The vaunted Virginia historic tax credit program is under attack by the IRS.  A tax court ruling favoring the Commonwealth’s position on the program was appealed by the Internal Revenue Service and reversed upon a hearing by the U.S. Court of Appeals for the Fourth Circuit. 

The issue is whether the partners in such a tax credit swap are exchanging property.  The IRS believes it is property and can be taxed as income.  The Commonwealth and the businesses, organizations, and institutions on the other side say it is a non-taxable exchange.

“Clearly, if this sticks, it will kill redevelopment in Virginia and put a lot of people in financial trouble,” Robert S. Mills AIA, CID, said in a telephone conversation.  Mills is a principal with Commonwealth Architects in Richmond.  “State and federal tax credits are the best catalyst we’ve had to encourage developers to come back to the cities and redevelop empty properties.  This would stop such development in its tracks and we’ll start to see developers running back to the suburbs.”

In making its March ruling, the Fourth Circuit panel of three judges overturned the decision of the U.S. Tax Court, which decided in December that capital contributions to Virginia historic rehabilitation tax credit partnerships were not equivalent to the sale of property.  The Fourth Circuit’s ruling, in effect, makes these transactions taxable.

The principals in the suit are appealing for a hearing by the full Fourth Circuit.  The American Institute of Architects and others have been asked to join an amicus brief being crafted by the National Trust for Historic Preservation.

“This will force a firm like mine that has focused almost entirely on existing structures to change our model,” Mills said.  “It’s a niche that is timely, that makes full sense considering the economy.  I am fearful that this will really change the dynamic growth that we’ve seen in all of the cities in Virginia.”

“The reason we have tax credits is that renovating old buildings is expensive,” Kathleen Kilpatrick said.  Kilpatrick is the director of the Virginia Department of Historic Resources, which determines which projects receive state tax credits.  “There is a gap between the cost and the economic value.  If you suck that out, you will be putting projects under water.  Without these incentives, many projects won’t pencil out.”

She explained that not only would many current projects be economically unfeasible without the tax credits, but should the IRS wish, it can go back six years to impose income taxes upon every renovation project that received such tax credits.    

At stake, she indicated, is the amount of income tax that would be imposed on the tax credit incentive.  For example, if a $10 million project received a 25 percent tax credit, that $2.5 million would be taxable.  At the 35 percent rate, such a tax would cost the partnership — and this example project — $875,000.

According to DHR figures, Virginia’s tax credit incentive program — modeled closely on the federal program — began in 1997 and has benefited 1,971 projects that have generated more than $2.7 billion in renovation investments.  The tax credits for these projects come to more than $677 million. In effect, each state tax dollar generated $4 in private investment. 

Some recent projects covered in these numbers include:

  • Carpenter Center/Center Stage in Richmond
  • Lucky Strike Power Plant in Richmond (home to A/E firm Odell Associates Inc.)
  • Lorton Workhouse in Fairfax County (home to Lorton Arts Foundation)
  • John Handley High School and George Washington Hotel in Winchester
  • Stonewall Jackson Hotel and Robert E. Lee High School in Staunton
  • City Produce Exchange in Harrisonburg
  • Chamberlin Hotel in Hampton

According to a study prepared for DHR in 2006 and updated in 2010, 58 percent of the survey respondents said they would not have rehabilitated their property without state tax credit assistance.  Another 15 percent said they were unsure whether they would have proceeded with the projects without the credits. 

The study went on to calculate the direct impact of the credits and arrived at these figures:

  • Rehabilitation projects during the 13-year period directly supported 5,804 jobs within Virginia
  • Economic activity associated with these jobs supported another 7,083 jobs indirectly
  • Taxes generated by this work — from sales and use taxes, income or corporate taxes, and other taxes — from 1997 to 2009 amounted to $55 million.

The study did not project the additional investment and rise in tax revenues resulting from the catalytic effect of the renovated properties.  Cities and towns experience a renaissance of investment in downtown areas when a critical mass of renovated properties has been reached. 

The study was conducted by Virginia Commonwealth University’s Center for Urban Development within the schools Center for Public Policy.