Table of Contents:
FAQs
Why Were Real Estate Tax Credits Created?
How Do Tax Credits Differ from Deductions?
Benefits of Tax Credits
Common Types of Real Estate Tax Credits
FAQs:
How do tax credits work for developers?
Real estate tax credits were developed to encourage investment in projects that provide a direct societal or environmental benefit. Today, as more people are seeking an investment strategy that’s guided by conscience as well as gain, these credits allow taxpayers to address vital environmental, social, and governance (ESG) issues—while substantially reducing their tax burden.
How can investors make money on LIHTC?
The LIHTC credit aims to promote the construction and renovation of affordable housing units for residents with income limitations. The LIHTC also frees up funds for additional community development projects.
How does a tax credit provide benefit to an investor?
A tax credit, however, is a dollar-for-dollar reduction in your taxes. Some tax credits can even make you money. Most tax credits are nonrefundable, meaning that if the credit reduces your tax obligation to zero or below, you owe nothing (and the IRS owes you nothing). With a refundable or partially refundable tax credit, however, if your tax obligation is brought below zero by claiming the credit, you’d get a refund from the IRS! That’s something no deduction can do
Real estate investors and developers have a keen eye for opportunity. One emerging investment strategy that’s gaining traction comes from an unlikely source—the IRS. Each year, millions of dollars in tax credits go unclaimed by eligible businesses. This includes valuable credits aimed at generating sustainable energy, reducing waste, addressing climate change, promoting health and safety, and encouraging workplace diversity.
Here we’ll review the purpose and role of tax credits, the ways credits differ from deductions, and how your business can benefit directly from tax credits. Then, to help you get started, we’ll list 10 tax credits useful to real estate developers and investors.
Why Were Real Estate Tax Credits Created?
Real estate tax credits were developed to encourage investment in projects that provide a direct societal or environmental benefit. Today, as more people are seeking an investment strategy that’s guided by conscience as well as gain, these credits allow taxpayers to address vital environmental, social, and governance (ESG) issues—while substantially reducing their tax burden.
For example, a business might claim a tax credit for converting its warehousing facilities from conventional to solar power. The resulting savings can then be used to fuel more ESG-conscious projects—like switching the company’s car fleet from gas to hybrid—or to make further improvements to processes, systems, or equipment.
The long-term goal is that, by spurring environmentally and socially conscious investment now, we as a society can encourage sustainable technologies for our economic future.
How Do Tax Credits Differ from Deductions?
When people talk about reducing their tax burden, there are two terms that commonly arise—deductions and credits. So what exactly is the difference between the two, and what advantages are unique to tax credits?
A tax deduction reduces your taxable income, and in turn can lower your tax obligation. A tax credit, however, is a dollar-for-dollar reduction in your taxes. For example, if you claim a $2500 tax credit, you’ll save $2500 on your bottom-line tax liability.
Some tax credits can even make you money. Most tax credits are nonrefundable, meaning that if the credit reduces your tax obligation to zero or below, you owe nothing (and the IRS owes you nothing). With a refundable or partially refundable tax credit, however, if your tax obligation is brought below zero by claiming the credit, you’d get a refund from the IRS! That’s something no deduction can do.
Benefits of Tax Credits
Both federal and state governments use tax credits to encourage specific types of investment, particularly public–private partnerships that create programs to benefit communities locally and globally.
Depending on the nature and amount of the credit, tax credits can guide investment toward socially responsible endeavors. Some examples include:
- Increasing the amount of affordable housing for those in need.
- Repurposing historic structures for preservation and community use.
- Growing the nation’s sustainable energy infrastructure through investment in solar, wind, and geothermal technologies.
- Promoting carbon sequestration technologies to reduce harmful greenhouse gas emissions.
Whether at the state or federal level, ESG-conscious tax credits share the long-term aim of benefiting society and humankind, while also stimulating economic growth. Today’s globally conscious investors can look forward to:
- Accelerated growth (ESG-conscious projects often receive higher valuations than competitors with less social capital)
- Lowered costs let you offset rising operating expenses
- Reduced regulatory pressure and greater strategic freedom
- Increased worker motivation and boosted morale
- Improved investment optimization as capital moves to sustainable technologies
Common Types of Real Estate Tax Credits
Which types of tax credits are of the greatest benefit to real estate developers and investors? Let’s have a look at 10 of the most often claimed real estate tax credits and see how they stack up:
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Opportunity Zones:
In 2017, Congress established a system of zones in neighborhoods in need. Developers were encouraged to build (or renovate) within these zones as a way of fostering the public good. Businesses that relocate to federal opportunity zones are often able to defer capital gains, allowing them to use the savings to add workers and value to a project. Developers can generate third-party investment by establishing a fund for projects built in these zones. This fund can then be used to defer tax on their initial investment and to eliminate tax on the sale of the development project. Unrealized profit from the sale of their properties or investments can then be channeled into “Opportunity Funds” dedicated to investing within these zones.
