An Introductory Guide to Tax Credits for Real Estate Development

by Warren Kirshenbaum

CEO, The Cherrytree Group

Trust me: I know that many in the real estate industry consider the topic of tax credits to be so “dense” as to almost be worth avoiding. There are so many variations, so many changing rules and regulations that it’s easy to wonder if one should become involved with tax credits at all.

But, plain and simple, prudent use of tax credits saves real estate developers money. And they can be a lucrative part of any high-net-worth investor’s financial strategy as well. 

Yes, tax credits may appear to be too complex and confusing for many developers to wish to look into on their own. Plus, many developers don’t need tax credits for their own personal use — at least, not at the moment. But here’s an important point: some investors want your tax credits. And they’re willing to, in essence, pay for them — always to your advantage as a developer who is trying to keep your project carrying costs as low as possible. 

To take advantage of these often-lucrative programs, you don’t ever need to become a tax credit expert. It’s a much better use of your time to consult with a real estate tax credit professional like one of the experts at Cherrytree.

So…maybe it’s worth your time to get to know this niche business a little better:

The originating idea: in the interest of promoting goals that help the public good — such as cleaner earth and water, clean energy, affordable housing, economic vitality in depressed areas, and preservation of our nations’s historic structures — Federal and state governments have created programs to reward those developers who tailor their projects to meet these goals. Here, the inclusion of commercial real estate tax benefits further incentivizes sustainable and socially responsible development. The most common method rewards those developers and investors with tax credits — not “deductions,” but real money that can be taken straight off one’s individual tax return.

The value that tax credits can provide, given the right strategies and guidance from experts, is usually significant. Reducing taxes is one thing; limiting construction costs and generating capital to put into projects is another; pairing them together is, simply, terrific. This is where understanding the tax credit for real estate development comes into play, offering a direct avenue to mitigate some of the financial challenges faced during the development process.

Regardless of your existing knowledge in the real estate and investing fields, I want you to be able to tackle tax credits with some foundational knowledge. Let’s begin with a summary for the real estate or investing professional who may know little about tax credits:

As I mentioned earlier, tax credits are the amount of money the government permits a taxpayer (individual or entity) to subtract, dollar for dollar, from the income taxes which that taxpayer owes. Unlike tax “deductions” or “exemptions,” tax credits directly reduce the total amount of taxes due. Tax credits are far more valuable to any taxpayer than other ways of limiting taxes. For one thing, tax credits don’t fluctuate depending on taxable income, so the amount of money you make doesn’t change how much money you save.

As a developer, you may not be able to use the tax credit benefit on your next 1040 return. But developers who earn tax credits are often allowed to “partner “ with tax-paying individuals who will invest at a discount on the value of the earned credits. Astute investors find they can lucratively participate in the tax credit market and reduce their tax bills. An investor could be any individual taxpayer with passive income— including those who’ve never been a developer. If the need is there, anyone is welcome to participate in this arrangement.

At Cherrytree we provide the guidance necessary for developers to earn these tax credits. If it makes sense to do so, we can match the developer with the investor who will benefit from those credits — which is what we call “syndication.” Individual investors repeatedly approach us to ask if we can match them with vetted developers for a mutually beneficial transaction. Regardless of what side of the fence you’re on, we can help you find the perfect partnership.

A developer can work with one, or many, investors to receive an equity investment in your business/project . Suppose you chose to be an investor yourself, you would have the opportunity to receive a credit against your federal income tax based on your investment size. Both parties win! We will help you decide the most profitable path by buying and selling tax credits for your business endeavors.

The process of buying and selling tax credits is Cherrytree’s only focus as a financial services firm, and we pride ourselves on securing competitive pricing for our clients. This is not the only area where we can source funding for developers, however. We do manage funds set aside specifically for tax credit-eligible development, such as for the Federal Opportunity Zone program.

Our clients come from a variety of backgrounds. We work with developers, environmental engineers, investors, investment consultants, property owners, and lessees of tax credit eligible sites. Each client has different needs based on their business goals. 

Here are the five primary tax credit development categories:

Brownfields Tax Credits. Many U.S. states have set aside programs to motivate developers to undertake a project which remediates tainted or contaminated land. This land can be used then for whatever purpose is desired. The Massachusetts Brownfields Tax Credit (BTC), for example, requires owners or lessees of contaminated properties to remediate contaminated land before development, regardless of who caused the contamination. Developers can negate 50% of a qualified remediation’s eligible costs when implementing a permanent solution.

Low Income Housing Tax Credits. Given the high cost of residential real estate these days, this is a priority for many governments. Non-profit entities often work with Cherrytree to find connections with developers and investors to develop partnerships to create affordable housing. There is an equivalent of nearly $8 billion in annual budget authority to issue tax credits for the acquisition, rehabilitation, or new construction of rental housing targeted to lower-income households..

Historic Tax Credits. The Federal Government offers tax credits to those renovating a historically significant building. The credit amount can add up to 40% of tax credit eligible construction costs. Usually, the property will need to be included on the National Register of Historic Places, be eligible for a National Registry Listing, or have a location within a designated Historic District. Developers and investors can combine the historic credit with other credits, such as Brownfields credit, renewable energy credit, or a low-income housing tax credit. Some examples of eligible properties are older U.S. post office buildings, abandoned factories, mill buildings, and city or town halls that are targets for re-development.

Creation of Renewable Energy. As the technology of renewable energy advances and the cost of generating renewable energy decreases, many developers are jumping into the creation of renewable energy as part or all of their projects. You as developer or investor will earn subsidies for choosing renewable energy such as solar panels, wind energy, geothermal, biomass, and hydroelectric. This support of energy conservation, pollution control, or various forms of desirable economic development benefits not only the greater good but also the year-end tax position of developers and/or investors.

Opportunity Zones. Introduced by Congressional legislation in 2017, these Federally-designated “zones” are in neighborhoods that would benefit the economy and public good if developers are willing to build or re-build within them. Businesses are willing to relocate or start-up in these zones to defer capital gains and enlarge the number of potential employees available for hire. Developers benefit by generating third-party investment capital or working with a fund for projects built in these zones. Investors can even then use this fund to defer tax on the initial investment and eliminate taxes on the development project’s sale. Investors can also re-invest unrealized profit from selling their properties or assets into “Opportunity Funds” dedicated to investing in these zones.

And that is a general introduction to the world of real estate tax credits. At Cherrytree, we’re looking forward to advising you through this process and helping you reach your financial goals! We will use our network of connections to match you with tax credit or investment opportunities. If our clients have a better understanding of the process that results in tax credits creation, I have faith that you will begin to feel as I do about them: nothing short of the most exciting of real estate development and investing opportunities!