How Do Federal Historic Tax Credits Work?

The Federal Historic Preservation Tax Incentives program provides a financial tool for the revitalization of older buildings. It is a federal tax credit designed to encourage private sector investment in the rehabilitation and reuse of historic properties. The program is a partnership, jointly administered by the National Park Service (NPS) and the Internal Revenue Service (IRS), which work with State Historic Preservation Offices (SHPOs). This incentive allows owners of income-producing properties to receive a tax credit for a percentage of the expenses incurred during a building’s rehabilitation on properties recognized for their historical importance.

Determining Project Eligibility

Before a project can benefit from the tax credit, both the building and the rehabilitation project must meet specific eligibility criteria. The first requirement relates to the building itself, which must be a “certified historic structure.” A building qualifies if it is individually listed in the National Register of Historic Places or if it is certified as a “contributing” building within a registered historic district. A contributing building is one that adds to the historic character of its district, a designation confirmed by the National Park Service.

The second requirement is the “substantial rehabilitation test,” a financial threshold set by the IRS. To pass this test, the costs of the rehabilitation must exceed the building’s adjusted basis or $5,000, whichever is greater. The adjusted basis is calculated by taking the original purchase price of the property, subtracting the value of the land, deducting any depreciation already claimed, and then adding the cost of any previous capital improvements. For example, if a building was purchased for $300,000, with the land valued at $50,000 and $20,000 in depreciation taken, its adjusted basis would be $230,000, and rehabilitation costs would need to exceed this amount. This test must be met within a 24-month period.

Calculating the Tax Credit

Once a project is deemed eligible, the financial benefit is calculated as a percentage of the rehabilitation costs. The federal historic tax credit is 20% of the “Qualified Rehabilitation Expenditures,” or QREs. These expenditures are specific costs associated with the physical work on the historic building that are properly chargeable to a capital account. QREs encompass a wide range of costs directly related to the building’s restoration, such as architectural and engineering fees, structural work, and system upgrades.

Certain costs are explicitly excluded from the QRE calculation. These non-qualifying expenses include:

• The property’s acquisition cost
• New additions that expand the building’s volume
• Site work such as landscaping or parking lots
• The cost of furnishings

The calculation itself is straightforward. If a developer spends $1 million on QREs for an approved project, the tax credit would be $200,000. This credit directly reduces the owner’s federal income tax liability. Recent changes to tax law stipulate that this 20% credit must be claimed ratably over a five-year period, meaning the owner would claim $40,000 per year for five years.

The Application and Certification Process

The application process is managed through the owner’s State Historic Preservation Office (SHPO) and the National Park Service (NPS) using a three-part Historic Preservation Certification Application. All applications must be submitted electronically. The SHPO acts as the initial reviewer, providing guidance and recommendations before forwarding the application to the NPS for a final decision.

The first step is the Part 1 application, the Evaluation of Significance. This part is used to certify a building’s historic status if it is not already individually listed on the National Register of Historic Places. For buildings located within a historic district, the Part 1 application secures certification from the NPS that the structure is a contributing element to that district.

Following the confirmation of historic status, the owner submits the Part 2 application, the Description of Rehabilitation, before construction begins. It includes photographs, architectural drawings, and written descriptions of the proposed treatments for the property. The NPS reviews this plan against the Secretary of the Interior’s Standards for Rehabilitation, a set of ten principles governing the appropriate treatment of historic properties.

The final stage is the Part 3 application, the Request for Certification of Completed Work. This part is submitted after the rehabilitation is finished and documents that the completed project adheres to the plans approved in Part 2. Once the NPS approves the Part 3 application, the project becomes a “certified rehabilitation,” and the owner receives the official certification needed to claim the tax credits.

Claiming and Maintaining the Credit

With the NPS approval of the completed work in hand, the building’s owner can formally claim the tax credit. This is accomplished by filing IRS Form 3468, Investment Credit, with their federal income tax return for the year the rehabilitated building is placed in service.

The IRS imposes a five-year holding period that begins when the building is placed in service. If the owner sells the property or it ceases to be an income-producing asset within this five-year window, a portion of the tax credit is subject to “recapture,” meaning it must be paid back. If the property is disposed of within the first full year after being placed in service, 100% of the credit is recaptured. The recapture amount decreases by 20% for each subsequent full year. No credit is recaptured after the property has been held for five full years.