First post here.
I currently own a property in a historic district and was planning on selling the HTC's to pay for renovations. I personally have no expertise with CRE, however I do have partners who were to handle the construction / financial aspects of the development while I was going to manage the property and also move a small business that I own and operate into one of the building's several retail spaces.
My partners have since decided that they are no longer interested in taking on the task of rehabbing the property, and I am currently pursuing buying them out and doing a pared down renovation of the property on my own. I am bullish on the property and have several interested investors, but am now having to learn a lot of the financial aspects on the fly.
My question pertains to the historic tax credits. My budget is a lot less than we had originally anticipated and I question I don't think the credits would be large enough to draw interest from anyone for purchase. Aside from the question of whether or not going the HTC route is even worth the trouble, I was interested in redeeming them personally rather than selling them to an investor. However, because I plan on operating my own business on the property, it is my understand that I cannot redeem the credits myself. I have read that there is a "material participation" exception here but am having difficulty wrapping my head around the concept of passive vs. non-passive tax credits. I am planning on operating my own business out of the property, which may allow me to qualify for non-passive credits, but also renting several commercial and residential units (which are by definition passive).
Any help would be greatly appreciated. Thank you in advance.
The tax credits themselves are not passive/non-passive. The distinction is the type of income offset by the credits due to your classification or activities (ie whether your activities are passive/non-passive). So basically if you either qualify as a real estate professional, or are active in your business then you can offset all of your income with the tax credit. If you do not meet one of the exceptions (I will post below) then you can only offset $25,000 per year--which might be enough actually that you do not need to worry about it. Check with your tax preparer. I hope that helps!
37. Under what circumstances would a taxpayer's rehabilitation tax credit not be limited?
Material Participation. Generally if a taxpayer either works more than 500 hours a year or performs substantially all of the work in a business, he or she is deemed to be materially participating, and losses and/or income are non-passive. However, the material participation rules do not apply to long-term rental real estate activities. Real estate rental is passive by definition regardless of the 500-hour test.
Example: John is an architect and rehabilitates a certified historic structure. If John uses the building for his architectural business, the credit is not limited because it is stemming from a non-passive activity. (Non-passive credit)
If John rehabilitates the same building and rents the space to a restaurant, the rehabilitated building is now rental real estate (passive by definition) and will be limited. (Passive credit)
Real Estate Professionals. If more than one half of a taxpayer's personal services in all business are in real property businesses (property development, construction, acquisition, conversion, rental, management, leasing, or brokering) and the taxpayer spends more than 750 hours a year in real property trade or businesses, the taxpayer is a real estate professional. If this is the case, any rehabilitation project the taxpayer is involved with, including rental real estate, will generate non-passive rehabilitation tax credits.
Short-term rentals. If a taxpayer rehabilitates an historic building and uses it for short term rental, such as a Bed & Breakfast or a Hotel/Motel, and materially participates in the operation of the business (i.e. spends more than 500 hours), the rehabilitation tax credit generated from this project is deemed to be non-passive, and the credit will not be restricted.
Corporate entity. While the passive activity loss rules do not generally apply to regular C- Corporations, they do apply to personal service corporations and to closely held corporations in a limited way. For personal service corporations and closely held corporations, material participation is determined based on the level of participation of the shareholders. One or more individuals who hold more than 50% of the outstanding stock must materially participate in the activity in order for the corporation to meet the material participation standard.