I am surprised by the number of people who are attempting to spin what is going on in Washington DC right now related to the Historic Tax Credit changes proposed by The Tax Reform Act as “not that bad” or “it could be worse”. True, an outright elimination of the Preservation Credit for Historic Properties could be worse, especially for developers who rely on the program. But the changes could not be more dire for the owners of historic shell properties who will not be able to qualify for grandfathering under the old rules. The City of Richmond’s real estate tax base is also going to suffer a whopping blow. Let me walk you through the math.

The primary problem is that the proposed change spreads credits over 5 years at 20% per year for what was previously available up front at the time of completion for a qualifying project. Another problem is that while a building owner completes a historic renovation project on the assumption that the tax credits will be available over 5 years while patiently waiting but receiving no benefit yet, the politicos in DC can change the rules and eliminate or cut the credits again just like they are doing now.

So how do you go about factoring this risk into the equation? I have assigned a 20% discount rate to account for the time value of money (pick your number here as some folks use different discount rates). I have also assumed a 20% “haircut” to account for the probability that DC could change the rules each year and either eliminate or cut the tax credits. That seems more than reasonable in the ever changing political environment in which we are all now living. Some might even argue that 20% is too low.

So what impact does the time value of money and political risk haircut have on an existing shell property value that doesn’t qualify for grandfathering? For the example below, the impact would be a whopping 60% reduction in value. Even if we lower both the discount rate and political risk haircut to 10%, the reduction in value is a sizable 39% hit. Here are the calculations on the first scenario:

Proposed Tax Reform Act Analysis

What does this mean For Richmond?

If a property does not qualify for grandfathering, (see the gobbledygook below in the footnote for what properties will qualify for “transitional” treatment), shell property owners just lost 60% of their property value using my example above. If the City of Richmond plays fair and reduces the tax assessed value for these shells and my assumptions hold true, the City could lose essentially 60% of the taxes it would have otherwise collected for these shell properties. It’s anyone’s guess what the City will do however. I suspect they will be under intense pressure to pretend this change didn’t just happen (if passed) and not adjust values downward in a desperate attempt to avoid seeing tax collections collapse. That leaves the owner of a non-grandfathered shell with a massive reduction in the value of their property, but potentially stuck paying inflated taxes.

So here’s the bottom line. If you are a property shell owner and you can’t qualify for grandfathering under the transitional rules, you better sell your property to someone who can and fast, or prepare to suffer the consequences. And to my realtor friends, good luck explaining to your property owner clients who aren’t good with math, or are in denial about what just happened to the value of their investment property in that sexy “up and coming” neighborhood they were hoping to sell at a pretty penny to help fund their retirement. Things are about to get real bumpy.

Said Gobblygook House Bill The House bill repeals the rehabilitation credit. Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (within the meaning of present law), with respect to any building owned or leased by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (under

section 47(c)(1)(C)) is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24-month period ends. Senate Amendment The Senate amendment repeals the 10-percent credit for pre-1936 buildings. The provision retains the 20-percent credit for qualified rehabilitation expenditures with respect to a certified historic structure, with a modification. Under the provision, the credit allowable for a taxable year during the five-year period beginning in the taxable year in which the qualified rehabilitated building is placed in service is an amount equal to the ratable share. The ratable share for a taxable year during the five-year period is amount equal to 20 percent of the qualified rehabilitation expenditures for the building, as allocated ratably to each taxable year during the five-year period. It is intended that the sum of the ratable shares for the taxable years during the five-year period does not exceed 100 percent of the credit for qualified rehabilitation expenditures for the qualified rehabilitated building.

Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (for a pre-1936 building) with respect to any building owned or leased (as provided under present law) by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (under section 47(c)(1)(C)) is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24- month period ends. Conference Agreement Between House & Senate The conference agreement follows the Senate amendment with a modification to the transition rule under the effective date relating to qualified rehabilitation expenditures under certain phased rehabilitations for which the taxpayer may select a 60-month period. Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (for either a certified historic structure or a pre-1936 building), with respect to any building owned or leased (as provided under present law) by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (section 47(c)(1)(C)(i)), or the 60-month period selected by the taxpayer under the rule for phased rehabilitation (section 47(c)(1)(C)(ii)), is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24-month or 60-month period ends.

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