Low-Income Housing Tax Credit
What is LIHTC?
The Low-Income Housing Tax Credit program is a federal government initiative which gives designated agencies authority over a roughly $8 billion budget for the purpose of providing tax credits for the acquisition, rehabilitation, or construction of rental housing for lower-income households. Enacted as a part of the Tax Reform Act of 1986, the LIHTC program is meant to incentivize developers to create low-income housing by offering a 10-year credit on federal income tax. Without the incentive, affordable rental housing projects would not be as appealing to multifamily investors, since they otherwise might not generate sufficient profit to justify investment.
4% vs. 9% LIHTC
An LIHTC can subsidize either 30% or 70% of the costs to create low-income units in a development project. A 4% LIHTC, which subsidizes 30% of a project’s development costs, is typically used for property acquisition and rehabilitation. The 9% LIHTC, which subsidizes 70% of the development costs, is usually reserved for new construction.
How Does the LIHTC Program Work?
Simply put, the low-income housing tax credit program subsidizes the acquisition, rehabilitation, or construction of affordable rental housing. The program functions as follows: The federal government grants state and territorial governments authority over a predetermined budget. State housing agencies can then award tax credits to private developers through a competitive process. Developers awarded low-income housing tax credits typically sell credits to private investors in order to obtain funding for a project.
Though technically a federal program, the LIHTC program is executed by individual state Housing Finance Authorities (HFAs), which are responsible for approving LIHTCs to investors and developers on a project-by-project basis. Each state has a Qualified Allocation Plan (QAP), created to detail specific eligibility requirements for LIHTC projects, which are typically stricter than at the federal level.
LIHTCs don’t provide a tax deduction, which would reduce a borrower’s taxable income. Instead, the credit provides a tax discount of a specific dollar amount that can be applied to the investor or developer’s tax bill. Once the housing project is made available to tenants, investors are then able to claim the LIHTC over a 10-year period.
LIHTC Property Eligibility Requirements
The LIHTC program is available for various property types, including apartment buildings, single-family homes, townhouses, and duplexes. In order for a property to be considered eligible for the program, it must pass at least one of these three affordability tests:
- 20% or more of the units are occupied by (or reserved for) tenants with an income of 50% or less of the area median income (AMI).
- 40% or more of the units are occupied by (or reserved for) tenants with an income of 60% or less of the AMI.
- 40% or more of the units are occupied by (or reserved for) tenants with an income of no more than 60% of the AMI, and the property has no units occupied by tenants with an income greater than 80% of the AMI.
What is the Low-Income Housing Tax Credit?
The Low-Income Housing Tax Credit (LIHTC) program is a federal government initiative which gives designated agencies authority over a roughly $8 billion budget for the purpose of providing tax credits for the acquisition, rehabilitation, or construction of rental housing for lower-income households. Enacted as a part of the Tax Reform Act of 1986, the LIHTC program is meant to incentivize developers to create low-income housing by offering a 10-year credit on federal income tax. Without the incentive, affordable rental housing projects would not be as appealing to multifamily investors, since they otherwise might not generate sufficient profit to justify investment.
LIHTCs help fund the new construction and rehabilitation of a variety of different property types, including traditional apartments, single-family homes, and two- to four-unit multifamily properties (think duplexes or triplexes). In addition, LIHTCs can fund the conversion of structures like schools, warehouses, and motels into multifamily properties. Properties using these credits must generally cap rents for some or all of the units at a certain percentage of a location’s Area Median Income, or AMI.
How does the Low-Income Housing Tax Credit work?
The Low-Income Housing Tax Credit (LIHTC) program is a federal government tax credit that, since 1986, has helped facilitate the construction and rehabilitation of 3.6 million affordable housing units throughout the U.S., according to housing advocacy organization NAHRO. Unlike tax deductions, which create a reduction in taxable income, tax credits provide a dollar-for-dollar reduction in an investor’s tax liability, which can be incredibly attractive.
