What Is Low Income Housing Tax Credit (LIHTC)?
The Low Income Housing Tax Credit (LIHTC) is a federal program designed to encourage private investment in the acquisition, construction, and rehabilitation of affordable rental housing for low- and moderate-income tenants. Falling under the broader category of Real Estate Finance, LIHTC provides a dollar-for-dollar reduction in federal income tax liability for investors who provide equity for these projects. This mechanism allows developers to reduce the amount of debt financing required, enabling them to offer lower rents while maintaining the financial viability of their real estate development projects49, 50. Since its inception, the LIHTC program has been instrumental in financing millions of affordable housing units across the United States48.
History and Origin
The Low Income Housing Tax Credit program was established under Section 42 of the Tax Reform Act of 1986. This landmark legislation, enacted under President Ronald Reagan, marked a significant shift in federal housing policy by incentivizing the private sector to develop and maintain affordable housing through tax incentives46, 47. Prior to LIHTC, federal government involvement in affordable housing often relied on direct provision or subsidies for construction45. The creation of LIHTC leveraged the expenditure of public money in the form of uncollected tax revenue with private equity investment to fund low-income housing development44. This approach provided a new avenue for a public-private partnership in addressing the nation's affordable housing needs. Since 1987, the LIHTC has become the most important resource for creating affordable housing in the United States, responsible for more than three million units.
Key Takeaways
- The Low Income Housing Tax Credit (LIHTC) is a federal program that provides tax credits to private investors to encourage the development of affordable rental housing.
- It operates by reducing an investor's federal income tax liability dollar-for-dollar.
- The program was established as part of the Tax Reform Act of 1986 and is administered by state housing agencies under guidelines from the Internal Revenue Service (IRS).
- Projects receiving LIHTC must meet specific affordability requirements for tenants, based on a percentage of the Area Median Income (AMI).
- LIHTC projects typically involve complex financing structures, often utilizing syndication to connect developers with investors.
Formula and Calculation
The calculation of the Low Income Housing Tax Credit involves several factors, but it is not a straightforward mathematical formula in the sense of a single equation that yields the credit amount. Instead, the credit amount is determined by multiplying a project's "qualified basis" by an applicable credit rate, which is then claimed over a 10-year period42, 43.
The general principle for calculating the annual credit is:
Where:
- Qualified Basis: This represents the eligible costs of the affordable housing project, excluding land acquisition and certain financing costs40, 41. It is calculated based on the portion of the building dedicated to low-income units.
- Applicable Percentage: There are two main types of LIHTC: a 9% credit (often for new construction and substantial rehabilitation without federal subsidies) and a 4% credit (often for projects involving the acquisition of existing buildings or those financed with private activity bonds)39. The actual percentages are set by the Treasury Department and fluctuate slightly, though they are often referred to as 9% and 4% credits38. Investors can claim the tax credits over a 10-year period37.
For a project to qualify, it must meet specific income and rent restrictions for a set percentage of its units. For example, a project might be required to have at least 20% of its units occupied by tenants earning 50% or less of the Area Median Income (AMI), or at least 40% of its units occupied by tenants earning 60% or less of AMI35, 36.
Interpreting the LIHTC
The LIHTC is interpreted as a critical tool for promoting the development of affordable rental property and addressing housing shortages for lower-income households. Its success is measured by the number of affordable units created and preserved, which has amounted to over 3.5 million units since its inception34.
For developers, securing LIHTC signifies a significant reduction in project financing needs, making otherwise unfeasible projects viable33. For investors, particularly corporations, the LIHTC offers a direct reduction in their federal tax liability, making it an attractive long-term investment. Banks, for instance, often invest in LIHTC projects due to their stable, reliable returns and eligibility for Community Reinvestment Act (CRA) credits, which help them maintain regulatory compliance and increase their CRA ratings32. The program aims to ensure that projects remain affordable for a minimum of 15 years, with most new properties maintaining affordability for 30 years31.
Hypothetical Example
Consider "Harmony Apartments," a hypothetical real estate development company planning to build a 100-unit apartment complex. The total eligible development cost, excluding land, is estimated at $15 million. Harmony Apartments aims to qualify for the 9% LIHTC, which targets new construction without federal subsidies.
To obtain the LIHTC, Harmony Apartments must apply to its State Housing Finance Agency (HFA) and adhere to the state's Qualified Allocation Plan (QAP). The QAP outlines specific requirements, such as setting aside a certain percentage of units for tenants below a specified Area Median Income (AMI) and limiting rents. Let's assume Harmony Apartments commits to reserving 40% of its units for tenants earning 60% or less of the AMI.
Once approved, the HFA allocates the tax credits to Harmony Apartments. Harmony Apartments then sells these credits to an investor, such as a large financial institution, typically through a syndication process. The investor provides upfront cash equity, perhaps $10 million, in exchange for the right to claim the tax credits over a 10-year period.
The annual tax credit amount would be 9% of the $15 million qualified basis, which is $1.35 million per year. The investor would then claim this $1.35 million as a dollar-for-dollar reduction in their federal income tax liability for 10 years, totaling $13.5 million over the credit period. This equity infusion significantly reduces the need for conventional debt financing, allowing Harmony Apartments to charge lower, affordable rents to qualifying tenants in the designated units.
Practical Applications
The Low Income Housing Tax Credit is primarily applied in the field of affordable housing development and investment. Developers utilize LIHTC to make projects financially feasible by reducing the amount of debt financing needed for construction or rehabilitation30. This allows them to offer units at rent-restricted rates to low-income individuals and families.
