Low income housing tax credit: Meaning, Criticisms & Real-World Uses

What Is the Low Income Housing Tax Credit?

The Low Income Housing Tax Credit (LIHTC) is a federal tax credit program in the United States designed to encourage the development and rehabilitation of affordable rental housing for low-income individuals and families. It falls under the broader financial category of Public Finance, as it involves government incentives to achieve social and economic objectives. The LIHTC program provides investors, typically corporations or high-net-worth individuals, with a dollar-for-dollar reduction in their federal income tax liability in exchange for investing in qualified affordable housing projects. This mechanism allows developers to raise equity financing for their projects, making the creation of affordable housing financially feasible. The program is a cornerstone of affordable real estate development across the nation, fostering community development by addressing critical housing needs.

History and Origin

The Low Income Housing Tax Credit (LIHTC) was established by the Tax Reform Act of 1986, a landmark piece of legislation that significantly overhauled the U.S. tax code. Prior to LIHTC, various federal programs aimed at promoting affordable housing had seen mixed results. The new credit was envisioned as a market-driven solution, leveraging private investment rather than direct government subsidies or loan programs. This shift marked a significant change in how the federal government sought to encourage the supply of affordable housing. The program's design allows state and local housing agencies to allocate credits to developers, who then sell these credits to investors. This framework has since become the primary federal program for creating and preserving affordable rental housing in the United States, driving billions of dollars in private capital into the sector. An overview of the LIHTC highlights its foundational role in addressing housing affordability challenges since its inception.

Key Takeaways

The Low Income Housing Tax Credit (LIHTC) is a federal tax incentive for investors in affordable housing projects.
It reduces federal income tax liability dollar-for-dollar, attracting private capital for affordable housing.
State housing agencies allocate LIHTC credits to developers, who then sell them to investors.
The program supports the construction and rehabilitation of rental properties for low-income tenants.
LIHTC is the largest source of new affordable rental housing in the United States.

Formula and Calculation

The amount of Low Income Housing Tax Credit (LIHTC) a project can generate is typically calculated based on two main factors: the eligible basis of the project and the applicable credit percentage. The eligible basis generally represents the cost of the depreciable portion of the building and common areas, excluding land costs. The applicable credit percentage is a rate set by the IRS, designed to yield a present value of either 70% or 30% of the qualified basis over a 10-year period.

For example, the 9% credit (which provides a credit that equates to roughly 70% of the project's costs over 10 years) is used for new construction or substantial rehabilitation without federal subsidies. The 4% credit (which equates to roughly 30% of project costs over 10 years) is typically for projects involving existing buildings, federal subsidies, or bond financing.

The annual LIHTC is calculated as follows:

\text{Annual LIHTC} = \text{Eligible Basis} \times \text{Applicable Credit Percentage} \times \text{Low-Income Unit Percentage}

Where:

Eligible Basis: The cost of the building and other depreciable property, excluding land. This can be subject to basis boosts in certain qualified census tracts or difficult development areas.
Applicable Credit Percentage: The rate, either approximately 9% or 4% (these are nominal, not actual, and fluctuate monthly based on prevailing interest rates).
Low-Income Unit Percentage (Qualified Basis): The percentage of the total project that is occupied by low-income tenants or the percentage of total floor space devoted to low-income units, whichever is less. This essentially represents the portion of the project eligible for the tax credit.

This credit is claimed annually for a period of 10 years. Investors use the credit to reduce their tax shelter obligations.

Interpreting the Low Income Housing Tax Credit

Interpreting the Low Income Housing Tax Credit involves understanding its impact on project financing, investor returns, and the broader housing market. For developers, the LIHTC represents a crucial source of capital stack financing that reduces reliance on traditional debt and allows for lower rents. By selling the credits to investors, developers can secure upfront equity that can constitute a significant portion of a project's total cost. The value of the credits is a direct incentive, enabling the construction of properties that might otherwise be financially unfeasible given the rent restrictions imposed to ensure affordability.

For investors, the LIHTC offers a predictable stream of federal tax reductions over a 10-year period, effectively enhancing their return on investment. These credits are distinct from tax deductions; they reduce tax liability dollar-for-dollar, making them highly attractive to entities with substantial tax obligations. The long-term nature of the credit also encourages a stable, long-term commitment to the housing project, as investors typically require the project to remain in compliance with affordability rules for at least 15 to 30 years to avoid credit recapture. This creates a powerful public-private partnership for housing provision.

Hypothetical Example

Consider "Harmony Heights," a proposed 100-unit apartment complex in a mid-sized city aimed at low-income families. The developer, "Affordable Homes Inc.," estimates the total eligible basis for construction costs (excluding land) to be $15 million. The project qualifies for the 9% LIHTC rate because it is new construction without federal subsidies.

