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Low Income Housing Tax Credit

May 6, 2009
By Danna Fischer, Legislative Director and Counsel, National Low Income Housing Coalition

The Low Income Housing Tax Credit (LIHTC) program is designed to expand the supply of affordable housing by offering tax credits to investors and thereby encouraging private investment. Because the economic downturn has dampened demand for tax credits, many developments have stalled because of a lack of sufficient financing.

History
LIHTC was created by the Tax Reform Act of 1986 and is codified at Section 42 of the Internal Revenue Code, 26 U.S.C. 42, so tax credit projects are sometimes referred to as ‘Section 42 Projects.’ The regulations governing the program can be found at 26 C.F.R. §1.42. The IRS provides additional guidance through revenue rulings, technical advice memorandums, notices, private letter rulings, and other means.

Program Summary
The LIHTC program is designed to expand the supply of affordable housing by encouraging private investment in affordable development. In 2007, just over $790 million in credits produced 74,663 units and as of 2005, the LIHTC program had created 1.382 million units. The encouragement comes in the form of a tax credit to the investors, who provide cash or ‘equity’ to the developer of a project and, in return, receive a dollar-for-dollar reduction in their federal income taxes. This infusion of equity reduces the amount of money a developer has to borrow, thereby lowering costs and allowing for lower rents. The LIHTC can be used to support a variety of projects including both multifamily and single-family housing, new construction, and rehabilitation, and  housing for the elderly and disabled. Tax credit projects are found in all parts of the country, including rural areas.

Tax credits are allocated to states based on each state’s population. The Housing and Economic Recovery Act of 2008 (HERA) increased each state’s credit cap (as the state allocations are called) for 2009 to $2.20 multiplied by the state population, with a minimum of $2,557,500. In 2010 the cap will return to its pre-HERA level of $2.00 per capita (adjusted for inflation), with a minimum of $2,325,000 to each state.  

In turn, states, through one or more agencies, including their Housing Finance Agency (HFA), allocate credits to specific projects according to the state’s Qualified Allocation Plan (QAP; for more information see QAP article). Both for profit and nonprofit developers can apply for credits, but at least 10% of an HFA’s total tax credits must be set aside for nonprofits.

Once awarded tax credits, a developer then sells them to investors, usually through a ‘syndicator.’ Most investors are corporations and many are financial institutions that receive Community Reinvestment Act credit for these investments. Syndicators act as a broker between the developer and the investor. Syndicators sometimes pool several tax credit projects together l and sell investors shares in the pool. The cash (equity) provided by the investors is used by the developer, along with other resources such as conventional mortgages, state loans and funds from federal programs such as HOME, to construct or substantially rehabilitate affordable housing

Tax credits are available only for qualified low income housing projects which are defined as housing where either (1) 20% or more of the units are rent restricted and occupied by persons at 50% of area median income or less (20/50 projects) or (2) 40% of the units are rent restricted and occupied by persons at 60% of area median or less (40/60 projects). Units are rent restricted when rent and utilities do not exceed 30% of the income limitation applicable to that unit, i.e. 50% or 60% of area median income.  

The amount of the tax credit varies with the type of project. There are two levels of credit: 9% and 4%. (The 9% and 4% rates are designed to yield 70% or 30% ‘net present value,’ respectively. Thus, in the case of a 9% credit, the stream of tax credits over the 10-year credit period has a value today equal to 70% of the eligible development costs, and in a 4% project, the present value of the credits is equal to about 30% of the development costs. Consequently, these projects are also called 70% and 30% projects, respectively.) The 9% tax credit is generally available for construction or rehabilitation projects that do not have other federal funds, and the 4% credit is for (1) acquisition of existing buildings for substantial rehabilitation; (2) new construction or substantial rehabilitation subsidized with other federal funds or (3) projects financed with tax-exempt bonds.  

The figures 9% and 4% are only approximate rates. The IRS computes actual rates monthly based on Treasury interest rates. For any given project, the real tax credit rate is set, at the developer’s option the month a project is ready for occupancy, or the month a binding commitment is made between an HFA and developer. This applicable percentage is applied to the project’s ‘qualified basis’ to determine the investors’ tax credit. These credits are taken over 10 years. Under HERA, non-federally assisted projects placed in service between July 30, 2008 and January 1, 2014, will receive credits worth at least 9% and projects with below market loans are eligible for 9% credits.

The ‘qualified basis’ is determined by applying the lower of (1) the ratio of lower income units to all units (the ‘unit fraction’) or (2) the ratio of square feet in the lower income units to the project’s total square feet (the ‘floor space fraction’) to the total ‘eligible basis.’ Eligible basis includes building acquisition, construction, soil tests, engineering costs, and utility hookups. Land acquisition and permanent financing costs are not counted toward the eligible basis, and the eligible basis is usually reduced by the amount of any federal funds. The eligible basis of a project can get a 30% increase (a ‘basis boost’) if the project is located in a census tract designated by HUD as a low income tract (‘Qualified Census Tract’ or QCT) or a high cost area (‘Difficult to Develop Area’ or DDA). The greater the proportion of rent-restricted lower income units in a project (the greater the applicable fraction), the more tax credits a project can receive. This is an incentive to create projects with more than the minimum number of required rent-restricted lower income units. HERA expanded the use of this basis boost to areas designated by a state as requiring an increase in the credit amount to be financially feasible.

