BILL ANALYSIS Ó
AB 1999
Page A
Date of Hearing: May 5, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1999 (Atkins) - As Amended: April 30, 2014
Majority vote. Tax levy.
SUBJECT : Personal income and corporation tax credits:
rehabilitation.
SUMMARY : Allows a temporary income tax credit for qualified
costs paid or incurred by a taxpayer in rehabilitation of a
certified historic structure, as defined, in modified conformity
with the federal income tax laws. Specifically, this bill :
1)Declares legislative intent to preserve and restore
California's historic buildings, which are an important asset
to communities throughout the state, and to create tools to
incentivize economic development and revitalize economically
distressed areas.
2)Allows an income tax credit, under both the Personal Income
Tax (PIT) and the Corporation Tax (CT) laws, in an amount
equal to 25% of the qualified rehabilitation expenditures with
respect to a certified historic structure, as defined.
3)Increases the applicable percentage to 30% in the case of a
certified historic structure that meets one of the following
criteria:
a) The structure is located on federal, state, or local
surplus property;
b) The rehabilitated structure includes affordable housing
for lower-income households, as defined by Section 50079.5
of the Health and Safety Code;
c) The structure is located in a designated census tract,
as defined in Section 17053.73(b)(7) of the Revenue and
Taxation Code (R&TC);
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d) The structure is a part of a military base reuse
authority established pursuant to Title 7.86 (commencing
with Section 67800) of the Government Code (GC); or,
e) The structure is a transit-oriented development that is
a higher-density, mixed-use development within a walking
distance of one-half mile of a transit station.
4)Allows the credit for taxable years beginning on or after
January 1, 2015, and before January 1, 2021.
5)Defines a "certified historic structure" as a structure that
is located in California and appears on either the national
Register of Historic Places or the California Register of
Historical Resources.
6)Authorizes the taxpayer to carry forward the tax credit to the
following tax year, and succeeding seven years, if necessary,
until the credit is exhausted.
7)Disallows any deduction for the amount of paid or incurred by
the taxpayer for which a credit is allowed to the taxpayer.
8)Requires the Governor's Office of Business and Economic
Development (GO-Biz) to do all of the following:
a) On and after January 1, 2015, and before January 1,
2021, to allocate tax credits to applicants.
b) Establish a procedure for applicants to file with the
GO-Biz a written application, on a form jointly prescribed
by GO-Biz and the Office of Historic Preservation for the
allocation of the tax credit.
c) Establish criteria for allocating tax credits,
consistent with the requirements of the tax credit program.
Criteria shall include, but not be limited to, all of the
following:
i) The number of jobs created by the rehabilitation
project, both during and after the rehabilitation of the
structure;
ii) The expected increase in state and local tax
revenues derived from the rehabilitation project,
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including those from increased wages and property taxes;
and,
iii) Any additional incentives or contributions included
in the rehabilitation project from federal, state, or
local governments.
d) Determine and designate, in consultation with the Office
of Historic Preservation, applicants that meet the
specified requirements to ensure that the rehabilitation
project upholds historical values in terms of architectural
and aesthetic standards.
e) Process and approve, or reject, all applications.
f) Allocate an aggregate amount of the tax credits, and any
carryover of unallocated credits from prior years, subject
to the annual cap of $100 million.
g) Certify tax credits allocated to taxpayers.
9)Limits the total aggregated amount of the tax credit that may
be allocated in any calendar year to $100 million, plus the
unused allocation tax credit amount, if any, for the preceding
calendar year.
10)Provides that the credit shall be allocated to the partners
of a partnership owning the historic rehabilitation project in
accordance with the partnership agreement, regardless of how
the federal historic rehabilitation tax credit, with respect
to the project, is allocated to the partners, or whether the
allocation of the credit under the terms of the agreement has
substantial economic effect, within the meaning of Section
704(b) of the Internal Revenue Code (IRC).
11)Requires the Legislative Analyst Office, beginning January 1,
2016, to collaborate with GO-Biz to review the effectiveness
of the historic building tax credit program.
12)Provides that the review shall include an analysis of the
demand for the tax credit, the types and uses of projects
receiving the tax credit, the jobs created by the use of the
tax credit, and the economic impact of the tax credit.
EXISTING FEDERAL LAW :
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1)Allows a two-tiered tax credit for the rehabilitation expenses
of older or historic buildings. Specifically, it provides:
a) A 10% credit for the rehabilitation expenses of
non-historic buildings with an additional requirement that
the building must have been originally constructed before
1936; and,
b) A 20% credit for the rehabilitation expenses of a
certified historic structure, i.e. a structure that is
listed on the national Register of Historic Places or
located in a Registered Historic District and determined to
be of significance to the Historical District.
