On Sept. 13, Mayor Jim Kenney struck a last-minute compromise with city council before its fall session began later that day, concluding the debates—for now—on two controversial real estate issues in Philadelphia: the 10-year tax abatement program and the proposed 1 percent construction tax on new construction and major renovations. The start of city council's session marked the deadline for Kenney to either approve or veto the construction tax bill recently passed by city council. Before the council session began, Kenney and city council reached a deal that breathed new life into the tax abatement program and dropped the proposed construction tax bill. As part of the compromise, Kenney agreed that tax revenue from properties with expiring abatements under the tax abatement program would fund affordable housing projects and, in return, city council agreed to withdraw the construction tax bill. On Oct. 4, city council passed legislation cementing the compromise, which also added an inclusionary zoning bill that could provide tens of millions of dollars for affordable housing.

To recap the history, in Philadelphia, a property owner must pay property taxes on the assessed value of the property, being the combined value of the land and any improvements. However, under Philadelphia's 10-year tax abatement program, property owners of newly constructed or rehabilitated properties are entitled to a 10-year tax abatement on the value of the newly constructed improvements. This means that property owners continue to pay property taxes on the property's land value and any pre-existing improvements, but not on the added value of the new construction for a period of 10 years.

The tax abatement program was enacted in 2000 to encourage new construction and rehabilitation of rundown properties in Philadelphia. Since 2000, about one half of all granted abatements under the program have expired, allowing the city to collect property taxes on both the value of land and all improvements of those properties. Approximately 10,000 properties currently enjoy these abatements. Notably, the number of properties with expiring abatements each year will decline over the next few years because of the sharp decrease in construction caused by the real estate market crash in 2008, leading to smaller increases in tax revenue for the city.

Since the inception of the tax abatement program, its value has remained an oft-debated issue. Proponents credit the program for the recent transformation of Center City, the revitalization of many underdeveloped areas in the city, and the profitability of many projects in the city, as Philadelphia is one of the most expensive construction markets in the country. Critics argue that the program worsens the already concerning poverty rate in Philadelphia—which is the highest poverty rate among the nation's largest cities—because it reduces the much-needed funding of tax revenues to underfunded city schools.

Last spring, city council narrowly passed the construction tax bill. Under the bill, a 1 percent tax would have been imposed on new construction projects and major renovations requiring a building permit in Philadelphia. The tax proceeds would have been directed into Philadelphia's Housing Trust Fund, which focuses on the development of new affordable housing projects in the city. City council estimated that the construction tax would generate nearly $19 million in tax revenue for the Housing Trust Fund each year. Similar to the tax abatement program, the construction tax bill was both applauded and criticized. Supporters believed that the tax would have helped address the city's economic and racial disparity by providing more affordable housing. Critics argued that the tax would have halted the ongoing transformation of the city by raising the already high construction costs and discouraging investments by major developers.

The compromise between Kenney and city council is presented as a combined response to these issues. Under the compromise, tax revenue from properties with expiring abatements will fund affordable housing projects, and developers will be relieved from the threatened rise in construction costs. On Oct. 4, city council solidified the compromise by passing a package of legislative bills providing $71 million for affordable housing over the next five years, which awaits Kenney's approval. As part of the legislation, approximately $53 million in tax revenue from properties with expiring tax abatements will fund the Housing Trust Fund. Kenney believes that this structure will provide a reliable source of funding for affordable housing. Critics argue that the amount of funding is inadequate and prefer a tax-funded trust, viewing that option as a more stable, permanent solution to providing more affordable housing.

Another part of the legislation is projected to generate the remaining $18 million through an inclusionary zoning bill, provided developers take advantage of the legislation. The new zoning bill increases the permitted height, density, and floor area for projects beyond current zoning limits. In exchange, developers must either add a certain amount of affordable housing units to new construction projects or pay a fee to the Housing Trust Fund for the additional housing units or square footage allowed under the bill, depending on the location of the project. The hope is that demand for these additional development opportunities will lead to the construction of more affordable housing projects throughout the city.

Although the compromise secures the short-term future of the tax abatement program, the long-term future of the program is murky at best. Some city council members have indicated that the program will continue to be a subject for debate in the coming months. In fact, a day before the compromise, Councilwoman Cindy Bass proposed a bill that would eliminate the tax abatement program, which city council may reconsider later this year.

Attorneys representing developers interested in building large construction projects in Philadelphia should apprise their clients of these recent developments. The continued existence of the tax abatement program and elimination of the construction tax should provide some comfort to developers concerned with the already high construction costs in Philadelphia for the time being. However, the future of the tax abatement program is uncertain and this uncertainty should be communicated to clients considering projects in the city in the next five to 10 years.

Further, attorneys should advise their clients to evaluate the new and potentially rewarding opportunities in affordable housing. The city's actions show a commitment to affordable housing to the tune of $71 million being placed into the Housing Trust Fund, which distributes funding to developers through a competitive RFP process. By securing some of this funding from the Housing Trust Fund, developers may find more affordable housing projects to be feasible or more profitable. Moreover, the inclusionary zoning bill allows developers to build multifamily projects beyond the current zoning limits as long as developers comply with the bill's requirements. This legislation could help developers counterbalance the high construction costs in the city by building larger projects with more units and square footage.

Despite the recent news, the long-term outlook of the tax abatement program is still unknown. City council's fall session might provide more insight into the viability of the tax abatement program moving forward. For now, the recent developments have breathed new life into the program's short-term future. That life, however, may be inextricably linked to the progress of affordable housing projects in Philadelphia if the funding is less than projected or does not make a meaningful impact on affordable housing, which may create more pressure on the city to revisit the tax abatement program.

Martin J. Doyle is a partner in Saul Ewing Arnstein & Lehr's real estate, environmental and energy department focusing on all aspects of transactional real estate law.  Doyle can be contacted at [email protected].

Megan E. Moyer is an associate in the firm's real estate, environmental and energy department focusing on all aspects of transactional real estate law. She can be reached at [email protected]. 

Ian M. Livaich is an associate in the firm's real estate, environmental and energy department focusing on all aspects of transactional real estate law. Livaich can be reached at [email protected].