 Hello. Welcome to Historic Tax Credits, How to Develop a Financial Plan for Real Estate Development. My name is Lorraine Minatoishi. We are speaking from Honolulu, Hawaii. This is Dr. Alan Downer. He is the Deputy Shippo for Hawaii. And I am an architect, also historic architect here. And we'd like to present to you this webinar. Here are some learning objectives, how to apply for Historic Tax Credit, learning about condition assessment for historic structures, and some financial criteria for long range planning. So this is going to be an hour presentation. Dr. Downer is going to be speaking first and I will be speaking second. Cool. So I want to talk a little bit about the Historic Tax Credit. Just to give you some sort of an overview of it, the Tax Credit Program was established in 1977 by Congress. I think the first regulations came out in 1978. The regulations, the guidelines have been fairly consistent, but they do evolve over time. So it is important while we are talking about the most current standards today. When you get to the point of considering a project of your own, you need to make sure that you are working off the most recent stuff. So let me consult with your State of Start Preservation Office. They are a resource of assistance on this. I will also offer up our disclaimer here. A lot of this is that we are going to talk a little bit about the tax card. We are going to talk specifically some things that are really, we are not going to talk specifically, I should say that. We are not going to talk about accounting issues in detail. We are not going to talk about tax issues in detail. Frankly, when you get to that point, you are developing a project. You need to go talk to your tax accountant. You need to talk to your accountant generally because a lot of these things, while you can read the standards, you can read the IRS rules, but unless you happen to be an accountant, you don't want to be on your own doing this. So I guess the last comment here is that the tax credit is 20% of the qualifying rehabilitation expenditures. That is a very large tax credit. I will say that although Congress and the IRS generally hate tax credits, this has survived several rewrites of the tax code that eliminated many, many tax credits. This one endures. This gives you some idea. I think of the purpose of this obviously was to preserve the character of historic downtowns, to reuse, adaptively reuse important historic buildings that had fallen out of into disuse or which had no longer served their initial purpose. Most of the benefits of tax credits are local. They go into jobs and purchases in the local community. And then honestly, as most people realize, doing work by historic buildings tends to be more labor-intensive than working on more modern buildings. But the end result is the reuse of historic assets. And the truth of the matter is, the greenest building is the building that already exists. When people look at these calculations, we build this brand new building with all of the energy savings and what not. 50 years ago, from now, we have recouped all of the energy costs in the construction. Well, in the historic building, all those energy costs have already been recouped. I don't know if I want to say a great deal here. The whole purpose of this is to reuse historic buildings, to preserve the distinctive character of historic communities. It is jointly administered by the National Park Service and the Internal Revenue Service, our pals at the IRS. It is done in partnership with the State Historic Preservation Officers. The SHPO is an important resource, but it is important to remember that at the end of the day, it's the National Park Service and the IRS that's the decision-maker. So, the federal tax credit, historic rehabilitation tax credit, is available only to buildings that are to commercial buildings. So, you know, people have to be, you know, they have to be able to earn some income or it has to house a business or something of that nature. Qualified, we'll talk a little bit more in detail about this, but what's covered, you know, it's not all of the expenses involved in taking a historic building, you know, bringing it back to the point where it can be used for contemporary processes, but it is, you know, so not all of the expenses involved in that are allowed and cost for the purposes of the tax credit. They're all business costs, they are all being dealt with as business expenses on the project itself, but they may or you know, they have to meet certain standards to qualify as recoverable costs for the tax credit. So, it has to be a commercial building of some sort and, you know, whatever the expenses involved have to be, you know, recovered or depreciated through straight straight line depreciation. One of the things that I think it should be clear to everybody is that, you know, all, you know, you're dealing with tax credit issues, you're dealing with the financial aspects of rehabilitation, but, you know, you're doing, you're talking about design, you're talking about a historic preservation. All of those things have to work together. On the financial side, one of the things that the tax credit can do is it can take, you know, if you think of a development project as one in which there's a risk and a reward, and, you know, just in this slide here illustrates sort of purely as an abstraction, the top line there, you know, that the risk above that is, you know, suggest the project in that area is probably too risky for the level of reward. What the tax credit can do is shift the project that may be above the line, you know, just sort of this ordinary reward to go in the area. We're going to renovate this building and, you know, put it back into service. Well, it may not be cost effective or it may be too risky, whereas when you factor in the tax credit, it can push that either closer to the line or below the line so that, you know, it makes more financial sense to go ahead and do that. So, there are federal credits, obviously applicable to federal income tax. There are also 27 states, I believe, that have state