6 Real Estate Tax Credits Available to Real Estate Funds

Real estate funds face the dual challenge of maximizing returns while meeting growing demands for socially responsible investments. Tax credits offer a powerful solution, potentially boosting financial performance while supporting important social and environmental goals.

Navigating these real estate tax credits can be complex, requiring careful planning and ongoing compliance. This guide explores key tax credits available to real estate funds, including incentives for affordable housing, historic preservation, community development and energy efficiency.

#1: Low-Income Housing Tax Credit (LIHTC)

The Low-Income Housing Tax Credit (LIHTC) incentivizes the development and rehabilitation of affordable housing. This federal initiative offers two credit rates:

• 9% for new construction
• 4% for acquiring existing buildings

To qualify, properties must be located in designated low-income areas and rented to a specific minimum percentage of low-income tenants. For this requirement, property owners can choose between two options:

• At least 20% of units occupied by tenants with incomes at or below 50% of the area median income (AMI)
• At least 40% of units occupied by tenants with incomes at or below 60% of the AMI.

The program also requires a minimum 15-year compliance period (often extended to 30 years at the state level).

While the LIHTC presents significant opportunities, its complexity typically suits larger organizations. The intricate application process and ongoing compliance requirements demand careful planning and management. That’s why consulting with tax experts experienced in LIHTC, such as those at James Moore, is often advisable.

#2: Historic Rehabilitation Tax Credit

The Historic Rehabilitation Tax Credit is a federal program that encourages the preservation and adaptation of historic buildings. It offers a 20% credit for qualified rehabilitation expenses on certified historic structures. Administered by the National Park Service, the credit applies to buildings in designated historic areas or individually listed as historic structures. It is particularly valuable for funds focusing on revitalizing historic areas or repurposing significant buildings.

To qualify, property owners must undergo a rigorous application process, detailing renovation plans and demonstrating compliance with the Secretary of Interior’s preservation standards. The credit is claimed over a five-year period, with 4% available annually.

Many states offer additional credits, potentially increasing the overall benefit. Due to the meticulous application process and specific preservation standards, seeking guidance from experienced advisors like James Moore can be beneficial.

#3: New Markets Tax Credit (NMTC)

Established in 2000, the NMTC program aims to stimulate economic growth in underserved communities. It provides a 39% tax credit over seven years, structured as follows:

• 5% in each of the first three years
• 6% in each of the remaining four years

The program involves community development entities (CDEs) as intermediaries between investors and projects. Eligible areas typically have a poverty rate of at least 20% or median income not exceeding 80% of the area median.

This credit can be particularly beneficial for funds investing in commercial or mixed-use developments in economically distressed areas.

As of 2024, the program has been extended through 2025. However, ongoing legislative efforts are underway to enhance the NMTC. The New Markets Tax Credit Extension Act of 2023 (S.234), introduced in the Senate, proposes to:

• Make the NMTC program permanent
• Introduce an inflation adjustment to the credit limitation amount after 2023
• Allow an offset against the alternative minimum tax for credits from qualified equity investments made after 2022

While this bill has not yet become law, its progression through the legislative process could significantly impact the future of the NMTC program and its attractiveness to investors.

#4: Investment Tax Credit (ITC)

The ITC encourages the installation of renewable energy systems in buildings. This credit typically offers 30% of installation costs for solar, geothermal and other qualifying systems, received in the year of installation, with potential carry-forward if the amount exceeds tax liability.

To qualify, the fund must install new renewable energy systems. Purchasing a building with existing systems doesn’t meet the criteria. This credit could align well with funds focusing on sustainable or green building practices.

The Inflation Reduction Act of 2022 extended and expanded the ITC, ensuring its availability for the foreseeable future. Notably, the act also introduced the ability to transfer credits to other taxpayers, potentially offering real estate funds more flexibility in structuring their investments and partnerships.

#5: Production Tax Credit (PTC)

The PTC benefits real estate funds that incorporate large-scale renewable energy projects into their developments. It offers a per-kilowatt-hour tax credit based on the amount of electricity produced through renewable sources.

These benefits are available for the first 10 years of a facility’s operation and are adjusted annually for inflation. The PTC can also complement other energy-related incentives, especially for properties with substantial wind or solar installations.

The Inflation Reduction Act of 2022 has extended and modified the PTC. For example, solar projects can now claim the PTC as an alternative to the Investment Tax Credit (ITC), offering more flexibility for investors.

Funds considering large-scale renewable energy components, such as installing solar panel farms on the roofs of buildings, should evaluate the potential benefits of the PTC alongside other available incentives. Early planning is crucial to maximize the credit’s value within the fund’s overall investment strategy.

#6: Section 179D – Energy Efficient Commercial Building Deduction

While not a credit, the Energy Efficient Commercial Building Deduction can support energy-efficient improvements. It allows building owners to deduct costs of energy-efficient systems (up to $5 per square foot for highest-efficiency improvements). It can be claimed every three years for consistent upgrades and applies to both new construction and renovations.

The Inflation Reduction Act of 2022 expanded eligibility to include tax-exempt entities and updated efficiency standards. Given the frequent changes to Section 179D rules, vigilant monitoring is necessary to ensure compliance and maximize benefits. Consulting with tax experts who stay current with these updates can be crucial for capitalizing on this deduction.

Strategic Considerations for Utilizing Real Estate Tax Credits

Early planning is crucial when incorporating tax credits into real estate fund strategies. By considering these real estate tax credits at the outset of project development, fund managers can align their investments with credit requirements, maximize potential benefits, and navigate complex application processes effectively.

This approach allows funds to evaluate the long-term implications of these credits, including extended compliance periods and reporting obligations. It also provides time to assess how these credits might impact the fund’s overall investment strategy and plan for key challenges, including:

• Complexity: Many credits involve intricate rules and application processes, often requiring specialized expertise and a careful approach to real estate fund accounting.
• Long-term commitments: Credits like the LIHTC typically require compliance periods of 15-30 years, demanding careful consideration of the fund’s long-term strategy.
• Financial impacts: While credits can enhance returns through potential stacking, they may also introduce costs related to compliance and project modifications. A thorough cost-benefit analysis is essential to determine if the tax savings justify the required changes to the fund’s plan.

By addressing these considerations early in the planning process, real estate funds can strategically leverage tax credits to enhance returns, attract environmental, social and governance (ESG)-focused investors, and contribute to broader societal goals while effectively managing the associated challenges.

Engaging with experienced advisors, such as those at James Moore, can provide valuable guidance in navigating this complex landscape and maximizing the benefits of these powerful financial tools.

James Moore: Real Estate Tax Experts

Real estate tax credits offer significant opportunities for funds to enhance financial performance while supporting social and environmental goals. These credits can increase a fund’s attractiveness to investors, especially given the growing emphasis on ESG considerations. However, they come with challenges due to their complexity and ongoing compliance requirements.

To target these tax credits effectively, consult with the experienced real estate tax advisors at James Moore. Your advisor can help navigate these programs, maximizing benefits while minimizing risks. Contact us today to learn more.

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