Tax credit units are available to persons with incomes at the time of initial occupancy at or below 50% or 60% of area median income depending on the election made by the developer. Tax credits are available only for rental units that meet either the 20/50 or 40/60 test outlined above, but projects do not have to contain 100% tax credit units. Therefore, it is possible for LIHTC projects to have a mix of units occupied by lower income people and moderate and middle income people. Some HFAs choose to create deeper targeting in order to serve households with even lower incomes.  

While rents on the tax credit units are restricted, tenants pay the fixed maximum tax credit rent, even if it is greater than 30% of their income. In other words, the rent a tenant pays is not based on the tenant’s income; rather it is based on the applicable (50% or 60%) area median income. Consequently, lower income residents of tax credit projects might be ‘rent burdened,’ paying more than 30% of their income for rent and utilities. Conversely, tax credit projects might simply not be financially available to very low and extremely low income people because rents charged are not affordable to them. HUD’s tenant-based Housing Choice Vouchers or project-based Section 8 vouchers or U.S. Department of Agriculture (USDA) Rural Development Section 521 Rental Assistance (RA) are often needed to fill the gap between 30% of a resident’s actual income and the tax credit rent.

The law requires units to be rent-restricted and occupied by income-eligible households for at least 15 years (called the ‘compliance period’), with an ‘extended use period’ of at least another 15 years (30 years all together). Some states require ‘extended low income housing commitments’ greater than 30 years or provide incentives for projects that voluntarily agree to longer commitments. Where states do not mandate longer restricted-use periods, during the 14th year of the 15-year compliance period, an owner can submit a request to the HFA to sell a project or convert it to market rate. The HFA has one year to find a buyer willing to maintain the rent restrictions for the balance of the 30-year period. If the property can’t be sold to such a ‘preservation purchaser’ then the owner’s obligation to maintain rent-restricted units is removed and lower income tenants receive enhanced vouchers enabling them to remain in their units for three years.

Although housing tax credits are federal, each state has an independent agency that decides how to allocate its share of federal housing tax credits. Each HFA must have a Qualified Allocation Plan (QAP), which sets out the state’s priorities and eligibility criteria for awarding federal tax credits to housing projects. The QAP is subject to public comment and thus is a tool advocates can use to influence how their state’s share of annual tax credits is allocated to affordable housing projects. For a more complete discussion, see the Qualified Allocation Plan chapter.
LIHTC credits can be, combined with funding from other federal and state programs. HOME, Community Development Block Grant (CDBG), HOPE VI funds, tax exempt and taxable bond-financing, Section 8 project-based assistance and the Federal Home Loan Banks (FHLB) affordable housing funds can all be combined with low income housing tax credits to support affordable housing. HERA made changes in the HUD and Department of Agriculture (USDA) programs to make them more compatible with the LIHTC program. Those changes include streamlining the approval process for use of LIHTCs in HUD and USDA projects, modifying the FHA insurance program so that they are more compatible with the LIHTC program and increasing the flexibility of the project-based Section 8 program, the McKinney-Vento Homeless Assistance Shelter Plus Care program and the Section 202 elderly housing program to enable them to coordinate better with the LIHTC program

Funding
This program is administered by the Treasury Department’s Internal Revenue Service (IRS). The LIHTC is a tax expenditure, which does not require an appropriation. The Joint Committee on Taxation estimates that the program will cost $5.1 billion in tax expenditures in 2009.

What Advocates Need to Know Now
The economic downturn has adversely affected the tax credit program and caused many developments to stall for lack of sufficient financing. The American Recovery and Reinvestment Act (ARRA) contained two provisions that will help some of these stalled projects.  The first provision allows states to trade in up to 40% of their 2009 LIHTC allocation authority and all of their unused 2008 authority for cash at $.85 on the dollar. ARRA also includes $2.25 billion in special HOME funds to address some of the financing gaps in projects that receive credits between October 1, 2006 and September 30, 2009.

While these changes are valuable, many believe they are insufficient to revive the market and attract new investors. Advocates should monitor the program carefully. Attempts to modify the program to attract new investors may provide opportunities to deepen the income targeting for the program or modify the rent structure to reduce potential rents burdens on very low income tenants.  

For More Information
Opening Doors, Issue 26, April 2005, “Using the Low Income Housing Tax Credit Program to Create Affordable Housing for People with Disabilities.” http://www.tacinc.org/Docs/HH/OpeningDoors/ODIssue26.pdf

HUD’s HOME program web page has a good, basic tutorial at www.hud.gov/offices/cpd/affordablehousing/training/web/lihtc/.

A list of QCTs and DDAs are posted at www.huduser.org/datasets/qct.html.

The Housing Assistance Council (HAC) has three resources:
A guidebook called Utilizing the Low Income Housing Tax Credit for Rural Rental Projects. Chapter III, “Tax Credit Basics,” is a good overview at www.ruralhome.org/pubs/guides/lihtc/toc.htm .   
The Winter 2003-2004 edition of Rural Voices is devoted to “Tax Credits and Rural Housing” at www.ruralhome.org/manager/uploads/VoicesWinter0304.pdf.  
A short one-page overview is available at www.ruralhome.org/infoSheets.php?id=177.

The Enterprise Foundation has a tutorial at www.enterprisecommunity.com/products_and_services/downloads/lihtc_101_ppt_10-06.pdf.   

Information about QAPs and HFAs
A capsule description of the preservation-oriented features of each state’s QAP is available from the National Housing Trust at www.nhtinc.org/documents/Pres_Scan_May2006_final.pdf.

The National Housing Trust lists LIHTC projects on a state-by-state basis at www.nhtinc.org/data_map.asp.

HUD’s data base of LIHTC projects, updated through 2007, is at www.huduser.org/datasets/lihtc.html.