credits. I'm not going to talk about that simply because when we did our tax credit bill here in Hawaii, I looked at most of the other states and there's just no way to generalize about the state credits. They are all different. Hawaii, for example, you know, it covers both commercial and non-commercial structures so private residents could qualify. It's a 30% tax credit. We do use exactly the same forms and the same standards of the park service applies, but, you know, the tax structure and the financial structure is different. So, applying for the tax credit, the first step is you have to, you know, the park service is a form you can see here on the screen, which is part one, which is to certify that the project is, you know, building that is historic. And that can be, you know, sort of the simple, simple way is it is already listed in the National Register of Historic Places or it is a contributing building in a historic district. Now, buildings that are not in those two categories can still be, you know, can still earn the tax credit. However, there's, you know, the process is slightly different and that's where part one, the part one comes in, you take a building and you basically put together a narrative that says this is why this building is historic and here are the features that characterize it as a historic building. And then you can then proceed as we talk about the process a little bit further on, into the process, but understand that the building has to be listed by the time the project goes back into service. And so that means that, you know, until the keeper of the National Register actually says, yes, this is on the Register, the developer is at risk. And just because the park service and the SH will agree at this initial stage that they believe a building is eligible, that's not sufficient to guarantee, you know, that's no guarantee that you will get the tax credit at the end. So there is a little bit more risk involved. There's also more work because somebody is going to have to do the National Register nomination and run it to the process. So part two of the application is essentially a description of what the rehabilitation work will consist of. And, you know, and there needs to be in their consideration of how are we going to apply the secretary's standards for rehabilitation projects. And to this particular project, what are we actually going to do? And, you know, what are the qualifying elements of the project? And then that has to be reviewed by the SHPO. We look at it, apply the standards and say, yeah, we think it looks good. We think this meets the requirements. If not, the SHPO is going to sit down with the applicant and, you know, talk about, well, could you do this instead of what you're proposing? Because this is, you know, what you're proposing really is, you know, it's problematic and we'd like you to see an alternative considered here that is, you know, fits better with the secretary's standards. That then gets sent to the National Park Service. They look at it and, you know, go through the same process of saying, yes, this project as designed, as described here, you know, meets the standards. And, you know, we think this is a qualifying project. A couple points here. There's more work to come and we'll talk about that. But one of the things the Park Service talks about in their rules is that, you know, they view each project as a unique project. And you cannot rely on knowing that a very similar project that a very similar building received approval by the Park Service. You can't rely on that as precedent. They will not, they will not, you know, you're looking at a building that's right next to a building you just finished. You're going to do the same things. You should not go into the park service. You're assuming that the Park Service is going to sign off on the way they did before. Let's see. So, you know, the Park Service, the secretary here, has standards. Those standards, you know, you can find them online, sort of in some reform on the National Park Service website. They are also in regulation. And that's, you know, that's the definitive source for information. Although I think the Park Service's website summarizes, I think, almost the data. You know, if you are doing a project, you really need to go to the regulations because the regulations are wrong. And then, you know, that's 36 CFRs, let's codify the regulations, Part 67. So, you know, the Parks, the Secretary's standards, you know, understand that while the standards read as if they're definitive, there is flexibility in how these get acquired. So, the first standard is the building ideally is going to be put into a use that has minimal changes to the character of defining features of the building, to its site and to its environment. So, that's particularly important if you're doing a building, for example, Historic District. The historic character is, say, the character defining features of the building are supposed to be retained. Removal of historic materials or alteration of those character defining features is to be avoided as far as possible. Each property is to be recognized as a physical record of its time and points and changes that create a false sense of historical identity are not allowable. So, you can't take a project, a building, and it's like, well, you know, it'd be really pretty if it was, you know, if it looked more like this, because that's the historic character I really wanted. That's not accepted. The standards recognize that the buildings change over time and in some cases, the alterations to a building have in and of themselves acquired historical character and to the extent that that's true, those need to be preserved. The state of features of the buildings, types of, you know, finishes, types of construction examples of particular craft specializations, those need to be preserved. The interior feature deteriorated features are to be repaired rather replaced where the deterioration is so bad that they can't be. There's a very strong preference that they need replaced with features that match the original