2)Allows a taxpayer engaged in a trade or business to deduct all
expenses that are considered ordinary and necessary in
conducting that trade or business.
EXISTING STATE LAW does not conform to the federal tax credit
for rehabilitation expenses of older or historic buildings, but
does allow taxpayers, in conformity with the federal law, to
deduct ordinary and necessary business expenses.
FISCAL EFFEC T : Unknown.
COMMENTS :
1)The Author's Statement : The author has provided the following
statement in support of this bill:
"California is one of the few states to not provide an incentive
for the preservation of our historic buildings. A state tax
credit for this purpose would help stimulate local economies,
revitalize downtown areas and communities, promote and
increase the supply of affordable housing, support smart
growth through infill development, encourage property
maintenance and rehabilitation, and leverage use of the
federal rehabilitation tax credit.'
'Additionally, it would increase construction and building
industry job creation, increase state tax revenues through
increased employment and wages, increase local property tax
revenues through increased property values, and increase local
tax revenues through sales tax and heritage tourism.'
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'AB 1999 helps communities adjust to the phase-out of
redevelopment dollars and stimulates public and private
investment, all while building civic pride as we celebrate our
heritage and preserve California's past."
2)Arguments in support . The proponents state that "AB 1999
would encourage economic development of properties on or
eligible for the State or Federal Register of Historic Places
through investment tax credits." Based on the experience of
other states, the proponents argue that a state historic tax
credit program, used in conjunction with the federal HTC,
would stimulate more "private investment in older
neighborhoods, thereby creating jobs, promoting sustainable
development through reuse of existing buildings and preserving
the historic fabric of communities." The proponents state that
this bill is carefully structured. It is modeled on the
successful state historic preservation tax credit programs
throughout the United States. This bill contains a very
important feature, which is a pre-screening process by the
Governor's Office of Business and Economic Development to
ensure that "development projects supported by the historic
preservation tax credit will result in a payback to the State
of California through increased tax collections and good
jobs." Finally, the proponents assert that, while the federal
HTC "has been successful in incentivizing the rehabilitation
of larger projects in California, such as the Ferry building
in San Francisco, the absence of a state tax credit in
California has resulted in a number of smaller historic
properties left abandoned or underutilized."
3)Federal Historic Tax Credit (the "HTC") . The Federal Historic
Preservation Tax Incentives Program, created in 1976, is
administered by the National Park Service in partnership with
the State Historic Preservation Office. The goal of the
program is to promote community revitalization and encourage
private investment through historic building rehabilitation.
Over 39,600 projects to rehabilitate historic buildings have
been undertaken since the first project using the historic tax
incentives was completed in 1977.<1> The HTC is claimed not
only by large projects. As reported by the National Park
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<1> Federal Tax Incentives for Rehabilitating Historic
Buildings, U.S. Department of the Interior, National Park
Service Technical Preservation Services, Washington, DC, March
2014.
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Service, in fiscal year 2013, almost 8% of the certified
projects were under $100,000, 46% were under $500,000, and the
majority of all projects - 59% - involved less than $1 million
in costs. (Id., p. 11.)
Housing has been the single most important use for rehabilitated
historic buildings under the program. Over the past five
years, between 36% and 69% of the projects have included
housing. Almost one-half of the projects certified in 2013,
or 46%, reported housing as a final primary use, including
multiple-family housing. As a result of this program, more
than 130,000 of low- and moderate-income housing units have
been created. According to the report issued by the National
Park Service, one of the objectives of the program is to
create and retain affordable housing. (Id., p. 12.) Other
incentives utilized by developers, in addition to the HTC,
include the New Market Tax Credit Program, Tax Increment
Financing, and local property tax abatements.
To qualify for the historic tax credit, a project must satisfy
the requirements of IRC Section 47 and related regulations, as
well as architectural standards regulated by the National
Parks Service. Certification of Historic Significance is the
first step in establishing eligibility for the HTC. A
building must be individually listed in the national Register
of Historic Places or be certified as contributing to a
registered historic district in order to qualify for the 20%
credit. A building that has been certified as non-significant
(i.e., not contributing to a National Register historic
district), but was built before 1936, can qualify for a 10%
tax credit, if it is rehabilitated for income-producing,
non-residential purposes. Second, a developer must submit an
application detailing the plans and specifications for the
rehabilitation. The plans must satisfy the Secretary of
Interior Standards for Rehabilitation.
