The Low-Income Housing Tax Credit, or LIHTC, is the largest federal program designed to encourage the construction of affordable rental housing in the United States.
Since its 1986 inception, the LIHTC has subsidized the construction or renovation of more than 3 million affordable housing units by providing tax credits to developers who build or rehabilitate qualifying properties, with an average of 107,000 housing units placed in service every year between 1995 and 2017 thanks to the credit.
How the LIHTC works
The LIHTC isn't awarded to developers directly from the U.S. government. Instead, the federal government issues the credits to state governments, which then give the credits to affordable housing developers.
There are two main criteria to qualify for the LIHTC: the income test and the gross rent test.
The income test
The income test is to ensure that the tenants of the property are actually low-income families, as the credit intends. There are three different types of rent restrictions a project can use to qualify:
- 20% or more of the housing units are occupied by tenants with incomes of 50% of the area median income (AMI) or less.
- 40% or more of the tenants have incomes 60% or less of the area median income.
- 40% or more of the tenants have income that averages 60% or less of AMI, and no tenant's income exceeds 80% of the area's median income.
Gross rent test
Rents for the restricted units cannot exceed 30% of either 50% or 60% of AMI, depending on the project's AMI qualification method in the income test. AMI is calculated for these tests as based on 1.5 occupants per bedroom (so, 3 people in a two-bedroom housing unit). To be clear, not all of the housing units in a project need to be rent-restricted for the developer to qualify for the LIHTC.
Here's how this works. Let's say that a two-bedroom unit is constructed in an LIHTC project that is targeted for residents who earn 50% of AMI or less. If the area's median income is $70,000 for a three-person household, that means the tenant must earn $35,000 or less to qualify. Rent will be set at 30% of this income threshold, which translates to $875 per month.
Both the income and gross rent tests must be satisfied in an LIHTC recipient project for at least 15 years. For LIHTC developments placed into service after 1989, the use restrictions last for 30 years, and some states have restrictions that last even longer.
In practice, real estate developers who are awarded the LIHTC typically sell the credits to real estate investors in order to obtain funding for their project. The investors can then claim the credit over a 10-year period, starting when the property's housing units are made available to tenants.
How much is the LIHTC worth?
States receive $3.1 million or $2.70 per capita per year in LIHTC, whichever is larger. So, a state with 10 million people would receive $27 million in LIHTC funding to distribute.
The value of the credit depends on the project. There is a 9% tax credit and a 4% tax credit, which are generally sold to investors, as we already mentioned. The 9% credit typically raises about 70% of the cost of development (property value), and the 4% credit raises about 30% of development costs.
How can developers get the credit?
Since the LIHTC is allocated to the states for distribution to real estate developers, the process varies depending on the state in which the developer is located. However, the LIHTC is a competitive, lengthy, and often expensive tax credit to receive.
For example, in my home state of South Carolina, applicants for an allocation of the LIHTC in 2020 must submit a nonrefundable $5,500 application fee, a $600 market study review fee, and a $2,500 appraisal fee as well as ongoing compliance monitoring fees and other expenses after the LIHTC award is granted.
The Millionacres bottom line
The Low-Income Housing Tax Credit is an important tool developers can use to subsidize construction of qualifying housing units and is considered to be a win-win situation. Developers (or their investors) get a nice tax incentive to construct affordable housing, and communities get some of their unmet affordable housing needs fulfilled.