The Tax Credits Hiding in Plain Sight

The Tax Credits Hiding in Plain Sight: How Historical Real Estate Investments Can Potentially Reduce Your Tax Bill

When most people think about reducing their tax bill, they think about deductions.

Maybe it’s contributing more to a retirement account. Maybe it’s charitable giving. Maybe it’s finding additional business expenses or taking advantage of depreciation.

But there is another part of the tax code that deserves more attention: tax credits.

And sometimes, the most interesting tax-planning opportunities aren’t sitting in your brokerage account or retirement plan. They can be tied to investments in the real estate market.

One strategy I’ve been talking about recently involves historic rehabilitation tax credits and the investment opportunities that can surround them.

The concept is relatively simple: the government has created tax incentives to encourage private investment in the rehabilitation and preservation of historic buildings.

For the right investor, that can create an interesting intersection between real estate, investing and tax planning.

A Tax Credit Is Different From a Deduction

This distinction is important.

A deduction generally reduces the amount of income that is subject to tax.

A tax credit, on the other hand, generally reduces the tax itself.

That can make credits particularly valuable when you’re looking at ways to manage a large tax liability.

The federal historic rehabilitation credit, for example, is generally equal to 20% of qualified rehabilitation expenditures for qualifying historic buildings. The credit is generally claimed ratably over five years.

That doesn’t mean every old building qualifies.

There are specific requirements involving the property, the rehabilitation work, certification and other tax rules. The National Park Service is involved in the certification process for qualifying historic structures.

That’s why this isn’t something I would approach as, “I found a tax credit online, let’s invest.”

The investment has to make sense before the tax benefit enters the conversation.

Think Beyond Your Tax Return

This is where financial planning becomes important.

A tax strategy shouldn’t exist in isolation.

If you have a high income, significant capital gains, business income or other sources of taxable income, you may have opportunities to structure your overall financial picture differently.

Instead of asking:

“How can I deduct another $10,000?”

A better question may sometimes be:

“What investments or planning strategies could potentially change my overall tax liability?”

That’s a much bigger financial-planning conversation.

And it can involve investments that many people have never even considered.

Historic Tax Credits and Real Estate

Historic tax credits are designed to encourage the rehabilitation of qualifying historic buildings rather than simply constructing something new.

The IRS describes the credit as an investment credit under Section 47. Qualified rehabilitation expenditures can potentially generate a federal credit, subject to the applicable rules and limitations.

That creates an interesting investment structure.

An investor may participate in a real-estate project where the rehabilitation of a historic property generates tax credits, potentially creating a tax benefit alongside the underlying investment.

But—and this is a big but—the tax benefit isn’t necessarily available to everyone in the same way.

Tax credits have rules.

Passive activity limitations, at-risk rules, alternative minimum tax considerations, basis adjustments and other provisions can affect whether and when an investor can actually use a credit.

In other words, seeing a “$100,000 tax credit” in an investment presentation doesn’t necessarily mean you get to reduce your tax bill by $100,000 this year.

That’s exactly why due diligence matters.

The Tax Benefit Isn’t the Whole Investment

This is probably the most important point I would make to someone considering a strategy like this.

Don’t let the tax benefit blind you to the investment.

If someone says, “This investment gives you a huge tax credit,” your next questions shouldn’t just be about the credit.

Ask:

• What exactly am I investing in?

• How does the underlying real estate make money?

• What are the fees?

• What is the expected holding period?

• What are the risks?

• How liquid is the investment?

• What happens if the project doesn’t perform as expected?

• How is the tax credit calculated?

• When can I actually use the credit?

• What happens if I sell my interest?

• What happens if the property is sold or its use changes?

The IRS specifically notes that historic rehabilitation credits can be subject to recapture if the property is disposed of or otherwise ceases to qualify during the five-year recapture period.

So this isn’t “free money.”

It’s a tax incentive attached to a real investment with real rules and real risks.

This Is Where a Financial Planner Can Add Value

Tax planning is one of the reasons I believe financial planning should go beyond simply managing a portfolio.

Your investments, taxes, retirement plan, estate plan, charitable giving and cash flow shouldn’t operate in separate boxes.

They interact.

For example, someone approaching retirement with a large taxable income could have a completely different set of planning opportunities than someone early in their career.

A business owner could have different opportunities than a W-2 employee.

Someone with significant real estate exposure may have different considerations than someone whose entire portfolio consists of stocks and bonds.

The goal isn’t to find a tax strategy just because it reduces your taxes.

