a U.S. taxpayer is also paying tax in Germany, for example, and pays less in the United States than the proposed 15 percent minimum tax, then the taxpayer could owe to Germany the difference between its U.S. effective rate and 15 percent, Hoopengardner said.

Wide Net

In response to a February 16 letter from Senate Finance Committee ranking member Mike Crapo, R-Idaho, warning about pillar 2 effects, Treasury asserted March 29 that “only 0.02 percent of U.S. C Corporations are in the scope of Pillar 2 as a percentage of U.S. Corporate returns.”

Looking only at taxpayers with investment tax credits, however, a far higher proportion — “50, 60, 80 percent of the taxpayers who invest in these kinds of tax credits” — are affected, Hoopengardner said.

In an April 5 letter to Treasury Secretary Janet Yellen, industry groups detailed expected disadvantages of the pillar 2 model rules on investments that rely on tax credits for affordable housing, historic buildings, and new markets, as well as tax-exempt bonds.

“It’s definitely something to watch as these rules become clarified — and especially if you work for a company that has global tax exposure and you’re doing a large amount of investing. It’s something your tax department probably wants to monitor,” Hoopengardner said.

Still Waiting

Professionals with experience in the area said that there isn’t enough clarity yet on how the rules will be implemented or interpreted, so deal documents and structures aren’t yet changing to take them into account.

“We see this on the horizon, but I don’t know that we have enough information on how it’s going to be implemented in the U.S. to know how to document it, how to protect the parties in an agreement,” Young said, adding that “we’re certainly on the lookout.”

Young and Tim Karp of JPMorgan Chase & Co. both confirmed that they haven’t seen provisions addressing this kind of change of law in the documents for any historic tax credit projects on which they worked. The five-year period over which investors take federal historic tax credits under section 47 and the proposed implementation of pillar 2 by 2023, however, mean that current and near-term projects may need to be adjusted midstream.

Hoopengardner noted that investors will have some flexibility in the ability to shift credits to other tax years. “One of the advantages of historic [tax credits] is you can carry back and carry forward, so there’s a little bit of a built-in safety valve if it turns out the investors got a little more in credits than they need,” she said.

Big Projects

Historic tax credit programs offered by the federal government under section 47 and by many states encourage the renovation and sometimes repurposing of existing buildings of historic significance or located in historic districts. The programs are rigorous, requiring extensive research and documentation of a property’s history and architecture and proof that the renovations envisioned will preserve the historic character of the structure and property.

Submissions often run into the thousands of pages and are vetted by the National Park Service and state historic preservation offices. The approval process has three parts: confirming the historic significance of the building, evaluating the planned rehabilitation to ensure it’s consistent with the historic character of the building (and sometimes its surrounding district), and certifying that the work has been completed consistent with the approved plan.

The federal historic tax credit is a 20 percent credit against federal tax liability, calculated based on qualified rehabilitation expenses spent on the project. State programs may match the federal credit amount — as Minnesota’s program did — or designate their own credit percentage or dollar value.

Because the credits can’t be taken until the project is approved, completed, and placed into service, but cash for the rehabilitation work is needed upfront, large corporate investors often step in to fill the gap, providing the necessary cash for the project and benefiting from the credits in later years.

In many cases, multiple tax credit programs are combined to make financing a project viable. Those include both state and federal historic tax credits as well as federal tax credits for low-income housing development and new markets, and state and local tax incentives.