WASHINGTON : Tax Reform Crimps Rehabilitation Work : Tax Credits: Legislation pending in Congress to restore greater tax benefits for revitalizing historic buildings, low-income housing.

California has been one of the greatest beneficiaries of the historic rehabilitation tax credit, which since 1976 has been used to refurbish single buildings, stabilize whole city blocks and prop up entire small towns and their economies.

A report by the National Park Service calls the rehabilitation tax credit “one of the most successful urban revitalization tools implemented by Congress.”

H. Ward Jandl, chief of technical preservation services at the National Park Service, wrote: “The completed projects have brought renewed life to business and residential districts, have resulted in new jobs, have increased local and state revenues, and have provided new, high-quality housing for families of all income levels.”

In Los Angeles alone, the Broadway theater district, the Spring Street financial district and Hollywood Boulevard commercial and entertainment district each has several projects that have benefited.

But in the tax reform of 1986, Congress took an ax to real estate tax shelters--and the historic rehabilitation tax credit. Although still available, the credit has been limited severely and the number of projects using it has dropped sharply.

In the last 13 years, 21,000 buildings qualified for the tax credit nationwide, including 100,000 housing units, 17,000 of which were for low- and moderate-income families.

From 1982 to 1985, California ranked fifth in the country for the amount of rehabilitation dollars and 19th in the number of approved projects. During that time, 210 projects generated $495 million in investments, which created 18,065 jobs and 1,355 rehabilitated housing units, according to the National Trust for Historic Preservation.

But as a result of tax reform, there has been a tremendous decrease in the use of the tax credit and the number of historic rehabilitation projects. For instance, California had 77 applications for the credit and was the location for $299 million worth of rehabilitation investment in 1985. By last year, the numbers had dropped to 24 applications and $36 million in investments--a decline of 64% and 88%, respectively.

Nationwide, the story is the same. The yearly investment in rehab projects is about one-third of pre-1986 levels and the number of projects has dropped to the same meager level.

The Community Revitalization Tax Act was introduced on both sides of Congress in 1989 to restore the vitality of the rehab tax credit and spur a new low-income housing tax credit. The concept seems to have large bipartisan support and has garnered dozens of co-sponsors.

The legislation is pending in the House Ways and Means Committee and the Senate Finance Committee, and proponents plan to attach it to the new tax bill when it emerges.

“Because of certain provisions of the 1986 tax law, the tax credits for historic rehabilitation and low-income housing do not work as Congress intended,” said Sen. John C. Danforth (R-Mo.), the bill’s sponsor in the Senate. “The net effect has been to depress investment in both areas, while raising the cost of capital that remains available.”

Prior to tax reform, the use of the tax credit was simple. You needed an income-producing building, either residential or commercial. It had to be historic individually or located in a historic district. Then the building had to be rehabbed within national preservation guidelines.

The cost of the rehabilitation had to exceed the adjusted basis or the initial investment. Then you were allowed to reduce your taxes by 25% of the amount you put into the rehabilitation.

Let’s say you bought a building for $100,000 and put $200,000 into fixing it up. You would be eligible for a $50,000 credit.

But in 1986, Congress reduced the credit to 20% and created “passive activity” rules. Passive investments are, for the most part, real estate investments. Active investments usually involve something like the stock market or rare coins.

“The passive-activity rules marked a dramatic change in federal tax policy,” said Rep. Barbara B. Kennelly (D-Ct.) when she introduced the Community Revitalization Tax Act in the House. “The rules were designed to prevent individual taxpayers from using losses for certain passive activities to shelter income from wages, salaries and other types of investment income.”

The passive-loss rules effectively restricted credit use to $7,000 for most taxpayers and completely eliminated the credit for others above specified income levels, phasing it out completely at $250,000. The few investors still able to use them fully were those with large amounts of passive income.

“Special tax planning strategies can make the rehab tax credit useful still for some taxpayers, such as large corporations or individuals with substantial passive income,” said William Delvac, preservation attorney and consultant with the Historic Resources Group in Los Angeles.

“But the legislation is important because the tax reform put a real squeeze on the middle-size projects. The new legislation will make the credit more useful and attractive to a larger cross section of people.”

Although the Community Revitalization Tax Act would maintain the limits on credit use, it would restore the vitality of the rehab tax credits by applying uniform eligibility rules to all taxpayers and allow investors to use up to $20,000 in credits a year, plus an amount equal to 20% of any additional tax liability they might have. Basically, the rehab tax credit would be treated like a business credit and income caps would be removed technically.

“We are trying to provide incentives to get investors to put their money in historic buildings, as opposed to stamps, coins, race tracks or skyscrapers. As the law stands right now, historic buildings are at a competitive disadvantage,” said Ian D. Spatz, director of the Center for Preservation Policy Studies at the National Trust for Historic Preservation.

“Historic buildings are often in the crummiest parts of town. They look bad. There is a lot of risk involved in such an investment because you never know what you will find when you tear out walls. Plus, we want people to do the work right, using federal standards.”

But why should we care about run-down buildings in shoddy neighborhoods? Why should they get a special tax break?

The beauty of the tax credit is that it doesn’t even work in prime markets, which obviously don’t need the boost. The credits do work, however, in places where they will have the most impact--declining inner-city commercial areas or struggling rural communities.

“A lot of this work represents craftsmanship and patterns of settlement from generations before us,” said Nellie Longsworth, president of Preservation Action. “Most of today’s developers look at things on a one-time basis. They don’t look at the context. But what we are finding is that settlement patterns of historic communities are turning out to be what works best.

“You need different kinds of space. Not everything needs to be a high-tech office tower. You need buildings for new and young businesses, and historic buildings often give then attractive space. There are also sound environmental reasons for reusing what we already have.”

In addition, the historic rehabilitation, tax credit works well in conjunction with the low-income housing tax credit, which began in 1986. Many developers have been able to use the two together to provide low-income housing.

“Congress reaffirmed its commitment to affordable housing and community revitalization by creating the low-income housing credit and preserving the rehabilitation credits in the 1986 Tax Reform Act,” Kennelly said. “If Congress is to make good on its commitment to create housing opportunities for our most needy citizens and revitalize our neighborhoods, we must ensure the vitality of the credits.”

Pennsylvania has become the first state to limit fees that realtors can charge for originating loans and has established an important legal precedent while other states continue the nationwide debate.

Although it is illegal for a realtor to accept a fee for a simple referral to a lender without any service, many now provide a service--filling out a loan application. And they then charge for that service.

The new limit is $100 per transaction. Although some realtors have been providing the service free, others have been charging as much as 2% of the loan amount.

But mortgage bankers and several consumer groups want the Real Estate Settlement and Procedures Act amended to make the practice illegal. Realtors, however, contend that mortgage bankers want a federal law to keep out the competition.

Of the Pennsylvania Real Estate Commission’s decision, Brian Chappelle, MBA’s vice president, said, “We believe it is a step in the right direction. It precludes a real estate broker from accepting excessive fees.”

“Whenever the services that a realtor performs are comparable to those that a mortgage banker or broker performs, they should be be allowed to charge comparable fees,” said Norman Flynn, president of the National Assn. of Realtors. “To restrict those artificially restricts the marketplace and may be detrimental to the consumer.”