Historic Tax Credit Transactions

The Historic Tax Credit Program

The federal Historic Tax Credit (HTC) — authorized under Section 47 of the Internal Revenue Code — provides a 20% tax credit against qualified rehabilitation expenditures (QREs) incurred in the certified rehabilitation of a certified historic structure. The credit is intended to incentivize the preservation and adaptive reuse of historically significant buildings by making rehabilitation financially competitive with new construction.

The program is administered jointly by the National Park Service (NPS), which certifies the historic significance of the building and reviews the rehabilitation work for compliance with the Secretary of the Interior's Standards for Rehabilitation, and the IRS, which governs the tax credit eligibility and compliance requirements. The Illinois Historic Preservation Tax Credit provides a state-level credit that can be layered with the federal credit to increase the total equity available for a qualifying project.

Historic tax credits are distinct from Low-Income Housing Tax Credits in program structure, investor requirements, and transaction mechanics — but HTC and LIHTC are frequently combined on rehabilitation projects that involve both historic structures and affordable housing, and the interaction between the two programs requires careful structuring.

How the Federal HTC Works

The federal HTC provides a credit equal to 20% of qualified rehabilitation expenditures (QREs). QREs are the costs of rehabilitating the interior and exterior of a certified historic structure, subject to specific exclusions — land, new construction, and certain building enlargements generally do not qualify. The credit is taken in the year the rehabilitated building is placed in service (unlike LIHTC, which is claimed over ten years), though it is subject to a five-year recapture period during which the investor must maintain its interest in the building to avoid credit recapture.

Certification Requirements

To qualify for the federal HTC, the project must satisfy three certification requirements administered by the National Park Service through the applicable State Historic Preservation Office (SHPO — in Illinois, the Illinois Historic Preservation Agency):

Part 1 — Historic Character: Certification that the building is a certified historic structure, either individually listed on the National Register of Historic Places or contributing to a registered historic district.
Part 2 — Rehabilitation Plan: NPS review and approval of the proposed rehabilitation work for conformance with the Secretary of the Interior's Standards for Rehabilitation. Part 2 approval must be obtained before work begins on any portion of the rehabilitation.
Part 3 — Completed Work: NPS certification that the completed rehabilitation conforms to the approved rehabilitation plan. Part 3 certification triggers final credit eligibility.

Managing the NPS/SHPO certification process — including the timing of Part 2 and Part 3 submissions relative to the construction and closing schedule — is a critical project management issue in HTC transactions. Changes to approved rehabilitation plans during construction require NPS approval and can affect credit eligibility if not properly handled.

The Substantial Rehabilitation Test

To claim the federal HTC, the rehabilitation must satisfy the substantial rehabilitation test — QREs must exceed the greater of $5,000 or the adjusted basis of the building (excluding land) at the start of the rehabilitation. For many historic properties that have been depreciated over time, the adjusted basis is low, and the substantial rehabilitation test is relatively easy to meet. For recently acquired or high-basis buildings, however, the required level of QREs can be a significant constraint on credit eligibility that must be evaluated early in project planning.

The Illinois Historic Preservation Tax Credit

Illinois offers a state Historic Preservation Tax Credit equal to 25% of QREs for qualifying rehabilitation projects, administered by the Illinois Historic Preservation Agency in conjunction with the Illinois Department of Commerce and Economic Opportunity. The state credit can be claimed in addition to the federal credit, increasing the total credit stack to 45% of QREs for eligible projects. The Illinois credit is transferable — it can be sold to third-party investors who can use it against their Illinois tax liability — which broadens the pool of potential credit buyers beyond those with sufficient federal tax appetite.

HTC Transaction Structure

The HTC investor — like the LIHTC investor — contributes equity in exchange for the tax credits and tax benefits from depreciation. But the HTC transaction structure differs from a LIHTC structure in important ways, driven primarily by the IRS requirement that the credit be claimed by the "owner" of the building. Structuring HTC transactions correctly requires close attention to the IRS rules governing who qualifies as the owner for HTC purposes and how the credit is passed through to the investor.

