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Tax Reform Act Will Obliterate Richmond’s Historic Shell Property Values

I am surprised by the number of people who are attempting to spin what is going on in Washington DC right now related to the Historic Tax Credit changes proposed by The Tax Reform Act as “not that bad” or “it could be worse”. True, an outright elimination of the Preservation Credit for Historic Properties could be worse, especially for developers who rely on the program. But the changes could not be more dire for the owners of historic shell properties who will not be able to qualify for grandfathering under the old rules. The City of Richmond’s real estate tax base is also going to suffer a whopping blow. Let me walk you through the math.

The primary problem is that the proposed change spreads credits over 5 years at 20% per year for what was previously available up front at the time of completion for a qualifying project. Another problem is that while a building owner completes a historic renovation project on the assumption that the tax credits will be available over 5 years while patiently waiting but receiving no benefit yet, the politicos in DC can change the rules and eliminate or cut the credits again just like they are doing now.

So how do you go about factoring this risk into the equation? I have assigned a 20% discount rate to account for the time value of money (pick your number here as some folks use different discount rates). I have also assumed a 20% “haircut” to account for the probability that DC could change the rules each year and either eliminate or cut the tax credits. That seems more than reasonable in the ever changing political environment in which we are all now living. Some might even argue that 20% is too low.

So what impact does the time value of money and political risk haircut have on an existing shell property value that doesn’t qualify for grandfathering? For the example below, the impact would be a whopping 60% reduction in value. Even if we lower both the discount rate and political risk haircut to 10%, the reduction in value is a sizable 39% hit. Here are the calculations on the first scenario:

Proposed Tax Reform Act Analysis

What does this mean For Richmond?

If a property does not qualify for grandfathering, (see the gobbledygook below in the footnote for what properties will qualify for “transitional” treatment), shell property owners just lost 60% of their property value using my example above. If the City of Richmond plays fair and reduces the tax assessed value for these shells and my assumptions hold true, the City could lose essentially 60% of the taxes it would have otherwise collected for these shell properties. It’s anyone’s guess what the City will do however. I suspect they will be under intense pressure to pretend this change didn’t just happen (if passed) and not adjust values downward in a desperate attempt to avoid seeing tax collections collapse. That leaves the owner of a non-grandfathered shell with a massive reduction in the value of their property, but potentially stuck paying inflated taxes.

So here’s the bottom line. If you are a property shell owner and you can’t qualify for grandfathering under the transitional rules, you better sell your property to someone who can and fast, or prepare to suffer the consequences. And to my realtor friends, good luck explaining to your property owner clients who aren’t good with math, or are in denial about what just happened to the value of their investment property in that sexy “up and coming” neighborhood they were hoping to sell at a pretty penny to help fund their retirement. Things are about to get real bumpy.


Said Gobblygook

House Bill

The House bill repeals the rehabilitation credit.

Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (within the meaning of present law), with respect to any building owned or leased by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (under
section 47(c)(1)(C)) is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24-month period ends.

Senate Amendment

The Senate amendment repeals the 10-percent credit for pre-1936 buildings. The provision retains the 20-percent credit for qualified rehabilitation expenditures with respect to a certified historic structure, with a modification. Under the provision, the credit allowable for a taxable year during the five-year period beginning in the taxable year in which the qualified rehabilitated building is placed in service is an amount equal to the ratable share. The ratable share for a taxable year during the five-year period is amount equal to 20 percent of the qualified rehabilitation expenditures for the building, as allocated ratably to each taxable year during the five-year period. It is intended that the sum of the ratable shares for the taxable years during the five-year period does not exceed 100 percent of the credit for qualified rehabilitation expenditures for the qualified rehabilitated building.

Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (for a pre-1936 building) with respect to any building owned or leased (as provided under present law) by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (under section 47(c)(1)(C)) is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24- month period ends.

Conference Agreement Between House & Senate

The conference agreement follows the Senate amendment with a modification to the transition rule under the effective date relating to qualified rehabilitation expenditures under certain phased rehabilitations for which the taxpayer may select a 60-month period.