LIHTCs help fund the new construction and rehabilitation of a variety of different property types, including traditional apartments, single-family homes, and two- to four-unit multifamily properties (think duplexes or triplexes). In addition, LIHTCs can fund the conversion of structures like schools, warehouses, and motels into multifamily properties. Properties using these credits must generally cap rents for some or all of the units at a certain percentage of a location’s area median income, or AMI.
The program functions as follows: The federal government grants state and territorial governments authority over a predetermined budget. State housing agencies can then award tax credits to private developers through a competitive process. Developers awarded low-income housing tax credits typically sell credits to private investors in order to obtain funding for a project.
Though technically a federal program, the LIHTC program is executed by individual state Housing Finance Authorities (HFAs), which are responsible for approving LIHTCs to investors and developers on a project-by-project basis. Each state has a Qualified Allocation Plan (QAP), created to detail specific eligibility requirements for LIHTC projects, which are typically stricter than at the federal level.
LIHTCs don’t provide a tax deduction, which would reduce a borrower’s taxable income. Instead, the credit provides a tax discount of a specific dollar amount that can be applied to the investor or developer’s tax bill. Once the housing project is made available to tenants, investors are then able to claim the LIHTC over a 10-year period.
What are the benefits of the Low-Income Housing Tax Credit?
The Low-Income Housing Tax Credit (LIHTC) program offers tax incentives in two separate ways, covering either 30% or 70% of a rehabilitation or development project’s costs. This program provides a dollar-for-dollar reduction in an investor’s tax liability, which can be incredibly attractive. Additionally, investors or developers may also be in a strong position to utilize additional credits if a property or development is located within an Opportunity Zone.
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What are the eligibility requirements for the Low-Income Housing Tax Credit?
In order for a property to be considered eligible for the Low-Income Housing Tax Credit (LIHTC) program, it must pass at least one of these three affordability tests:
Test Requirements 20% or more of the units are occupied by (or reserved for) tenants with an income of 50% or less of the area median income (AMI). 50% or less of the AMI 40% or more of the units are occupied by (or reserved for) tenants with an income of 60% or less of the AMI. 60% or less of the AMI 40% or more of the units are occupied by (or reserved for) tenants with an income of no more than 60% of the AMI, and the property has no units occupied by tenants with an income greater than 80% of the AMI. 60% or less of the AMI, and no units occupied by tenants with an income greater than 80% of the AMI. In addition to the above, a gross rent test must also be passed. This test requires that rents for the property do not exceed 30% of either 50% or 60% of AMI (the exact percentage depends on the number of rental units set aside for the credit). LIHTC properties are required to pass these income and rent tests for a period of no less than 15 years — or risk having the tax credits recaptured by the local housing authority.
Competition for the LIHTC program is fierce, as each state only receives a limited amount of LIHTC funds each year, based on population and a specific multiplier. The program costs an estimated $10.9 billion annually, according to an analysis by the Federation of American Scientists. The LIHTC generally has a 15-year compliance period, during which the property must remain affordable and before which the property cannot be sold. This, however, is only a minimum, and many states have more restrictive rules in place.
Investors should also know that Low-Income Housing Tax Credits come in two varieties, a 4% and a 9% LIHTC. The 4% LIHTC subsidizes 30% of a project’s cost, while the 9% covers 70% of a project’s cost.
How can I apply for the Low-Income Housing Tax Credit?
In order to apply for the Low-Income Housing Tax Credit (LIHTC), you must first apply with a state’s Housing Finance Authority (HFA) and submit a project proposal. If the HFA agrees to approve the credits, the next step is for the project’s Land Use Restrictive Agreement (LURA) to be negotiated. After negotiations, the project can begin construction or rehabilitation. Once complete, the property can be certified by the HFA, after which units are ready for leasing. All communities must be recertified on an annual basis in order for investors or developers to continue to receive the tax credits.
For more information on the LIHTC program, please visit apartment.loans/posts/what-is-the-lihtc.