The Master Tenant Structure

The most common structure for HTC transactions — and particularly for HTC/LIHTC combination deals — is the master tenant structure, also known as the lease pass-through structure. This structure was developed to address the IRS's requirement that the HTC be claimed by the owner of the building while also satisfying the LIHTC requirement that the tax credit entity hold a long-term ownership interest in the property.

In the master tenant structure, the tax credit ownership entity (the "fee owner" or "landlord entity," typically a limited partnership or LLC) enters into a long-term master lease of the property to a second entity (the "master tenant entity"), also typically a partnership or LLC. The master lease is structured as a genuine lease for tax purposes — with a market rent, a defined term, and appropriate economic substance — and the master tenant entity becomes the "owner" of the building for HTC purposes by virtue of holding the leasehold interest. The HTC investor invests in the master tenant entity and claims the 20% credit through that entity. The LIHTC investor, by contrast, invests in the fee owner entity and claims the housing tax credits through that entity.

The master lease term, rent, and economic terms must be structured to satisfy both the IRS requirements for HTC qualification and the LIHTC requirements for the fee owner entity. The interplay between the two sets of requirements — particularly around the master lease rent, the distribution of cash flow between the two entities, and the treatment of the leasehold at the end of the master lease term — is the central structural challenge in HTC/LIHTC combination deals.

Single Investor vs. Dual Investor Structures

Some HTC/LIHTC transactions use a single investor who invests in both the fee owner entity (for LIHTC) and the master tenant entity (for HTC). This simplifies the investor relationship and reduces the number of parties at the closing table, but it requires an investor with appetite for both credit types and sufficient tax liability to absorb both. More commonly, separate investors — a LIHTC investor and an HTC investor — invest in the respective entities. This requires careful coordination between two sets of investor documents, two sets of closing conditions, and two sets of guaranty and indemnity obligations.

The Legal Work in an HTC Transaction

HTC transactions — and particularly HTC/LIHTC combination deals — involve a layered set of legal workstreams that must be coordinated across the NPS certification process, the investor closing, and the construction and rehabilitation schedule.

Entity and Investment Structure

Formation of the fee owner entity and master tenant entity
Master lease between the fee owner and master tenant
LIHTC investor documentation in the fee owner entity
HTC investor documentation in the master tenant entity
Intercreditor and coordination provisions between the two investor structures
Illinois state credit transfer documentation where applicable

NPS Certification Coordination

Review of Part 1, Part 2, and Part 3 certification status and timing
Construction contract provisions addressing NPS Standards compliance
Change order review for potential impact on Part 2 approval
Closing deliverable requirements tied to Part 2 and Part 3 status
Investor and lender requirements regarding certification timeline

Financing Documentation

Construction and permanent loan documentation at the fee owner level
Leasehold financing at the master tenant level where required
Lender consent to the master lease structure
SNDA and recognition agreements between the lender, fee owner, and master tenant
Title insurance covering both the fee and leasehold interests

Guaranties and Risk Allocation

Completion guaranty covering both LIHTC and HTC investors
HTC delivery guaranty and recapture indemnity
NPS certification guaranty (Part 3 completion)
Operating deficit guaranty at fee owner and master tenant levels
Coordination of guaranty obligations between LIHTC and HTC investor documents

Five-year recapture period. Unlike LIHTC, which has a fifteen-year compliance period, the federal HTC is subject to a five-year recapture period. If the investor disposes of its interest in the master tenant entity, or if the building ceases to be a qualified rehabilitated building, within five years of being placed in service, a proportional amount of the credit is subject to recapture. The recapture indemnity in the HTC investor documents must address this risk for the duration of the recapture period.

HTC Counsel at Snow LLP

Snow LLP advises developers and sponsors on Historic Tax Credit transactions — including standalone HTC deals and HTC/LIHTC combination transactions. The practice handles the transactional legal work associated with the master tenant structure, the investor and financing documentation, and the coordination of HTC and LIHTC workstreams in combination deals.

HTC transactions require tax opinions regarding credit eligibility and the master lease structure. Tax counsel coordinates with the transaction team; Snow LLP does not provide tax opinions.