Effective date.−The provision applies to amounts paid or incurred after December 31, 2017. A transition rule provides that in the case of qualified rehabilitation expenditures (for either a certified historic structure or a pre-1936 building), with respect to any building owned or leased (as provided under present law) by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (section 47(c)(1)(C)(i)), or the 60-month period selected by the taxpayer under the rule for phased rehabilitation (section 47(c)(1)(C)(ii)), is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the provision apply to such expenditures paid or incurred after the end of the taxable year in which such 24-month or 60-month period ends. 

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33 thoughts on “Tax Reform Act Will Obliterate Richmond’s Historic Shell Property Values

  1. Michael, it could be way worse than what your math shows. If the highest and best use of shells is not for adaptive reuse, then there may be no market at all. Seriously, a $35/ft shell may have to continue in use at $5/ft to an industrial tenant.

    1. Agreed, Matt. I was assuming in my analysis that adaptive reuse was already baked into the comparables that justified the original shell acquisition price before these proposed Tax Reform Act changes. But if adaptive re-use isn’t possible for a building, then you are absolutely correct that these historic buildings could essentially become worthless. Given the number of historic shell properties that remain in Richmond, the collective impact is going to be a big number with a lot of zeros behind it. Not a good situation for old cities like Richmond.

  2. How about mobilizing citizens to vote against the Trump machine,and we can reverse this awful plan to begin with!………Don’t blame me,I didn’t vote for the dude,did any of you?,if so then you reap what you sow!.

    1. How about the tax payers stop subsidizing other peoples investments… everyone pay their own way… I voted for him and very proud of it!

      1. Government intervention (in numerous forms including poorly conceived urban renewal projects, subsidizing freeways and suburbs and ramming them through city centers, ad infinitum) and nonmarket behavior (racially exclusive housing/lending/banking policies and so forth) created or accelerated the urban decay that these tax credits help address. Furthermore, the credits generate sufficient additional economic activity that they more than pay for themselves, meaning they aren’t so much a subsidy as a very good investment.

        This was a program supported by Ronald Reagan for crying out loud -But you “voted for [Trump] and” your “very proud of it,” so why let facts or reason slow you down?

        1. Correction….”spell right” acting up……once more to the earlier comment…. I voted for him,and I’m proud of it”……sounds just like this Nazi my cousin was speaking to at the C-Ville Rally. …..hope that came out correct.

  3. I’m curious why all these developers feel so entitiled to these massive tax credits to begin with. There is so much fraud within this system. Why should the federal government have to subsidize all these developments. It’s just my opinion that these credit programs do way more to line the pockets of developers then to help the communities in which the developments are happening.

    1. It’s not a question of entitlement, it’s a simple arithmetic problem related to the huge cost associated with fixing old buildings. Without the credits, it will make many of those old buildings worthless, or at a minimum substantially reduced in value. So the old buildings will rot/detiorate and eventually be torn down, rather than being renovated.

  4. 🇺🇸Remember this date November 6, 2018. That’s the date on which 33 senate seats, all 435 seats in the House of Representatives, and 14 governorships will be up for re-election. Put it on your calendar now and be prepared to be an informed voter. If you are worried, concerned, angry, disappointed about the direction the government is going this is the most effective way to make a change, stop complaining and start planning.

    1. At the rate we are going, by November 6, 2018 we won’t even recognize the America and opportunities that were available in 2016. It’s going to be hard to reverse alot of what’s being put it place and by the time it can be reversed, the damage will be done and Trump Administration will be over the horizon with the goods.

  5. Michael

    I think your analysis need to account for the change in tax rates (either corporate or pass thru) from 40 ish to 21. I suspect the the change in the tax credit is more than offset by the decline in income tax. Given that your cost of capital / discount rate is 20%, that would suggest that this property would be generating 230,000 in income and the tax saving would be approx $46000 annually and forever. I would think that the developer / investor would be better off in this scenario

    1. Yes, the corporations who invest in these tax credits will be incentivized to hold onto cash, or use it for other purposes rather than investing it in historic tax credits at prior prices/levels. That’s the whole point. That benefit will come directly out of the pocket of the shell building owner who will see his/her property drastically depreciate in value. The City of Richmond and its historic property owners will be left holding the bag with no countervaling benefit.

  6. Wow, comment sections. Always fun. How about some of these folks make more reasonable offers on cost per square foot in neighborhoods that are ‘up and coming’? A lot of these folks have bought space expecting a get rich quick, next Church Hill game and have no idea about the growth of a neighborhood.

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