design, the color, texture and other qualities of it and wherever it's possible. Excuse me. To do so, using the same, the same materials. Cleaning of historic features, you know, using physical treatments or chemical treatments are to be avoided. You don't sand the last brick, for example. And interior alterations are new construction should be done in a manner that doesn't affect, doesn't destroy the historic materials at all, you know, as far as possible. And the work new work needs to be differentiated from old needs to be compatible in size, mass and so on. And, you know, part of the part of the deal has to be that if those features are removed, at some point in the future, that it will not affect the historical integrity. Excuse me. Okay. So then the final step in the process is you have done your project. Now you have to report to the SHPO, the park service, that, you know, here's what we did. Here's, you know, in essence, we said we're going to do a certain thing, we're going to do it a certain way. Here's our documentation to prove we did it. And then, you know, let's get reviewed at the SHPO and look at it and say, yep, they did what they said they were going to do. We liked it before, we like it now. Park Service will look at it the same way. And then they will certify that the work that was done meets the standards and, you know, the qualifying expenditures can be used to claim the tax credit. Do you want to add anything to that? No, thank you. Okay. So talk a little bit about, this is just a reminder. The Secretary of Interior's administration standards are to be founded 36 CFR Park 67. As I said, those aren't those are rules, they are federal regulations, they are the law when it comes to what standards historic property, historic rehabilitation projects need to, excuse me, need to be met. So they are, you know, let's look a little bit again, I'll repeat the disclaimer, we're not accountants, we're not tax experts. When you get to the point of actually thinking seriously about a project like this, you need to make sure that you are involved in tax experts. I think on this one we were, we went through the IRS questions. And even though they are answered, we thought it would be best to share in layman's terms, what these explanations really mean. So I think first of all, just along those lines, just as a pointer here, if you search on the web for, you know, IRS rehabilitation tax credit, or historic tax credit, it'll take you to an IRS frequently asked questions page. That will give you some idea, you know, particularly if you're an accountant, some of it, some of it's a little bit hard to understand if you're not an accountant. But to begin with, so, you know, just to summarize some of this stuff for you. Rebuildation credit can be, you know, is to be claimed in the year, you know, initially, for the first year that the building was going to serve. Qualified rehabilitation, the rehabilitated building is, you know, a building that goes back to the part one, it's either a listed building, it's a contributing building in a historic district, or, you know, it was not necessarily listed, but did get listed before the building went into service. The taxable year, you know, usually the, you're able to claim the rehabilitation tax credit after the building goes into service. So if you complete a project in 2022, you know, you would, in 2023, when you file your taxes, get your accountant, probably, for these projects, to file your taxes for you, you know, that defile, you know, for the 2022, that's the year that the first year you could claim the credit. But understand that all of the paperwork's got to be done before you, you know, you've got to have the approval from the Park Service on the Park 3. Okay, so it's a 20% credit, and it has to do with, you know, what's eligible for the qualified rehabilitation expenditures. So you can't take the 20% as a lump sum, it has to be claimed over a five-year period. So it's 4% per year. To qualify as a qualified rehabilitation expenditure, so the building has to be substantially rehabilitated. So if you have a historic building, and all you have to do is paint it to make it look serviceable, but it's not going to be substantial. The building is substantially rehabilitated when you've done some, you know, significant amount of work on it. As far as I can tell, there are no standards. You know, the state of Hawaii has a written standard for what is the minimum amount of work that has to be done, and that's against the total value of the building itself, but you don't find that in the federal guidelines. So the building has to be a certified historic structure. So I have said that's a national registered building, or a building in a national registered district that is a continuing structure. The depreciation has to be based on a straight line depreciation, and it must be a capital expense. Now, this is one of those things. This is really an accountant, and a tax accountant question. You know, businesses sometimes define certain expenses as capital expenses, because they're very large. They may not be capital expenses for the purposes of this tax credit and the IRS code. That's really something you need to work with your accountant on. You know, we're simply not qualified to comment on that. Okay, this is, you know, a building, I don't know, the IRS needs to define this in detail, so you can get some information on that here. The rehabilitation period can take as long as it takes. You know, there's, you know, if you have a very large project, it can take a very long time to complete. Sometimes you have, you know, gaps in funding that, you know, those are just, those are the realities, and that's recognized as part of this. Understanding that according to the Park Service, roughly half of the projects that, that, you know, have gotten the tax credit are under a million dollars. So, you know, well, I think in our mind, a lot of us, certainly I do, think of these as tending to be very large projects, but in fact, they are not, not necessarily. I have a question. Yeah. Say you start a