Investors, particularly corporations and financial institutions, are key participants in the LIHTC market. They purchase the tax credits from developers, either directly or through syndication firms, to reduce their federal income tax liability28, 29. Banks, for example, are significant investors in LIHTC projects, often motivated by the consistent, reliable returns over the 10-year credit period and the eligibility for Community Reinvestment Act (CRA) credits, which encourage investments in low- and moderate-income communities26, 27.
The program has been a cornerstone of housing policy in the United States, driving the creation of millions of affordable rental units. It has also spurred the growth of an entire industry focused on the development, financing, and compliance of LIHTC projects25. The equity generated by LIHTC investments allows for lower financing costs, enabling rental property to charge more affordable rents24. According to the Office of the Comptroller of the Currency, the private capital and market discipline provided by LIHTC investors have made it one of the most successful affordable rental housing production programs offered by the federal government23.
Limitations and Criticisms
Despite its widespread use and effectiveness in producing affordable housing, the Low Income Housing Tax Credit program faces several limitations and criticisms. One significant concern is the program's complexity and inefficiency. The multi-layered structure involving federal regulations, State Housing Finance Agency (HFA) Qualified Allocation Plan rules, and the syndication process can increase project costs and delays21, 22. Studies suggest that LIHTC-financed housing can be more expensive to develop per unit compared to other housing assistance programs, partly due to these complexities and associated transaction costs19, 20.
Another criticism revolves around the concept of "crowding out," where LIHTC-subsidized housing may partly displace market-based housing that would have been built anyway, thus having a smaller net impact on the overall housing supply than intended17, 18. Critics also argue that a substantial portion of the subsidy may be captured by developers and other intermediaries in the form of profits and fixed costs of competing for subsidies, with a smaller fraction ultimately flowing to tenants15, 16.
Furthermore, while LIHTC projects are designed to remain affordable for at least 15 to 30 years, properties are not permanently affordable. Once the compliance period ends, owners may be able to convert units to market-rate rents, potentially reducing the long-term supply of affordable housing12, 13, 14. Some studies also raise concerns about the program's impact on neighborhood demographics, suggesting that LIHTC developments, at times, can contribute to concentrated poverty or racial segregation, although newer research offers more nuanced perspectives10, 11. Experts propose that reforming land use regulations and reducing government-imposed barriers to construction could be more effective in increasing overall affordable housing supply8, 9.
Low Income Housing Tax Credit vs. Housing Vouchers
The Low Income Housing Tax Credit (LIHTC) and Housing Vouchers represent distinct approaches to addressing housing affordability, each with different mechanisms and impacts within public finance.
The LIHTC is a supply-side subsidy that incentivizes developers to create and rehabilitate affordable rental housing. It provides a tax credit to investors, reducing their federal income tax liability in exchange for equity that lowers the development costs of affordable units. This results in the creation of specific affordable housing properties with rent and income restrictions tied to the units themselves. The benefit is embedded in the property, ensuring a physical supply of affordable housing for a set period.
In contrast, Housing Vouchers (such as Section 8 vouchers) are demand-side subsidies that directly assist low-income tenants with their rent payments. Vouchers allow eligible households to choose housing in the private market, with the government paying a portion of their rent to landlords. This provides flexibility and mobility for tenants, allowing them to live in various neighborhoods rather than being restricted to specific affordable housing developments. While vouchers empower tenants, their effectiveness in increasing the overall supply of affordable housing can be limited by market conditions and landlord willingness to accept them.
A key difference lies in who receives the primary benefit. LIHTC benefits developers and investors by lowering project costs and providing tax expenditures, which in turn, enables lower rents for tenants. Housing vouchers directly benefit the tenants by subsidizing their housing costs. Debates often arise about which approach is more cost-effective or equitable, with some studies suggesting that vouchers might achieve similar household benefits at a lower fiscal cost due to less "crowding out" and lower administrative overhead compared to LIHTC6, 7.
FAQs
How does the Low Income Housing Tax Credit benefit developers?
Developers benefit from the LIHTC by receiving a significant equity infusion from investors in exchange for the tax credits. This reduces the amount of conventional debt financing they need, making the development or rehabilitation of affordable housing projects financially viable. This lower cost structure enables them to charge reduced rents to qualifying tenants.
What are the income requirements for tenants in LIHTC properties?
To live in a LIHTC property, tenants must meet specific income limits, which are typically based on a percentage of the Area Median Income (AMI) for the local area, adjusted for family size. Common requirements include a certain percentage of units being occupied by tenants whose incomes are 50% or 60% of the AMI or less. Some projects may use an "income averaging" test, allowing a wider range of incomes as long as the average remains below a set threshold4, 5.
How long do properties remain affordable under LIHTC?
Initially, federal regulations required LIHTC properties to uphold affordability for a minimum of 15 years, known as the initial compliance period. However, since 1990, all new LIHTC properties generally must maintain affordability for 30 years3. After this period, owners may have options to transition their properties to market-rate units, though states can implement policies to encourage longer affordability2.
What is the role of a syndicator in LIHTC transactions?
A syndicator acts as an intermediary between developers and investors in LIHTC transactions. Developers, who are awarded the tax credits, typically sell these credits to syndicators. The syndicators then package these credits from multiple projects into funds and sell interests in these funds to institutional investors (like banks or corporations) seeking to reduce their federal income tax liability. This process streamlines the investment for both developers and investors1.