Low-Income Housing Tax Credit

The Low Income Housing Tax Credit (LIHTC) program was created by Section 42 of the Tax Reform Act of 1986, in response to growing awareness that a large proportion of families need some form of assistance to afford their monthly rent. According to the 2010 American Community Survey, more than 19 million households (49% of apartment renters) pay more than 30% of household income in rent.

LIHTCs quickly became the most important federal program for encouraging development of affordable rental housing. The program works by incentivizing private investors to provide equity at lower costs for construction or rehabilitation of low income housing.

Studies show that without the LIHTC program, the housing market will support affordable apartments only if construction costs drop another 28%. According to a 2011 Harvard study, nearly three out of ten low-cost rental housing units available in 1999 are no longer on the market.

More valuable than tax deductions against income, LIHTCs are direct reductions in the amount of U.S. federal tax you pay, each year that you pay tax, for a full 10 years. Even better, participation does not preclude receiving other government subsidies on the same project, such as development grants, below-market-rate loans, or Section 8 assistance to individual tenants.

To take advantage of the LIHTC program, you begin by proposing a project with its estimated cost to a state housing finance agency. Several times a year, the agency compares all currently proposed projects and awards credits to those it ranks highest — in descending order — until it has allocated all its available credits.

Developers who hope to win LIHTCs in a particular state should study its publicly-available "Qualified Allocation Plan", which lays out the state's criteria for awarding these credits.

As part of an LIHTC proposal, a developer must commit to one of the following two "set-asides":

To beat out other applicants, developers tend to offer more than these minimums — such as lower rents, longer set-asides, or allocating more of a project (sometimes up to 100%) to rent-restricted units.

As part of the deal, developers agree to charge low income tenants just 30% of their income. However, they are free to ask market-rate rents on any units not reserved for low-income tenants.

Winning projects must abide by LIHTC program rules or suffer recapture of their credits, and possible black-listing for future credits. The rules are set forth in a "Land Use Restriction Agreement" (LURA), covering a 15-year initial compliance period plus a subsequent 15-year or longer extended use period.

The actual amount of LIHTC credits awarded depends on: the actual cost of the project, the applicable "tax credit rate" established by the IRS, and the percentage of the project's units rented to low income tenants. LIHTCs are generally limited to a maximum of 9% of the project's qualified basis. For projects financed with tax-exempt bonds, LIHTCs are generally limited to 3–4%.

Once you've obtained LIHTCs, you can quickly utilize them to enhance the profitability of the project. Developers typically use any LIHTCs they win to attract private equity — effectively reducing their need to borrow. The usual method is to "sell" a project's LIHTCs through LLCs or limited partnerships, allocating as much as 99.99% of the project's profits, losses, depreciation, and tax credits to investors.