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Resources for Affordable Housing
Low-Income Housing Tax Credit
If your agency has not yet used federal low-income housing tax credits (LIHTCs) to create affordable housing for low- and moderate-income families, the program may seem complicated and difficult. However, many local housing and community development agencies have effectively used these tax credits to raise equity for developments that otherwise would not have been built or purchased and rehabilitated.
This primer is intended to provide basic, understandable information on LIHTCs: what they are, how they work, what projects are eligible, and how to get started. Requirements vary from state to state, so it is essential that you consult with your state housing finance agency and with competent tax and legal counsel before deciding whether to proceed.
What Are Low-Income Housing Tax Credits?
The LIHTC is based on section 42 of the Internal Revenue Code, enacted in 1986 and made permanent in 1993. By providing a credit against tax liability or a dollar-for-dollar reduction in the amount of liability, the LIHTC is an incentive for individuals and corporations to invest in the construction or rehabilitation of housing for low-income families. Tax credits have become the single most important source of capital subsidy in the development of affordable rental housing.
How Does the Tax Credit Work?
For 2002, the Internal Revenue Service (IRS) permits each state to allocate LIHTCs equal to 1.75 times its population. Beginning in 2003, the limit will be adjusted for inflation.
The IRS requires that 10 percent of each state's annual tax credit allocation be set aside for projects at least partially owned by nonprofit organizations; however, many states have enacted policies ensuring that a larger share of the credits are allocated to nonprofit organizations.
Each state designates an agency (usually the housing finance agency) to administer the tax credit program. The agency must develop a plan for allocating the credits consistent with the state's consolidated plan. Federal law requires that the allocation plan give priority to projects that (a) serve the lowest income families and (b) are structured to remain affordable for the longest period of time.
After holding public hearings, the state may enact specific policies to promote geographic targeting, encourage rural or distressed urban neighborhood projects, and so on. According to its plan, the state allocates tax credits to qualified projects, usually through a competitive application process and a rigorous evaluation.
State allocation plans vary in their treatment of projects sponsored by local housing authorities (LHAs). Some states award bonus points to such projects; others require that LHAs work with nonprofit organizations to be eligible to apply for tax credits. The structure of those arrangements is very important and can typically be negotiated.
Most new construction and substantial rehabilitation projects are eligible for a 9 percent tax credit; that is, credit equal to 9 percent of qualified costs each year for 10 years. For example, in a rehabilitation project with $100,000 in qualified costs, tax credits can equal $90,000 over 10 years.
Projects that are financed through the issuance of tax-exempt bonds may qualify for an automatic 4 percent tax credit allocation. Credits awarded to these projects are not subject to the per capita limit; however, the underlying bonds are subject to the state private activity bond cap.
After a project has been awarded tax credits, the owner or developer usually hires a broker or syndicator to market them. Many private firms, statewide equity funds, and national organizations specialize in raising capital for nonprofit projects. Competition for tax credits can be fierce, and project developers often find multiple bidders for the right to syndicate them.
The credits, which must be taken over a 10-year period, are sold to investors on the basis of their current value. For example, a project may be awarded $1 million in tax credits. Because the credits must be spread over 10 years, investors typically discount the value to about 75-85 cents on the dollar. Thus, $1 million in tax credits would generate $750,000-850,000 in equity for the project, minus the syndication costs.
Investors in tax credit projects can use the credits to reduce their tax liability, dollar for dollar, each year for 10 years. However, individual investors are restricted in their use of housing tax credits; thus, most credits are purchased by widely held C corporations, which may use them against any amount of tax liability on all income.
According to the IRS, units that qualify for low-income housing tax credits must be affordable to low-income families. This means that
at least 20 percent of the units in the project must have rents affordable to* and be occupied by households with incomes no greater than 50 percent of median (adjusted for family size);
OR
at least 40 percent of the units must be affordable to* and occupied by families with incomes no greater than 60 percent of median (adjusted for family size).
(*To be affordable, maximum rents can be no more than 30 percent of income, adjusted for family size.)
The number of low-income units in the project determines the percentage of qualified costs used to calculate the tax credit.
According to IRS rules, low-income occupancy must be maintained for at least 15 years. However, there are very strong federal incentives to maintain the restrictions for 30 years, and some states impose additional requirements.
States are required to monitor all tax credit projects for compliance with these restrictions and for their physical condition, and must report any noncompliance to the IRS. Noncompliance carries stiff penalties, including retroactive tax liabilities for the investors.
How Do You Begin?
If your agency is considering developing a project that may qualify for low-income housing tax credits, the first step is to contact the agency responsible for tax credit allocation in your state to learn about the application process and the criteria by which the agency awards credits. It is a good idea to contact someone in an agency similar to yours who has gone through the application and allocation process in your state. Many experienced consultants are available to help you through the process, especially if this is your first attempt. You may also find assistance through the NAHRO Access Alliance, available via the NAHRO web site at nahro.org.
The application process is very competitive in most states. Some states accept applications continuously throughout the year, while others accept them only at specific times. Some have consolidated the tax credit application with applications for other state housing programs.
Tax credit applications undergo a rigorous evaluation; typically, they are awarded points for criteria outlined in the state's allocation plan. For example, the state plan may give priority to projects with units for tenants with special needs or units affordable to very low-income tenants. Usually, the projects that receive the highest number of points receive allocations.
For more information on how low-income housing tax credits are administered and allocated in your state, contact the appropriate state agency. Please click on state agencies to view a list of state housing finance agencies assembled by the National Council of State Housing Agencies.
Copyright 1997 - 1998 - 1999 - 2000-2001-2002
Affordable Housing and HOME
National Association of Housing and Redevelopment Officials (NAHRO)
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Washington, DC 20001-3736
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