Once the project is completed, a request for certification of
completion is submitted. If the request is granted, the
rehabilitation is considered a "certified rehabilitation." A
certification of a completed project is issued only when all
work has been finished on the certified historic building.
Generally, the HTC must be claimed in the tax year in which
the rehabilitated building is placed in service. However, the
credit may be claimed before the date the property is placed
in service under the rules for qualified progress expenditures
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(IRC Section 47(d).) Existing federal law contains a
so-called "recapture provision," which provides that a portion
of the tax credit must be recaptured (returned to the federal
government) if the rehabilitated building is sold or otherwise
ceases to qualify within five years from the date the building
is placed in service.
4)The Financing Structure . In order to raise funds for
rehabilitation of historic buildings, the owners, in most
cases, enter into various financing transactions with private
entities using the HTC, among other tax and financial
incentives. A property owner, because of his/her tax
position, may elect to syndicate the HTC to a third party,
through the issuance of partnership or limited liability
company (LLC) interests. The financing of a historic building
rehabilitation using the HTC requires the participation of a
private investor (mostly a taxable corporation) that could
take advantage of the credits to reduce its income tax
liability. A typical arrangement is to match a corporate tax
credit investor entity with a project developer, creating a
partnership [such as a limited liability company (LLC)] where
the investor is allocated the tax credits in exchange for cash
and the developer acts as a managing partner (or member).
Usually, the percentage of allocated tax credits matches the
percentage of allocated profits. Thus, if an investor entity
is allocated all of the tax credits, then it will also receive
all or nearly all of the profits for at least five years. In
exchange, the developer will receive a developer fee or other
distributions. An investor must retain ownership of the
property (i.e. remain in the partnership) for at least five
years after the project is placed in service in order to
receive the full benefit of the tax credits, or the tax
credits will be subject to recapture. At the end of this
period, either the developer will buy out the investor or the
investor will sell its interest in the partnership.
In the case of a HTC, a certified historic structure, i.e. a
building, must be owned by either the entity that utilizes the
credit or a master tenant that leases the entire building from
the owner. In a case of a master tenant partnership
structure, the corporate entity will be allocated most, if not
all, of the credit and profits. It will also likely to
receive an annual priority return, the amount of which is
equal to a very small percentage of the investor's equity in
the project. In exchange, the investor will contribute cash
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to the partnership to provide financing for the rehabilitation
project. It is expected that, after the expiration of the
five-year recapture period, the financing structure will be
unwound and the property owner will directly own the historic
building.
5)Tax Incentives: Do They Work ? Generally, advocates for tax
incentives, such as Arthur Laffer and N. Gregory Mankiw, argue
that reduced taxes allow taxpayers to invest money that would
otherwise be paid in taxes to better use, thereby, creating
additional economic activity. "Supply-siders" posit that
higher taxes do not result in more government revenue;
instead, they suppress additional innovation and investment
that would have led to more economic activity and, therefore,
healthier public treasuries, under lower marginal tax rates.
Industry-specific credits complement this theory by lowering
tax costs for industries that provide positive multiplier
effects, such as stimulating economic activity among suppliers
and increasing economy-wide purchasing power resulting from
hiring additional employees.
Critics, however, assert that tax incentives rarely result in
additional economic activity. Companies locate in California
because of its competitive advantages, namely its environment,
weather, transportation infrastructure, access to ports,
highways, and railroads, as well as its highly skilled
workforce and world class higher education system. These
advantages trump perceived disadvantages resulting from
California's tax structure and other policies. Additionally,
critics argue that industry-specific tax incentives do not
actually effect business decisions; instead, enhanced credits
and deductions reward firms for investments they would have
made anyway. [See, e.g., D. Neumark, J. Zhang, and J. Kolko,
Are Businesses Fleeing the State? Interstate Business
Location and Employment Change in California, (a PPIC report
showing that, while California loses jobs due to firms leaving
the state, these losses have a minimal effect on the economy);
D. Neumark and J. Kolko, Are California Companies Shifting
Their Employment to Other States? (finding that, while
California companies have shifted jobs to other states,
out-of-state firms have offset these losses by hiring more in
California).]
As noted by the Legislative Analyst Office (LAO) in the
presentation at this Committee's hearing "Assessing Tax
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Expenditure Programs in Light of California's Fiscal
Challenges" on February 22, 2012, "policymakers should regard
many TEPs [tax expenditure programs] evaluations with
skepticism." It was further explained that, "Analysis of
alternative uses of public funds is difficult and often
omitted entirely from? studies [of TEPs]. These studies also
usually rely on extensive and sometimes subjective assumptions
which, if changed, can produce very different results ? It is
rare that the value of TEPs can be demonstrated conclusively
compared to these alternate uses of tax dollars. If the
Legislature wishes to use TEPs, despite these challenges, it
is important that TEPs be used cautiously, structured
carefully, and reviewed regularly to consider if they operate
in an effective and cost-efficient manner."