The goal is to determine whether the strategy makes sense within your entire financial plan.

Don’t Let Taxes Drive the Bus

I’ve seen people make the mistake of buying something they don’t really want simply because someone told them it would “save taxes.”

That’s backwards.

You shouldn’t spend a dollar simply to save 30 cents in taxes.

Instead, look for investments and planning strategies that could make sense on their own—and then determine whether the tax code provides an additional benefit.

That’s the difference between tax planning and tax chasing.

Tax planning looks at the bigger picture.

Tax chasing looks for the biggest deduction.

Those aren’t the same thing.

There are tax strategies hiding in places many investors never think to look.

Historic real estate rehabilitation is one example.

There are also charitable strategies, retirement strategies, business-owner strategies, estate-planning strategies and other investment structures that can potentially affect your tax picture.

But the key is knowing which strategies actually apply to you.

That’s where personalized financial planning comes in.

At Lloyd Financial Group, I look at financial planning as more than simply asking, “What should you invest in?”

It’s about looking at the entire picture and identifying problems and opportunities—including some you may not even know exist.

Because sometimes the biggest financial opportunity isn’t finding another investment.

It’s understanding how the investments you already have—and the ones you’re considering—fit into the bigger tax and financial-planning picture.

And when you can potentially keep more of your money working toward your goals instead of unnecessarily sending it to the IRS, that’s a conversation worth having.

Click here to schedule a meeting — I’m here to help you take the next step toward financial freedom.

Colin Symons, CIO Lloyd Financial Group

Some were convinced that the FOMC choosing to raise rates would surely take the stock market down. Instead, we’re seeing stocks bid up, anyway. How does that happen?

Ultimately, markets move on expectations, not on what just happened. That’s the Wayne Gretzky quote of “skate to where the puck is going to be, not where it has been.” The market wasn’t surprised by the hike, it was already priced in. The market is focused on what comes next, not what happened.

In this case, the market is already pricing in a fair amount of rate hawkishness for the rest of the year, with the market saying a hike is more likely than not for October, two hikes by the end of the year is possible, and those two hikes are likely by the January meeting (see below, with the blue numbers.)

To invoke the Great One again, that’s where the puck is already going. That rate hike expectation may not be maximally hawkish, but a lot of hikes are already baked into current pricing. Added to that, the decision by the Fed to hike rates seemed to focus a lot on crude prices. With oil moving down from $106 to $95 in less than a week, is it reasonable to think those coinflip odds of an October rate hike may be going down?

If you really want high conviction that the market is going down, you’d want to believe that the rate picture is going to get worse. We would want a higher terminal rate, meaning we’re going to get more hikes than is currently priced in. We’d also want those hikes to arrive sooner, rather than later. Right now, that isn’t happening, so risk assets can be held more comfortably.

Instead, inflation expectations are moving down, presumably as the bond market reprices oil risk lower. Admittedly, I don’t see a reason for real rates to come down, as they’re largely elevated due to AI and government spending, but they don’t need to. If we push towards one hike instead of two, this year, that will mean the short-term curve needs to price yields lower, which is bullish for risk assets, even with another hike expected.

Another way to look at this is that most models that made the Fed hike say they are still accommodative. They’d need another 1-3 hikes to catch up to those models as they currently stand. In that sense, the Fed remains too low on their rate and thus is still accommodative of an upward-trending stock market.

This can still go wrong, of course. Something can happen to solidify an October rate hike, or worse, solidify two hikes by the end of the year. That doesn’t look overly likely to me, right now, but something can certainly change. More likely, in my mind, is the market gets ahead of itself pricing in good times, then we fall from those loftier heights. Put differently, I tend to think the most likely path is up, but as we go higher, the risks of a crash would grow with us.

Chicago Fed National Activity Index was -0.04 vs. prev. 0.08. The decline was mostly from production slowing, but these aren’t huge changes.

Oil fell further yesterday as Saudi and other flows are coming back through the Strait of Hormuz. It’s down another -3% this morning, to under $90, on attempts to restart talks, potentially opening the Strait within a week.

META was up 11% on an upgrade from Wells Fargo and a subsea cable deal linking the US and France.

Quest Diagnostics (DGX) and LabCorp (LH) are down -6% and -3% after Medicare cut reimbursement rates for diagnostic tests by the statutory max of -15%

ADP Employment, 2Y T auction, and UN meetings today.

Bottom line: Oil under $90 is causing more relief

Click here to schedule a meeting — I’m here to help you take the next step toward financial freedom.

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