project, you identify all the work that you want to do, and then you decide to scale back that project. So, you've done maybe three out of the 10 points that you wanted to complete. Can you at that point change part two, redact some of it and basically complete the project as such? So, if you're, if you make changes, if you make substantial changes to what the, to the nature of the project, you need to go back and amend your part two, and then, you know, it'll be subject to the review and approval of the State Historic Preservation Office and the Park Service. So, you know, in theory, I would say there's no reason to say that that can't be done. I think it's going to be partly a matter of scale. So, to get to the, you know, the question of the substantial, whether it still is a substantial rehabilitation. So, generally, you know, the buyer can't, you know, so kind of buyer claim the credit for a rehabilitation expenditure incurred by the seller. You know, the answer is yes. But that's, that is their conditions here, obviously. The portion of the building has to be, that is acquired, you know, has to be acquired, has to go into service after the acquisition. So, in other words, the rehabilitation project could be ongoing, but it's not necessarily, you know, it's hadn't received certificate of occupancy until after the sale closes. Okay. So, the credit cannot be claimed by the buyer if they haven't been, you know, if someone else has claimed it. So, if the developer has claimed the credit, the buyer can't do this, can't also do it. No doubt about that. And those can only claim expenses that are incurred after the acquisition. Oh, I have a question. So, you're saying that a seller has done a substantial amount of work on the building they want to sell. And that's very typical because you do want to make sure the building looks nice before you sell a lot of times. And so, let's say you've done the restuckoing, you've done repainting, you've done all the kinds of interior work, you've rehabbed the paint, decorative paint, things like that, you put the building on the market. That buyer now can get all of the receipts from the contractor that you've paid to the contractor and then use that amount for a tax credit, but they still have to go through part one, part two, and part three. How does that work? Well, I think some of that is. So, certainly, you know, if the developer has not done part one, two, and part one and two, then somebody's going to have to hurry up and do that. You know, I also think that, I mean, I think part of this is the question for your tax account. I also think that that's going to, that how you, how the buyer incorporates that into the actual purchase agreement is going to be critical to their ability to make claim there. So, somehow or the other, they're going to have to be able to claim that they, they, in effect, pay for those costs. And that's going to have to be, I think, in the purchase agreement. I see. So, you know, I just added, there is throughout the IRS, we've talked a little bit about it here, but in the frequently asked questions and in the regulations itself, it talks about qualified rehabilitation expenditures. And it's a qualified rehabilitation expenditure. If it's something that's in the part two that's been approved and that has, you know, has been documented to have been done in part three. So, you know, you don't have to go, there are certain kinds of things that you cannot claim. You can't claim, for example, the acquisition cost of the building. You can only claim things, you can only claim them on capital expenditures, I said that already. You have to be using the, the straight line deduction method. And, you know, I think that's the basic thing is, if it's a building that, you know, has some tax exemptions, you can't apply the credit to the portion of the building. So, you have to parcel out the portion that's used for tax, you know, tax exempt purposes, would not be such a thing. It's going to have to be that. I think that's it. We thought it would be a good exercise to review an example of a building that would go through this tax credit process. This is the Hawaiian Electric Company building in Honolulu. It is a four-story building, and it's constructed of reinforced concrete and steel framing. The roof form is a composite of HIP, gable, and flat-width parapet. The hip gable roof sections are surfaced with straight line barrel mission tile. There's a richness of decorated plaster, sculptor, and hand-painted ceilings, and fine detail of the Chirikura stonework. There's a combination of wrought iron and brass fitting grillwork and gates used throughout the building, which lend a character of refinement to the structure of the building that is not typically seen in commercial architecture. It's a rare and intelligently articulated example of Spanish colonial architecture. It is, like I said, it's listed as a contributing building in the capital historic district in Honolulu, Hawaii. This is the historic district outline, which you can see a little better here in the Google map view. So it's basically this area, this green area here, and the Hiko building is located right here. This is the Hiko building. This is the state capital. This is a historic post office, and this is the Ilani Palace right here. And here's another view of it. The state capital is here. The Hiko building is here. The Ilani Palace, it's right in front here. And this is the ocean front, very nearby, as you can see, three blocks away. And just to give you an idea, here are some photos from the historic nomination of the capital district buildings. This is the state capital. I guess it's the only capital in our nation that is not of the Greek or Roman style architecture. It's a modern, very modern building. This is the this is the YMCA building. Here's the Ilani Palace, which is the only palace in the nation. It's located kitty corner to the Hawaiian Electric building, which is I think the reason that why the Hawaiian Electric building is located here is because it was the first electrified building in America, the