Low income housing tax credits

What Is Low Income Housing Tax Credits?

Low Income Housing Tax Credits (LIHTC) are a federal program in the United States designed to incentivize the creation and preservation of affordable housing for low- and moderate-income individuals and families. Falling under the broader financial category of Tax Incentives, LIHTC provides a dollar-for-dollar reduction in federal tax liability for investors who contribute to the development or rehabilitation of qualifying rental properties²². This program does not directly provide housing subsidies to tenants but rather reduces the cost of developing affordable rental units for developers, who then pass these savings on through lower rents²¹. The Low Income Housing Tax Credit program is the largest source of new affordable housing in the United States, having financed millions of units since its inception²⁰.

History and Origin

The Low Income Housing Tax Credit program was established as part of the Tax Reform Act of 1986¹⁹. This landmark legislation, officially Public Law 99-514, aimed to reshape the U.S. tax code and created Section 42 of the Internal Revenue Code, which governs the LIHTC program¹⁸. Before LIHTC, various direct federal subsidies supported affordable housing, but the 1986 Act shifted the approach towards leveraging private equity and market forces to address housing needs¹⁷. The program was designed to encourage developers to undertake real estate development for lower-income households by offering substantial tax benefits. States were given the responsibility to allocate these federal tax credits through a competitive process based on their specific housing needs¹⁶.

Key Takeaways

• Low Income Housing Tax Credits (LIHTC) are federal tax credits that incentivize private investment in affordable rental housing.
• Developers receive LIHTC in exchange for agreeing to reserve a certain percentage of units for lower-income households at restricted rents for an extended period.
• The credits are typically sold to investors, often corporations or banks, who use them to offset their federal income tax liability over a 10-year period.
• LIHTC is the largest program for creating new affordable rental housing in the United States, contributing significantly to the affordable housing stock.
• Projects receiving LIHTC must adhere to specific tenant income limits and rent restrictions based on the area median income (AMI).

Interpreting the Low Income Housing Tax Credits

The Low Income Housing Tax Credit (LIHTC) program is interpreted primarily as a mechanism for financing affordable rental housing. For developers, receiving LIHTC significantly reduces the capital needed for a project, making otherwise financially unfeasible affordable housing developments viable¹⁵. For investors, LIHTC represents a stream of highly predictable tax benefits, often likened more to a fixed-income investment than a traditional real estate venture where returns are tied to variable cash flow or capital appreciation¹⁴.

The value of the Low Income Housing Tax Credit is typically calculated annually over a 10-year period, based on a percentage of the qualified basis of a low-income building. The qualified basis reflects the eligible development costs attributable to the low-income units. State housing agencies play a critical role, distributing the credits through a competitive process outlined in their Qualified Allocation Plan (QAP)¹³. Investors can claim these credits against their federal tax liability, and since these are often structured as passive income activities, they can also take advantage of related passive activity loss rules¹².

Hypothetical Example

Consider "Harmony Apartments," a hypothetical 100-unit affordable housing development project. The developer, "Community Builders Inc.," seeks to construct this building in a city where the area median income (AMI) is $70,000. To qualify for Low Income Housing Tax Credits, Community Builders Inc. commits to reserving 40% of the units for tenants earning 60% or less of the AMI, with rent restrictions ensuring affordability.

The total eligible development costs (excluding land) for Harmony Apartments are $15 million. Based on the LIHTC program rules, a certain percentage of these costs can generate tax credits. For a typical new construction project, investors might be eligible for a credit equal to 9% of the qualified basis annually for 10 years¹¹. If the qualified basis is determined to be $10 million (reflecting the portion attributable to the affordable units), the project would generate $900,000 in annual tax credits for 10 years ($10 million * 9%).

Community Builders Inc. then sells these future tax credits to a large financial institution, "Unity Bank," for an upfront cash payment, which helps to cover a significant portion of the construction costs and reduce the amount of traditional debt financing needed for the project. In return, Unity Bank receives $900,000 in federal tax credits each year for 10 years, which directly reduces its own tax obligations. This allows Harmony Apartments to operate with lower debt service, enabling lower rents for qualifying residents.