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Historic Tax Credits:
Society values history, and both federal and state tax credits are available to taxpayers renovating historically significant older structures. Taking state and federal tax credits together, the credit can reach 40% of eligible construction costs. To be eligible, the property needs to be included on the National Register of Historic Places, be eligible for a National Registry Listing, or be located within a designated Historic District.
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Low Income Housing Tax Credits (LIHTC):
Since its introduction in 1986, the LIHTC has subsidized over 3 million housing units in the U.S. The credit aims to promote the construction and renovation of affordable housing units for residents with income limitations. The LIHTC also frees up funds for additional community development projects. For a project to qualify, Housing and Urban Development (HUD) deems a unit affordable if the tenant is spending 30% or less or their adjusted gross income (AGI) on rent. Additionally, a project must offer either 20% of units at an affordable price for tenants earning 50% of the area’s median income (AMI) or 40% of units affordable to those earning 60% or less in AMI.
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Year 15 Exit (LIHTC):
Year 15 is a time when real estate investors frequently look to divest from their low-income housing projects. You may opt to sell the property, or merely to sell your interest in it. Whichever you choose, your exit strategy should be part of an overall tax and investment strategy. A seasoned tax professional can help you understand the potential advantages of divesting and can guide you safely through the process.
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New Markets Tax Credit:
Created by Congress in 2000, the New Markets tax credit is designed to encourage investment in low-income communities. The program aims to generate $15B in new investment in these communities. Most businesses located in low-income communities could qualify for loans or equity lines of credit. Residential rental property does not qualify as an active low-income business.
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Cost Segregation:
Cost segregation is a strategic tax planning tool that allows taxpayers who have constructed, purchased, expanded, or remodeled any type of real estate to accelerate depreciation deductions and defer federal and state income taxes to free up cash for other projects or investments. A tax strategist can help you understand the details of cost migration studies so you get the most from your credit.
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Investment Tax Credit (ITC):
Introduced in 1962, investment tax credits were initially designed to protect American industry from foreign competition. Today, credits are more often used in areas such as pollution control, energy conservation, green technology, and other methods of economic development. Available investment tax credits include the Reforestation Credit, Rehabilitation Tax Credit, Solar Energy Investment Tax Credit, and the Federal Business Energy Investment Credit.
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Production Tax Credit (PTC):
Designed to encourage investment in renewable and sustainable energy sources, the renewable electricity production tax credit (PTC) is a per kilowatt-hour (kWh) federal tax credit for electricity generated by qualified renewable energy resources. The PTC provides a corporate tax credit of 1.3 cents/kWh for electricity generated from landfill gas (LFG), open-loop biomass, municipal solid waste resources, qualified hydroelectric, and marine and hydrokinetic (150 kW or larger). Electricity from wind, closed-loop biomass and geothermal resources receive as much as 2.5 cents/kWh.
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Energy/Renewable Energy Tax Credit:
By building or investing in renewable energy, you as a developer or investor will earn subsidies for your effort. This support of energy conservation, pollution control, or various forms of desirable economic development not only improves the world, it benefits your year-end tax position. Created as part of the Consolidated Appropriations Act of 2021, the renewable energy tax credit offers substantial reductions in your tax burden for fuel cells and small wind turbines. Geothermal heat pumps now feature a gradual step down in the credit value, similar to those for solar energy systems. The credit offers a 30% reduction for systems in place by 12-31-2019, 26% for systems in service after 12-31-2019 but before 1-1-2023, and 22% for systems in service after 12-31-22 but before 1-1-2024. The deadline to claim the credit is December 31, 2023.
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Brownfields Tax Credit:
Some states offer programs that reward developers who engage in projects aimed at reclaiming tainted or contaminated land. The Brownfields tax credit in Massachusetts exists to lessen the financial burden for owners who did not cause the contamination but are obligated to clean up the land. Developers claiming the credit can negate 50% of the eligible costs of a qualified remediation when implementing a permanent solution to a property or investment.
Have Questions? Moskowitz LLP Has the Answers
Navigating the world of real estate investment and tax law can seem treacherous, especially for the uninitiated. Fortunately, the team of accountants, attorneys, and financial advisors at Moskowitz LLP is ready and eager to help. Our experienced tax and accounting professionals can help you get organized, then we’ll look at your complete tax and investment picture. We’ll work with you to develop a tax and investment strategy that focuses on today’s needs and tomorrow’s goals.
Why leave your financial future to chance? Contact Moskowitz LLP today!