Building Communities and Tax Savings with the Low-Income Housing Tax Credit
Originally published on October 21, 2019
Updated on October 30th, 2023
Building communities is about more than the structures created. It’s about making it possible for more people to thrive and work toward their dreams. And tools like the Low-Income Housing Tax Credit (LIHTC) help real estate developers do exactly that for the communities that they serve.
What is the LIHTC?
The country’s largest affordable housing production program, the LIHTC was created as an incentive for private developers and investors to provide more low-income housing in exchange for federal income tax credits. Since 1986, the program has helped finance the construction of nearly three million rental units for low-income Americans.
Within the LIHTC program there are two types of credits. A 9% credit is commonly used for new construction and is generally highly competitive. It allows the investor to claim a tax credit each year for ten years for 9 percent of the project’s qualified cost basis. The credit increases by 30 percent in difficult development areas, census tracts with many low-income households or in areas designated by the state housing agency.
There is also a 4% credit that provides a more shallow capital subsidy. This credit must be combined with private activity housing bonds, which are special tax-exempt bonds issued by a local or state government.
Qualifying for the Credit
The IRS sets the general guidelines and state housing agencies administer the LIHTC program, reviewing applications and allocating the credits to developers through a competitive process.
According to the Tax Policy Center, owners or developers receiving the LIHTC must meet one of three income tests:
- At least 20% of the project’s units are occupied by tenants with an income of 50% or less of area median income (AMI) adjusted for family size.
- At least 40% of the units are occupied by tenants with an income of 60% or less of AMI.
- At least 40% of the units are occupied by tenants with income averaging no more than 60% of AMI, and no units are occupied by tenants with income greater than 80% of AMI.
Priority is given to housing projects that serve the lowest-income tenants and safeguard affordability for the longest period of time. The developer typically secures a conventional loan from a private mortgage lender, gap financing from a public or private source and equity from the developer or private investor in exchange for the tax credits.
Credits usually cover only about 60–70 percent of the cost of new construction or renovation, so developers typically utilize other funding sources, including state and local governments and state housing trust funds.
Allocating the Credit
Typically, developers sell the tax credits to investors who are able to use the tax credits and other tax benefits of the housing project. Most investors in LIHTC projects are corporations that have sufficient income tax liability to fully use nonrefundable tax credits. Additionally, the Community Reinvestment Act is a federal law designed to encourage banks to invest deposits back into their community, including investing in a LIHTC project.
The developer can either work with an investor who invests directly into a partnership (or LLC) and receives tax credits, or work with a syndicator who acts as a broker between the developer and investor.
Maintaining the Credit
Once the housing project is made available to tenants, investors can claim the LIHTC over a 10-year period. Developers and investors must contend with the carryover allocation, cost certifications and submission of numerous compliance forms on an annual basis over a 15-year period with an extended compliance period of 30 years in total. Some states require affordability periods even beyond 30 years.
Failure to comply with the applicable rules, or a sale of the project or an ownership interest before the end of at least a 15-year period, can lead to recapture of credits previously taken, as well as the inability to take future credits.
A LIHTC project developer can obtain a developer fee and cash flow from the project as a general partner. There is a high learning curve due to the federal and state regulations. Lisa Stephens, with Saigebrook Development, noted that LIHTC properties tend to have both lower debt service payments and lower vacancy rates than market-rate rental housing. She also noted that they generally experience a relatively quick lease-up, and these properties provide some risk management against economic downtowns.
LIHTC Builds Healthy Communities
Affordable housing projects give developers like you more than just a business advantage; they’re a way to contribute to the long-term success of a sustainable community. Such projects can be tough to navigate without proper guidance. With the right advisory team, you can leverage these credits to mitigate tax exposure while creating a home for people who need it the most.
Ready to explore the LIHTC and quality affordable housing development? Contact your real estate CPA to learn more and get connected with knowledgeable investment partners.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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