Calculate Annual Eligible Basis for Credit: $15,000,000 (Eligible Basis)
Determine Applicable Credit Percentage: For new construction, it's typically the 9% credit (though the actual rate floats monthly based on Treasury yields, let's use 9% for simplicity in this example).
Determine Low-Income Unit Percentage: All 100 units will be designated for low-income residents, so the percentage is 100%.

Using the formula:
Annual LIHTC = $15,000,000 (Eligible Basis) × 0.09 (Applicable Credit Percentage) × 1.00 (Low-Income Unit Percentage)
Annual LIHTC = $1,350,000

Affordable Homes Inc. can generate $1.35 million in LIHTC annually for 10 years, totaling $13.5 million over the credit period. To fund the construction, they might approach a large bank or corporate investor. The investor would agree to provide an upfront equity investment (e.g., $10 million to $12 million, depending on the syndication rate) in exchange for receiving the $13.5 million in tax credits over the next decade. This upfront capital allows Affordable Homes Inc. to finance a significant portion of the construction without taking on additional debt financing, making the project viable and ensuring the long-term affordability of the units under strict property management guidelines.

Practical Applications

The Low Income Housing Tax Credit (LIHTC) has diverse practical applications primarily in the financing and development of affordable rental housing. It is extensively used by private developers, non-profit organizations, and syndicators to close funding gaps that traditional financing alone cannot cover for affordable projects. LIHTC projects typically involve a complex investment property ownership structure where a partnership, often a limited partnership or limited liability company, is formed. An investor (the limited partner or member) provides equity capital in exchange for the tax credits and other benefits like depreciation and potential passive income, while the developer serves as the general partner or managing member.

Beyond direct development, LIHTC also has applications in:

Community Revitalization: Many LIHTC projects are located in underserved or blighted urban and rural areas, spurring economic activity and improving neighborhood conditions.
Preservation of Existing Affordable Housing: Credits can be used to rehabilitate older, at-risk affordable housing stock, ensuring its continued availability and extending its useful life.
State and Local Housing Policy: States use their allocation of LIHTC to achieve specific housing goals, such as supporting housing for seniors, individuals with disabilities, or homeless populations. The program is critical for meeting demand for affordable rental housing across the U.S. A⁸¹ report from the Federal Reserve Bank of San Francisco notes that the LIHTC is "the most significant federal program to stimulate the production and preservation of affordable rental housing."

⁸⁰The Internal Revenue Service provides detailed information and forms related to the LIHTC, underscoring its regulatory framework and compliance requirements for participants.

⁷⁹## Limitations and Criticisms

While highly effective in stimulating affordable housing development, the Low Income Housing Tax Credit (LIHTC) program faces several limitations and criticisms. One common critique revolves around its complexity and administrative burden. The program involves intricate rules regarding eligible costs, tenant income limits, and compliance monitoring, which can make it challenging for smaller or less experienced developers to navigate. This complexity can also lead to higher development costs for LIHTC projects compared to market-rate developments, as consultants and legal experts are often required.

Another point of contention is the geographical distribution and impact of LIHTC projects. Some studies suggest that while LIHTC has produced a large volume of units, it has not always effectively deconcentrated poverty or created units in areas with high-performing schools or significant job opportunities. This can perpetuate existing patterns of segregation and limit opportunities for residents. A Brookings Institution article, for instance, explores whether the LIHTC program is working and discusses various research findings regarding its impact and efficacy.

⁷⁸Furthermore, the "syndication" model, where developers sell credits to investors, means that a portion of the credit's value is absorbed by intermediaries and transaction costs. Critics argue that this reduces the direct benefit to the housing project itself. The fixed nature of the credit also means its value can fluctuate with changes in inflation or market conditions, potentially making it less attractive during periods of high interest rates, impacting the overall return on investment for investors and the amount of equity available to developers.

Low Income Housing Tax Credit vs. Section 8

The Low Income Housing Tax Credit (LIHTC) and Section 8 are both federal programs designed to support affordable housing, but they operate through fundamentally different mechanisms and serve distinct purposes. Confusion often arises because both aim to provide housing for low-income individuals.

The Low Income Housing Tax Credit is a supply-side program that incentivizes the creation and rehabilitation of affordable housing units. It provides a direct federal tax credit to investors who provide equity financing for the development of these properties. The benefit is primarily to the developer and their investors in the form of tax relief, which in turn enables the construction of units with rent restrictions. Tenants living in LIHTC properties pay a fixed, affordable rent based on a percentage of the Area Median Income (AMI), but they do not receive a direct subsidy themselves. The program's goal is to increase the supply of affordable housing stock.

In contrast, Section 8 (officially the Housing Choice Voucher Program) is a demand-side program that provides direct rental assistance to eligible low-income individuals and families. The benefit is primarily to the tenant, who receives a voucher that covers a portion of their rent, allowing them to choose housing in the private market that meets program requirements. The payment goes directly to the landlord on behalf of the tenant. The program's goal is to make existing housing more affordable for tenants, rather than directly stimulating new construction.