In addition to the above, a gross rent test must also be passed. This test requires that rents for the property do not exceed 30% of either 50% or 60% of AMI (the exact percentage depends on the number of rental units set aside for the credit). LIHTC properties are required to pass these income and rent tests for a period of no less than 15 years — or risk having the tax credits recaptured by the local housing authority.
How the LIHTC Process Works for Developers
In order for a developer to obtain LIHTCs, they must first apply with a state’s HFA and submit a project proposal. If the HFA agrees to approve the credits, the next step is for the project’s Land Use Restrictive Agreement, or LURA, to be negotiated. The LURA establishes a maximum limit for rents that the owner of a property can charge. This amount is usually based on a specific percentage of the area median income.
After negotiations, the project can begin construction or rehabilitation. Once complete, the property can be certified by the HFA, after which units are ready for leasing. All communities must be recertified on an annual basis in order for investors or developers to continue to receive the tax credits.
How the LIHTC Process Works for Investors
In order for an investor to be granted low-income housing tax credits, they must own shares in the project itself. This typically means they own all or part of an LLC or are in a direct partnership with the developer. Tax credits issued to an investor are based on their contribution towards a project. To determine the exact amount of an investor contribution, the developer creates a projected cost for the credits, and then applies a specific discount rate (incorporated to ensure investors profit from the transaction) that was negotiated beforehand by both parties. The resulting figure is then multiplied by the share of the LLC or partnership an investor owns.
Let’s illustrate this with an example. A developer forecasts an LIHTC of $2 million. An investor partners with the developer for an 80% take, with a discount rate negotiated at 75%. The investor’s contribution would be calculated as follows:
$2 million x 80% take x 75% discount rate = $1.2 million
LIHTC-Eligible Financing Options
Even though low-income housing tax credits subsidize a portion of an affordable housing project, the rest of the costs are typically financed using a loan. Many financing options, including agency programs like HUD, Fannie Mae® and Freddie Mac®. offer incentives for LIHTC-eligible properties.
For instance, the flagship HUD 221(d)(4) and HUD 223(f) programs both permit LTVs of up to 87% for affordable properties, with LTVs of up to 90% for properties that have 90% or more units reserved for low-income families. HUD also offers a discounted 0.45% annual MIP for LIHTC or Section 8 properties compared to market-rate properties which require payments of 0.65% annually.
Fannie Mae® and Freddie Mac® also offer a plethora of loan options for affordable properties. Freddie Mac has a couple of financing options that are specifically geared toward the LIHTC program. The Freddie Mac Bond Credit Enhancement with 4% LIHTC, for example, is a flexible finance vehicle designed to either provide forward commitments for both the new construction or substantial rehabilitation of LIHTC properties. Alternatively, it can provide immediate funding for current LIHTC properties able to maintain at least 90% occupancy for 90 days. It can also be utilized to provide preservation rehabilitation funds for projects with tenants in place undergoing moderate rehab.
The Freddie Mac LIHTC Enhancement program is designed to protect LIHTC investors in the event that an owner/operator defaults on their loan. The protections make it substantially easier to attract investors to a project. Even Freddie Mac Tax-Exempt Loans provide up to 30 years of financing for 4% LIHTC projects. For LIHTC properties that are part of the HUD Section 8 program, the Freddie Mac HUD Section 8 loan permits LTVs of up to 90% and DSCRs as low as 1.15x.
Alternatively, Fannie Mae’s LIHTC-focused products include the Fannie Mae MBS as Tax-Exempt Bond Collateral (M.TEB), which allows existing bond refunding and new issues for 4% LIHTC properties. The program offers LTVs of up to 90%, with an interest-only option for eligible borrowers. Another LIHTC-focused option is the Fannie Mae Credit Enhancement of Variable Rate Tax-Exempt Bonds (Index Bonds), which also permits LTVs of up to 90% for eligible 4% LIHTC properties.