Ilani Palace, so they needed power. This is the Kinkameha statue. And here is the Hawaiian Electric building, Hiko building located nearby in the capital district. There are many upgrades required of this building. And we will go through these required required upgrades. First, there's an exterior stucco repair that's required. As you can see in the pictures, there's degradation of the stucco over time. There's beautiful painted ceilings, both exterior and interior, yet these are these need to be redone completely because they've just been degradated over time. There's terracotta work that is also needs to be refurbished. So there's quite a bit of exterior work that needs to happen. There are window repairs. These windows are steel windows. And as you can see, there's quite a bit of rot and rust in these windows. The paint is also peeling. So there's quite a bit of hazardous waste material that needs to be abated properly. And there's interior repairs such as the lobby area. You can see that the original tiles are in very poor condition. Those would need to be replaced. And just this is a stairway that's leading up. It's just very, it hasn't been renovated in the last 100 years, I guess, close to 100 years. So all of these need to be renovated or rehabilitated. This is the basement view. And there's a lift here. And that is no longer there. That needs to be included in the rehabilitation, a new lift, repainting, cleaning of the walls, abatement of all these hazardous materials, just general cleaning of the basement area. A lot of items are still here left in the basement. You can see the fluorescent lights are just exposed. There's some water damage along the basement walls. This is the interior office areas. We have carpet that needs to be removed, ceiling tiles, most of which also are hazardous materials. General look of the interiors have to be refurbished. There's a drop ceiling that needs to be removed. The elevator that you can see here beyond also needs to be rehabilitated. Again, the lift needs to be redone. And here are the bathrooms. You see the lead paint all have to be removed, abated properly. And the utilities of electric and plumbing also have to be redone. Fire sprinklers need to be installed. And wastewater as well as stormwater needs to be analyzed. So looking at, I'm sorry, this is very hard to see, I know. But what we've done is calculated on our Excel spreadsheet, all of the hard costs up here and soft costs. So hard costs include the actual capital expenditures for rehabilitation. This includes the sanitary sewer system, first water distribution, $375,000. We have sanitary, sewer, lead paint disposal, photovoltaic panels that we'd like to integrate into the roof. HVAC upgrades, which is heating ventilation, air conditioning, those needs to be upgraded. Electrical upgrades needs to happen. We have the lobby repairs and bathroom repairs, window replacement, exterior stucco repair, new lift to basement, and elevator motor replacement. Also there's interior decorative painting that needs to happen. Offsite work includes water distribution, storm drains, sanitary sewer replacement. So there's a total site work and onsite as well as offsite site work costs of $8,800,000. There's some demo costs. Then there's interior new construction. We're planning to create living units on the upper floor. That is estimated to be $100 a square foot for $1.1 million. The footprint of the building is about 10,000 square feet. And so each level is about 10,000 square feet. So we have the second and third levels that we would convert to office. And a first floor, which would be retail, that would also be at $100 a square foot. So we're looking at interior modifications of about $3 million for a total hard cost of $11 million. Now we would list these in parts, in part two. And we believe, I guess it still has to be checked, but I would say all of these costs would be qualifying expenditures. Would you agree with that? I think almost all of them certainly would be. Obviously part of that determination is how the work will actually be conducted. But I think certainly all of those costs sound like that the only, this may be something that has to be worked out with the part service and with the IRS is that they generally found on doing anything that's outside the envelope of the building. So if you're having to replace the silver lines exterior of the building, there may be a problem there. I don't really know the answer to that. Okay. Okay. Thank you. Now as far as soft costs, there's permits, permitting fees, architecture, and engineering fees, and then financing fees. Now my understanding is that architecture and engineering fees can be included in the costs. You can also include interest payments, not acquisition, but if you have, if you're getting a loan to do this work, the interest costs on that are also a lot. Wow. Okay. That's good to know because we have on 6.5 percent, we have a 6.5 percent construction insurance, and then we have 8 percent of construction interest. So that is about a million dollars total of financing costs, including a construction loan origination fee of 1 percent of the borrowed amount, which is just over $100,000. And there are bonds, financing, can bonding also be included in the costs? Issuing, somebody, somebody wish it, somebody issuing a bond for, what do you mean there? Contracting, but contractors won't know. I don't know about that. Okay. We also have attorneys fees for the CCNRs and contract review, shifty review fees, and other consultant project manager third party review fees for the bank. Are all of those qualifying expenses? I think some of them are. I'm not sure that they are. Okay. Great. So we have a total soft project cost of 2.6 million dollars, a lot of which would actually be attributed to qualifying costs and a total development project of $14 million. We have hard costs of 11 million as well as soft costs of about 3 million. So a total of 14 million. Okay. I think we're done with our presentation. Thanks for bearing with us through this. Okay. Great. So yeah, thank you so much.