6)The Proposed Historic Preservation Tax Credit: a Different
Kind of Credit ? This bill creates a historic preservation tax
credit program modeled after the federal HTC. Unlike the
federal HTC, however, the proposed credit is not permanent; it
is allowed only for five taxable years, beginning with the
2015 tax year. This bill also provides for an increased tax
credit rate of 25% and allows an additional 5% for certain
projects, such as low-income housing, a transit-oriented
development, and a structure located on federal, state, or
local surplus property, in a designated census tract, on a
specified military base. A building that is not included in
the National Register of Historic Places may still qualify for
the state credit if it appears on the California Register of
Historical Resources.
The proposed credit is different from other state tax credits,
where a certain class of individuals or businesses may claim a
credit based on membership in a certain industry or business
location. In contrast to many tax incentives in California,
the proposed tax credit is targeted, is capped at $100 million
per calendar year, and is required to be allocated to
taxpayers by the Go-Biz on a competitive basis. In many
respects, it is similar to a grant program. This bill
prescribes certain criteria for GO-Biz to utilize in
determining whether a project should be awarded the state HTC,
including the estimated number of jobs and potential state and
local tax revenues to be generated by the project. Thus, the
proposed credit is intended to result in a quantifiable public
benefit. Finally, the LAO is required to review the
effectiveness of this tax credit program, on an annual basis.
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The credit cannot be used after January 1, 2021, and is not
refundable.
7)How Effective Are Historic Tax Credit Programs in Other
States ? Thirty-five states offer state tax incentives of
various kinds for historic preservation rehabilitation
projects. In many states, the income tax credit programs are
similar to the federal HTC program. Several studies conducted
by Rutgers University have shown that "in many parts of the
country, $1 million in historic rehabilitation yields markedly
better effects on employment, income, GSP, and state and local
taxes than an equal investment in new construction or many
other economic activities (e.g., manufacturing or services)."
<2> It was concluded that states with the strongest
historical preservation tax credit statutes regularly lead the
nation in the use of the federal HTC, which, due to its
leverage and multiplier effects, benefits both state economies
and the national economy. For example, an annual report of
the Ohio Historic Preservation tax credit program states that
the $327 million in tax credits approved are projected to
leverage more than $2 billion in private investment and
federal tax credits, which translates to $6.25 of investment
for every dollar of the state tax credit.<3> The Ohio
Historic Preservation tax credit is capped at $60 million per
year and allocated to applicants. According to a 2011 economic
impact study conducted by Cleveland State University, the $246
million in approved tax credits is expected to result, during
the construction period alone, in nearly $10 billion in
economic activities in the state between 2007 and 2025.
Recognizing the economic impact and job creation of the
program, the Ohio General Assembly renewed the Program in the
state's fiscal year 2012-13 budget. Similarly, it was found
that, in Minnesota and North Carolina, respectively, every
dollar of the state historic tax credit creates $8.32 in
economic activity and $12.51 in economic benefit.
8)Bifurcation of the Credit . A taxpayer who uses a state tax
credit to reduce his/her state tax liability generally loses
---------------------------
<2> Annual Report on the Economic Impact of the Federal Historic
Tax Credit for FY 2012, Rutgers University, E. Bloustein School
of Planning and Public Policy, p. 5.
<3> Ohio Historic Preservation Tax Credit Program, 2012 Annual
Report, prepared by the Ohio Development Services Agency, the
Ohio Historical Society and the Ohio Department of Taxation,
April 2013, p. 15.
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the ability to take a federal deduction for the state tax paid
with the use of the state historic tax credit. As such, the
value of a state tax credit is less that its face value. In
practice, when federal credits are allocated through a
partnership to an investor, ownership interests are valued at
$.95 or more on the dollar, while the after-tax value of the
state tax credits tends to be in the range of $.50 to $.55 on
the dollar.<4> Furthermore, a state tax credit has value only
to the extent that the taxpayer holding the credit has
sufficient tax liability in the state. To remedy this
problem, some states have permitted an outright sale of the
credit or made it refundable, while others have allowed a
partnership owning the property to make a disproportionate
distribution (or bifurcation) of the federal and state credits
to its partners. The bifurcation approach allows investors to
enter into partnership agreements where they can purchase
state tax credits without the corresponding federal credits.