Practical Applications

Low Income Housing Tax Credits are primarily applied in the funding and operation of affordable rental housing projects across the United States. They are instrumental in fostering real estate development aimed at addressing housing shortages for low- and moderate-income populations. Investors, particularly commercial banks, are major participants in the LIHTC market, often driven by both the tax benefits and the desire to meet obligations under regulations like the Community Reinvestment Act (CRA)⁹, ¹⁰.

The credits enable developers to access significant capital, reducing the need for traditional loans and allowing them to charge lower rents than market-rate units⁸. The Internal Revenue Service (IRS) administers the program, with investors claiming the Low Income Housing Tax Credit on their federal income tax returns using forms such as IRS Form 8586. The stability of LIHTC investments is notable; they have shown very low foreclosure rates, indicating their reliability as a long-term investment vehicle for banks and other entities⁷.

Limitations and Criticisms

Despite its widespread use and effectiveness in generating affordable housing units, the Low Income Housing Tax Credit program faces several limitations and criticisms. One significant concern is the complexity of the program, which can lead to high administrative and legal costs. Some critics argue that a substantial portion of the subsidy value is consumed by various intermediaries—including lawyers, syndicators, and consultants—rather than directly benefiting the tenants or reducing construction costs.

A⁵, ⁶nother critique suggests that LIHTC can, in some instances, inflate project costs. Since the amount of tax credits is tied to development expenses, there may be less incentive for developers to seek cost efficiencies, potentially leading to higher per-unit costs compared to market-rate construction. Th⁴ere are also debates regarding the program's efficiency compared to direct housing subsidies like housing vouchers, with some studies indicating that LIHTC housing can be more costly per unit. Fu³rthermore, some experts contend that the LIHTC program "crowds out" private development that might have occurred otherwise, meaning the net effect on the overall housing stock may be smaller than perceived.

#²# Low Income Housing Tax Credits vs. Housing Vouchers

Low Income Housing Tax Credits (LIHTC) and Housing Vouchers represent two distinct, yet complementary, federal approaches to addressing affordable housing needs. The primary difference lies in their mechanism and target beneficiaries.

LIHTC is a supply-side program, meaning it focuses on increasing the supply of affordable housing units. It does this by providing tax incentives to developers to construct or rehabilitate properties that must then be rented to qualifying low-income tenants at restricted rates. The benefit primarily flows to the developers and their investors, making the creation of affordable units financially feasible.

In contrast, Housing Vouchers (such as Section 8) are demand-side housing subsidies. These vouchers are provided directly to eligible low-income individuals and families, allowing them to choose housing in the private market and helping them afford rent. The benefit directly flows to the tenants, increasing their purchasing power in the housing market. While LIHTC creates specific affordable units, housing vouchers enable recipients to rent existing units, often offering greater geographic flexibility for tenants.

Confusion can arise because both programs aim to make housing more affordable for low-income populations. However, LIHTC encourages new construction and long-term affordability commitments on specific properties, while housing vouchers focus on direct tenant assistance for existing housing stock.

FAQs

What types of properties qualify for Low Income Housing Tax Credits?

Many types of residential rental properties can qualify for LIHTC, including large apartment buildings, multi-unit buildings, and even some single-family homes, provided they meet specific tenant income and rent restriction requirements.

How do developers get Low Income Housing Tax Credits?

Developers apply to state housing agencies, which competitively award the credits based on a Qualified Allocation Plan (QAP). Once awarded, developers typically sell these tax credits to investors for upfront capital to finance their real estate development projects.

Who benefits most from the Low Income Housing Tax Credit program?

The program primarily benefits low- and moderate-income tenants by increasing the supply of affordable rental housing. Developers also benefit from the reduced financing costs, and investors (often financial institutions) benefit from significant reductions in their federal tax liability.

Are there income limits for tenants in LIHTC properties?

Yes, projects receiving Low Income Housing Tax Credits must adhere to strict income limits for tenants. Typically, a certain percentage of units must be occupied by tenants earning 50% or 60% or less of the area median income, adjusted for family size.

#¹## What happens after the tax credit period ends?
LIHTC projects typically have a minimum compliance period of 15 years, and often extend to 30 years or more, during which they must maintain affordability. After this period, properties may, in some cases, convert to market-rate units, though many continue to operate as affordable housing due to ongoing financing agreements or state regulations.