The Low Income Housing Tax Credit, or LIHTC, is a government-backed incentive designed to encourage the production of more affordable rental housing. The credits offer a dollar-for-dollar reduction of the developer’s or investor’s tax liability.
What is the Low Income Housing Tax Credit?
The federal Low Income Housing Tax Credit was initially established in 1986 with the Tax Reform Act. It has since been modified several times (most recently in 2018). The program offers about $9.9 billion in funding annually.
There are two types of LIHTCs: the 9% credit and the 4% one. Both credits are spread across a 10-year period.
Here’s how the two credits differ:
- 9%: This one is worth around 9% of the project’s qualified costs of construction (though actual credits have ranged from 7.35% to 9.26% depending on market conditions). It’s generally reserved for new construction projects. According to the Urban Institute, 9% credits are "highly competitive, with many more projects requesting credits than can be funded."
- 4%: This credit is worth 4% of the project’s costs (between 3.15% and 3.97%, historically). It's more often used on rehab projects, as well as new construction that’s financed with tax exempt bonds.
Funds for the LIHTC are allocated by the federal government to each individual state. State housing agencies then distribute those funds as they see fit, usually via some sort of scoring system.
Qualifying for the Low Income Housing Tax Credit
Apartments, single-family houses, multifamily buildings, and other types of rental properties can also qualify for the LIHTC credit.
Developers can claim the LIHTC for new construction projects or the rehabilitation of an existing property, as long as the end result meets these requirements:
- Household income of units:
- At least 40% of all occupied housing units must make 60% or less of the area median income (adjusted for family size) OR
- At least 20% of all occupied units make 50% or less than the area median income OR
- The average income of 40% of all occupied units is less than 60% the area median income AND no other tenant has an income above 80% of the area median income
- Rent costs: Gross rent must be equal no more than 30% of the 50/60% area median income (depending on which option you choose from the above) for the entire year.
Properties must meet these requirements for at least 15 years and need to certify eligibility annually (with their state housing agency) to continue receiving the credit.
It’s important to note that just applying to the LIHTC program isn’t enough to guarantee the credit. States have limited funds, and by federal law, they must prioritize projects that serve the lowest-income residents or that offer the longest periods of housing affordability. They typically use a scoring system to determine which projects will receive allocations and which will not.
Claiming the LIHTC
To apply for the federal LIHTC program, you’ll need to work with your state agency or housing authority. Most agencies have two allocation periods each year, during which they’ll reserve certain credits for projects they deem worthy.
If you’re lucky enough to get an allocation, you can’t claim the tax credit until the property has been officially "placed in service." This means the property is built, leased, and occupied. Once that occurs, the developer can claim the credit for the year the property went into service.
What to consider before taking on an LIHTC project
Investors should be cautious when pursuing a Low Income Housing Tax Credit. There is a lot of red tape involved, as well as years of compliance requirements. There’s also no guarantee you’ll get the credit -- especially if you’re opting for the more limited 9% credits.
For these reasons, you may want to consider bringing in a consultant before pursuing an LIHTC development. They can help guide you in the process and ensure you have the best chances at success. (Novogradac is one example of an LIHTC consultant. You can also look to your state housing agency for another recommendation.)
Generally, LIHTCs are best reserved for:
- Experienced developers or those willing to bring in an experienced LIHTC consultant.
- Larger projects, which tend to have a higher chance of approval with state housing agencies.
- Markets where wages are growing, ensuring you can ask for higher rents as the years go on.
You’ll also need to be sure you have the cash to cover all the up-front costs of the LIHTC process. This includes costly application, compliance monitoring, and appraisal fees, as well as the costs of bringing in a consultant, accountant, and other professionals to ensure you’re on track for success.
Investing in the affordable housing market in general
In addition to considering whether an LIHTC project is right, you’ll also want to think about whether the affordable housing market in general is a good fit for your goals.
One of the big upsides of investing in lower-income housing is that there’s a high demand for it. Affordable rental properties are in short supply, and with many Americans hurting economically (thanks to COVID-19), vacancies are likely far and few between on these units.
On the downside, there’s less opportunity to raise your rents on low-income properties (especially if you want to qualify for an LIHTC), and it can be hard to keep up with repair and maintenance costs as units get older. Remember: A broken AC system would cost just as much to replace in a high-rent unit as it would a low-rent one.
Another option: trading tax credits
Some developers choose to use their tax credits to drum up investments in affordable housing projects. In these scenarios, an investor could purchase the allocated tax credits from a developer and claim it themselves (once the project is operable). The developer, in turn, would get extra capital to put toward the project.
The investor usually gets a stake in the property, too, but it’s not generally expected to be profitable. "Typically, investors do not expect their equity investment in a project to produce income," a report from the Congressional Research Service reads. "Instead, investors look to the credits, which will be used to offset their income tax liabilities, as their return on investment."
These deals are often brokered by syndicators, who help structure the arrangement and ensure it’s compliant with tax code.
The bottom line
The Low Income Housing Tax Credit program can help you offset the costs of building, rehabbing, or just investing in an affordable housing project, but be careful in taking on too much. LIHTCs can be hard to qualify for, and there’s a lot of red tape required.
If you do choose to go this route, consider bringing in an experienced LIHTC consultant to guide the way. They can also help you with the various compliance requirements you’ll need to adhere to during the application process, as well as once your property is placed into service.
In addition to federal and state tax credits, you should also look into low-income housing funds you may be eligible for. Many state housing trust funds offer money for these projects, as does the Community Development Block Grant program, the Affordable Housing Program of the Federal Home Loan Banks, and the National Housing Trust Fund.