In essence, LIHTC helps build the buildings, while Section 8 helps people pay the rent in various housing types, including, at times, LIHTC properties.

FAQs

How do I qualify for housing under the Low Income Housing Tax Credit program?

To qualify for housing in a Low Income Housing Tax Credit property, your household income must typically be below a certain percentage of the Area Median Income (AMI), often 50% or 60%, depending on the project's specific set-aside. There are also occupancy standards and other criteria, but income is the primary factor. You would apply directly to the management of an LIHTC property in your desired location.

Is the Low Income Housing Tax Credit a direct subsidy to tenants?

No, the Low Income Housing Tax Credit is not a direct subsidy to tenants. It is a tax incentive provided to private investors and developers. This incentive helps finance the construction or rehabilitation of investment property that is then rented to low-income individuals at affordable rates. Tenants benefit from the affordable rents and quality housing, but they do not receive direct payments or vouchers like those from programs such as Section 8.

What is the difference between tax credits and tax deductions in the context of LIHTC?

A tax credit, like the Low Income Housing Tax Credit, is a dollar-for-dollar reduction in a taxpayer's actual tax liability. For example, a $1,000 tax credit reduces the amount of tax owed by $1,000. A tax deduction, on the other hand, reduces the amount of income subject to tax. So, a $1,000 deduction for someone in a 25% tax bracket would only reduce their tax liability by $250. This distinction makes tax credits a more powerful incentive for investors.

How long does a property remain affordable under LIHTC?

Properties developed with the Low Income Housing Tax Credit must adhere to affordability requirements for a minimum of 30 years. This typically includes a 15-year compliance period during which the owner must maintain the low-income occupancy and rent restrictions to avoid credit recapture, followed by an extended use period, often another 15 years, during which the affordability restrictions generally remain in place. This ensures a long-term commitment to providing affordable housing.

Can LIHTC projects be sold?

Yes, LIHTC projects can be sold, but the affordability restrictions and compliance requirements associated with the tax credits generally transfer to the new owner. The new owner must continue to meet the program's obligations for the remainder of the compliance period and any extended use period to avoid credit recapture by the IRS. This ensures the long-term viability and mission of the affordable housing property.¹ ², ³ ⁴ ⁵ ⁶, ⁷, ⁸ ⁹ ¹⁰, ¹¹ ¹², ¹³, ¹⁴ ¹⁵, [¹⁶](https://www.hud.gov/sites/dfiles/Housing/documents/RADResidentFactSheet_13_RADandLow-Income[⁷⁶](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit-and-how-does-it-work), ⁷⁷TaxCredits.pdf)¹⁷, ¹⁸ ¹⁹ ²⁰[²¹](https://www.youtube.com/watch?v=cNka_g[⁷³](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit-and-how-does-it-work), ⁷⁴LXMEc)²², ²³[^2⁷¹, ⁷²4^](https://www.congress.gov/crs-product/RS22389)[²⁵](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit-and-h[⁶⁹](https://www.ihda.org/developers/tax-credits/low-income-tax-credit/), ⁷⁰ow-does-it-work), ²⁶[²⁷](https://www.frbsf.org/community-development/wp-content/uploads/sites/3/learning-low-income-ho[⁶⁷](https://nlihc.org/sites/default/files/AG-2025/5-10_Low-Income-Housing-Tax-Credits.pdf), ⁶⁸using-tax-credit-building-new-social-investment-model.pdf)[²⁸](https://www.hud.gov/sites/dfiles/[⁶⁴](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit-and-how-does-it-work), ⁶⁵, ⁶⁶Housing/documents/RADResidentFactSheet_13_RADandLow-IncomeTaxCredits.pdf)[²⁹](https://www.brookings.edu/[⁶¹](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit-and-how-does-it-work), ⁶², ⁶³wp-content/uploads/2016/06/20040405_Freeman.pdf)[³⁰](https://www.brookings.edu/wp-con[⁵⁹](https://www.nhlp.org/resource-center/low-income-housing-tax-credits/), ⁶⁰tent/uploads/2016/06/20040405_Freeman.pdf)³¹ ³² ³³ ³⁴, ³⁵, ³⁶[³⁷](https://taxpolicycenter.org/briefing-book/what-low-income-housing-tax-credit[⁵⁵](https://www.ihda.org/developers/tax-credits/low-income-tax-credit/), ⁵⁶-and-how-does-it-work), ³⁸ ³⁹ ⁴⁰ ⁴¹[⁴²](https://www.frbsf.org/about-us/regional-engagement/investment-vehicles/low-income[⁵²](https://www.ihda.org/developers/tax-credits/low-income-tax-credit/), ⁵³-housing-tax-credits/), ⁴³[⁴⁴](https://www.ihda.org/developers/tax-credits/low-inco[⁵⁰](https://www.ihda.org/developers/tax-credits/low-income-tax-credit/), ⁵¹me-tax-credit/)⁴⁵, ⁴⁶ ⁴⁷ ⁴⁸, ⁴⁹