(LIHTC) is a critical tax incentive designed to encourage private developers and investors to construct or rehabilitate affordable rental housing for low-income households. Established under Internal Revenue Code (IRC) Section 42, it provides investors with federal tax credits to offset the costs of financing low-income housing projects.
Here’s an overview of how LIHTCs work:
Introduction to IRC Section 42 and LIHTCs
IRC Section 42 allows for the allocation of tax credits to developers of low-income housing. These credits are typically sold to investors (usually through syndication) to raise capital for projects. In return, investors receive a dollar-for-dollar reduction in their federal tax liability over a period of 10 years. The LIHTC aims to lower the cost of capital for developers, making it more feasible to provide affordable housing options.
Example of Tax Credit Calculation
The LIHTC is generally calculated based on the eligible development costs, which include both construction and acquisition costs. The amount of credit allocated depends on whether the project qualifies for the 9% tax credit or the 4% tax credit.
The 9% tax credit applies to new construction or substantial rehabilitation projects.
The 4% tax credit applies to acquisition/rehabilitation projects (often referred to as “acq/rehab” deals).
The tax credit amount is typically calculated as a percentage of the total project costs, and these credits are then distributed to investors over a 10-year period. A project may qualify for tax credits if it meets certain affordability requirements for rent and income limits.
The 9% Tax Credit Floor and the Floating 70% Present Value Rate
The 9% tax credit is the standard and provides the maximum amount of tax credits a project can receive. However, the 4% tax credit rate is usually tied to the floating 70% present value rate, which can fluctuate based on market conditions. This means that the actual amount of credit can vary, especially for projects using the 4% tax credit.
The 9% Competitive Tax Credit Pool and States' QAPs
Each state administers its allocation of the 9% LIHTCs through a competitive process. The state’s Qualified Allocation Plan (QAP) sets the rules for how tax credits are allocated within the state. States consider various criteria, such as the project's location, the developer’s experience, the project’s financial structure, and its ability to meet community needs.
The Tax Credit Application Process
Credit Reservation: Developers submit applications to the state housing agency for a reservation of tax credits. This begins the process of securing credits for the project.
Carryover Allocation and the 10% Test: After receiving a reservation, developers must meet the 10% test, which means that within 12 months of receiving the reservation, the developer must have incurred at least 10% of the total development costs. If this test is not met, the credits may be rescinded.
Typical LIHTC Partnership Structure
Most LIHTC projects involve a partnership structure with several key parties:
Investor: The party that provides equity capital in exchange for the tax credits.
Syndicator: The entity that packages the credits and sells them to investors.
Developer: The party that is responsible for the construction and operation of the property.
Fund: A fund can pool investments from multiple investors to fund several LIHTC projects.
Operating Partnership (OP): The entity that manages the day-to-day operations of the development.
Investor Equity Contributions and Credit Pricing
Investors contribute equity to the project in exchange for receiving the LIHTCs over 10 years. The value of the credits depends on market conditions, and the syndicator typically works to sell these credits at a competitive price. The price of the credits is often driven by the supply and demand for such investments.
Construction Completion and Certification Process
Once the project is completed and units are rented, developers must obtain a Certificate of Occupancy and submit a Placed-in-Service package to the state, confirming that the project is operational and meets all requirements for claiming credits. This includes submitting Form 8609 to the IRS, which is the formal claim for tax credits.
Nuances of “Acq/Rehab” Deals
Acquisition and rehabilitation projects (“acq/rehab”) involve purchasing existing buildings and making significant improvements. These projects are eligible for the 4% tax credit and have different criteria for determining eligible costs. There are specific guidelines for how rehabilitation work must be conducted and how the credits can be claimed.
Program Rules: "20 at 50", "40 at 60", and Average Income Minimum Set-Asides
LIHTC projects must meet specific income and rent limits to ensure the housing remains affordable for low-income individuals and families. For example:
The 20 at 50 rule means at least 20% of the units must be reserved for tenants earning 50% or less of the area median income (AMI).
The 40 at 60 rule means at least 40% of the units must be reserved for tenants earning 60% or less of the AMI.
An average income minimum set-aside allows for deeper income targeting but must meet specific compliance rules.
Earning and Claiming Tax Credits
The tax credits are claimed over a 10-year period, with the developer earning the credit amount gradually each year. The property must remain in compliance with the low-income occupancy requirements for a 15-year compliance period, ensuring the continued affordability of the housing.
Noncompliance and Credit Recapture
If a property fails to comply with the affordability and other program rules, the credits may be subject to recapture, meaning the investor could lose previously claimed tax credits. Noncompliance issues must be addressed immediately to avoid penalties.
Target Audience: This overview is useful for professionals new to LIHTC or those with some experience who need a refresher. Developers, investors, syndicators, and compliance officers can all benefit from understanding the mechanics of this complex program. Whether you're working on a tax credit application, managing the financial structure of a project, or ensuring compliance with program rules, understanding these elements is crucial to successfully navigating the LIHTC landscape.
Would you like further details or specific examples related to any of the sections mentioned above?
Comments