Thus, it allows investors to join the developing partnership
and be awarded the federal HTC, a state historic tax credit,
or both. Consequently, investors with no federal tax
liability, but sufficient state tax liability, would have an
incentive to invest in a rehabilitation project that would
allow them to offset unrelated state income tax liability with
the state HTC.
This bill requires that the credit be allocated to the partners
of a partnership in accordance with the partnership agreement,
regardless of how the federal HTC is allocated to the
partners, or whether the allocation of the state credit under
the partnership agreement has "substantial economic effect."
Because this bill specifically excludes any consideration of
the "substantial economic effect" of the partners'
distributions, it creates a divergence from long-established
tax policy and potentially leads to tax shelter opportunities.
A bifurcation of the proposed tax credit from the federal HTC
highlights a natural tension between the need to draw more
investors and investment dollars to projects that rehabilitate
historic buildings and create more low-income housing units
and tax policy that strives to ensure that investments have
substance other than tax incentives. The bifurcation
approach, with very little economic impact on investors other
---------------------------
<4> State Tax Credits for Historic Preservation, National Trust
for Historic Preservation, a policy report, H. Schwartz, p. 3.
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than tax credits, balances at the precipice of tax sheltering
activities. However, this approach was already approved by
the Legislature in the case of the state's low-income housing
tax credit (LIHTC) program. This has been allowed in large
part due to the type of projects created from the investment
and the difficulty of raising sufficient capital to create
low-income housing absent the credit incentives. In that
case, the Legislature determined that the benefits of
increased project capital exceeded the tax policy concerns of
sanctioning a state tax shelter. Traditionally, the
low-income housing tax credit (LIHTC) has been administered
just as though it were an allocated grant program. The Tax
Credit Allocation Committee evaluates the applications and
allocates the available funds (the amount of which is capped)
to those investors/developers who promise to produce the most
housing for the state's dollar. Although the program is in
the form of a tax credit, all the participants behave
virtually as though they were dealing with an allocation of
grant funds. For this reason, the Legislature decided that it
is unlikely that a separation of a state and federal LIHTC
would result in a significant increase of tax sheltering
activities. The proposed credit is intended as a tool of
economic development, especially in economically distressed
areas that are difficult to revitalize, and in light of the
recent dissolution of the redevelopment program. The
Committee may wish to consider whether the proposed historic
preservation tax credit program is sufficiently comparable to
the LIHTC program and, thus, warrants a similar treatment.
9)Abandonment of Partnership Interests . As discussed, many
rehabilitation projects are developed by a partnership or a
limited liability company, in which the developer is the
general partner or manager with a de minimus ownership
interest and investors are limited partners/members with a
99.9% ownership interest in the partnership for the tax credit
compliance period. A partner who sells or exchanges his/her
partnership interest recognizes a capital loss or capital gain
on that sale or exchange, depending on the partner's basis in
the partnership and the purchase price. If a partner abandons
or forfeits his/her partnership interest, he/she will
recognize an ordinary loss, provided that there are no
partnership liabilities from which the partner is relieved.
The amount of that loss is equal to the partner's basis in the
partnership.
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One of the concerns raised in connection with the separation of
the state and federal LIHTC was that an investor would be able
to offset his/her income (albeit in different tax years) with
both the LIHTC and a loss realized from the abandonment or
sale of his/her partnership interest. Consequently, the
Legislature decided to defer a recognition of that loss until
the first taxable year following the expiration of the federal
credit, i.e. a 10-year period, which mitigated the negative
effect of an allocation of the state credit lacking
substantial economic effect. The Committee may wish to
consider a similar deferral of the recognition of loses in the
context of the state historic preservation tax credit program.
10)Owner-Occupied Building . Under the federal HTC program,
owner-occupied buildings are not eligible for the credit.
This bill takes a different approach in that it would allow
both income-producing properties and owner-occupied
residential buildings to qualify for the state tax credit.
The Committee may wish to consider whether a subsidy for
rehabilitation of an owner-occupied building is an effective
tool of economic development.
11)Tax credit Percentages . This bill proposes tax credit
percentages that are higher than the federal HTC rates. The
Committee may wish to consider whether the proposed
percentages should be reduced in light of the fact that the
California income tax rates are substantially lower than
federal income tax rates.
12)Implementation Concerns . The FTB staff notes in its analysis
of this bill that the phrase "federal, state or local surplus
property" is undefined. The absence of definition may lead to
disputes between taxpayers and the FTB and may complicate the
administration of the tax credit.
REGISTERED SUPPORT / OPPOSITION :
Support
The California Preservation Foundation
The American Institute of Architects California Council
Structural Engineers Association of California
Opposition
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None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098