Elvira Lawlor, CPA
Gray, Gray & Gray, LLP
Both the federal government and the Commonwealth of Massachusetts are eager to help fuel the ongoing development and construction boom with some very attractive tax programs. Here are three tax programs you should know about.
Opportunity Zone Program
A brand-new tax incentive program was created by the Tax Cuts and Jobs Act to spur economic development and job creation in undercapitalized communities throughout the country. Such communities or census tracts were identified by the Program and designated by the U.S. Treasury as Opportunity Zones. Investors could invest in Opportunity Zones through a Qualified Opportunity Fund “QOF”, an investment vehicle organized as a corporation or a partnership for the purpose of investing in eligible property located in a Qualified Opportunity Zone “QOZ”. A QOF is a necessary instrument for investing in a QOZ, in other words, investors cannot put money directly into a specific project or business in a QOZ to receive tax benefits. QOFs are required to keep 90 percent of the investment in designated areas, either via properties or businesses.
The Opportunity Zones program offers three tax benefits for investors:
- Deferral of Gain Invested in Opportunity Zone property. Taxpayers can elect to exclude capital gain from gross income. In order to be excludable, the capital gain must be reinvested in a QOF. The deferred gain must be recognized on the date on which the opportunity zone investment is disposed of or December 31, 2026, whichever occurs first.
- Basis adjustment for holding property for 5 or 7 years. The basis is increased by 10 percent if the investment in the QOF is held by the taxpayer for at least 5 years and by an additional 5 percent if held for at least 7 years, thereby excluding up to 15 percent of the original gain from taxation.
- A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a QOF if the investment is held for at least 10 years. This exclusion only applies to gains accrued after an investment in an Opportunity Fund.
Locally, there are 138 designated QOZ in Massachusetts (as of Dec. 14, 2018), 27 in New Hampshire, and 25 in Rhode Island. But QOFs can invest in any zone.
Low-Income Housing Tax Credit (LIHTC) Program
Since 1986 the Low-Income Housing Tax Credit (LIHTC) program has helped to create the construction of affordable housing with lower than market rents by offering tax incentives to the property owners (not the tenant renting the unit). The LIHTC offers a dollar-for-dollar reduction in a taxpayer’s income tax liability in return for making a long-term investment in affordable rental housing. State agencies award LIHTC to developers, who then sell the Credits to private investors in exchange for funding for the construction and rehabilitation of affordable housing. These funds allow developers to borrow less money and pass through the savings in lower rents for low‐income tenants. Investors, in turn, receive a 10‐year tax credit based on the cost of constructing or rehabilitating housing that cannot be rented to anyone whose income exceeds 60 percent of area median income. The credit is claimed each year beginning with the year the property is placed in service. The credit is calculated in proportion to the total depreciable basis of a qualified housing project. The amount of credit depends on 1) whether the taxpayer acquires existing housing or whether the housing is newly constructed or rehabilitated and 2) whether the housing project is financed by the tax-exempt bonds or other federally subsidized financing. The applicable credit rates are the appropriate percentages issued by the IRS for the month in which the building is placed in service. The LIHTC is part of the general business credit subject to its tax liability limitation and carryover rules.
Low-Income Housing Tax Credits in Opportunity Zones
More recently, the U.S. Department of Housing and Urban Development “HUD” has announced an initiative to encourage affordable housing investment within the thousands of designated QOZs nationwide. While the Opportunity Zones program does not have a requirement to build affordable housing, the hope is that the new HUD program will spur the development of additional low-income housing. Credit eligibility will include both new construction and “substantial rehabilitation” of multifamily projects.
Historic Preservation Tax Incentive Program
Federal Rehabilitation Tax Credit is part of the Historic Preservation Tax Incentive Program administered by the National Park Service and the Internal Revenue Service in partnership with the State Historic Preservation Offices. Developed to encourage private sector investment in the rehabilitation and re-use of historic buildings, this tax credit has been a powerful and popular tool since it’s enactment in 1978. The Program allows taxpayers to take up to 20 percent of the qualified rehabilitation expenditures with respect to the qualified rehabilitated building as a tax credit. To meet the qualification criteria the building must be income producing property certified by the National Park Service as a historic structure. To receive such certification and ultimately the credit, the property owners must complete the three-part application process. Additionally, the building must be placed in service before the beginning of the rehabilitation, and the rehabilitation work must meet specified standards determined by the National Park Service. Among other requirements, the cost of the rehabilitation must exceed the pre-rehabilitation cost of the building to meet substantial rehabilitation test.
Modified by the Tax Cuts and Jobs Act of 2017, the credit is spread over a 5-year period and must be taken in proportion to the ratable share of expenditures. The new tax law also eliminated a 10 percent rehabilitation credit for the rehabilitation of non-historic buildings. To incentivize investment in Historic Preservation Program projects, the IRS also established “safe harbor” for investors in such projects.
Massachusetts mirrors the Federal Program with the State Historic Rehabilitation Tax Credit Program. Initially available on January 1, 2016, the program has been extended to expire on December 31, 2022. The State program allows a 20 percent credit for the rehabilitation expenditures in regard to a historic structure or phase of a structure for projects completed in phases. To qualify for the credit, the project or phase of the project must be certified by the Massachusetts Historical Commission. Similar to the Federal requirement, the rehabilitation work must be “substantial” and the building must be placed in service. Massachusetts qualifies buildings as “placed in service” when occupancy of the entire structure or some identifiable portion of the structure is permitted. Unlike the federal rules, the State rules allow to take the credit in the year the property is placed in service with unused credit to be carried forward for the next 5 years. The Credit is non-refundable but transferable meaning that the credit could be transferred to other qualifying taxpayers that acquire a historic structure, given certain criteria are met. The credit may be subject to recapture if the taxpayer disposes of its interest in the structure within 5 years of being placed in service. The state authorization amount for the credit is capped at $50,000,000 per year.
Unlike a tax deduction that reduces taxable income, tax credits are a direct reduction in taxes owed, making them an excellent way of recouping part of your design, development, and construction costs. If you are interested in learning more about these and other tax credits that may be available for your business to take advantage of, please contact Gray, Gray & Gray at (781) 407-0300.
Elvira Lawlor is a member of the Architecture, Engineering & Design practice group at Gray, Gray & Gray Certified Public Accountants and Advisors in Canton, Mass. (www.gggcpas.com)