Understanding Low-Income Housing Tax Credits (LIHTC)
Jeffrey Promnitz
Introduction
The Low-Income Housing Tax Credit (LIHTC) program is a critical component of affordable housing development in the United States. This federal tax incentive encourages investment in the construction and rehabilitation of affordable rental housing by providing tax credits to developers. This comprehensive overview will delve into the intricacies of understanding LIHTC, exploring its mechanics, calculation methods, and benefits for both developers and investors.
LIHTC: A Mechanism for Affordable Housing Development
LIHTC is a federal tax incentive program administered by the Internal Revenue Service (IRS) and allocated to states based on population. State housing agencies then award these credits to developers through a competitive application process. Developers utilize these credits to attract investors, who provide equity capital for their projects in exchange for tax benefits.
Calculating LIHTC
The calculation of LIHTC is key to understanding them and involves several key components:
- Eligible Basis: This refers to the qualified costs associated with the development, excluding land acquisition, financing costs, reserves, syndication expenses, and marketing costs. Eligible basis primarily encompasses construction-related expenditures.
- High Cost Adjustment Boost: Projects located in designated Difficult Development Areas or Qualified Census Tracts may be eligible for a 30% increase in their eligible basis, recognizing the higher development costs in these areas.
- Applicable Fraction: This fraction represents the proportion of the project dedicated to low-income housing. It is determined by the lesser of the Unit Fraction (low-income units divided by total units) or the Floor Space Fraction (low-income floor space divided by total residential floor space).
- Qualified Basis: The qualified basis is calculated by multiplying the eligible basis by the applicable fraction.
- Tax Credit Rate: Projects qualify for either a 4% or 9% tax credit rate, applied annually to the qualified basis over a 10-year period. The actual rates are subject to monthly adjustments by the IRS and are calculated to ensure the present value of the tax credits equals 30% of the eligible basis for 4% credits and 70% for 9% credits.
- Tax Credit Factor: This factor represents the market price for each $1 of tax credit and can fluctuate based on market conditions and investor demand.
4% vs. 9% Tax Credits
- 9% Credits: These credits are highly competitive due to their limited availability and are awarded through a competitive process. They cannot be combined with tax-exempt bonds and are typically reserved for new construction or substantial rehabilitation projects.
- 4% Credits: These credits are less competitive and can be combined with tax-exempt bonds. They are often used for new construction projects utilizing tax-exempt bonds and for acquisition/rehabilitation of existing properties.
Investor Benefits
Investors in LIHTC projects receive valuable tax benefits, including:
- Annual Tax Credits: Investors receive tax credits over a 10-year period, offsetting their tax liability.
- Tax Losses: As limited partners, investors can claim tax losses from depreciation, interest expenses, and other deductions associated with the project.
Example
Consider a new construction project with a total development cost of $10 million and an eligible basis of $7 million. The project has 100 units, with 80 units designated for low-income residents. The applicable fraction is 80% (80 low-income units / 100 total units). The qualified basis is $5.6 million ($7 million eligible basis x 80% applicable fraction). Assuming a 9% tax credit rate and a tax credit factor of $0.90, the total tax credits generated over 10 years would be $4.536 million ($5.6 million qualified basis x 9% tax credit rate x 10 years x $0.90 tax credit factor).
Conclusion
LIHTC is a complex but vital program for incentivizing affordable housing development. Understanding its intricacies, including eligible basis calculation, applicable fractions, and tax credit rates, is crucial for developers and investors seeking to participate in this impactful program. By fostering public-private partnerships, LIHTC plays a critical role in expanding access to safe, quality affordable housing across the United States.
To learn more about the Low Income Housing Tax Credit (LIHTC) program, visit Zeffert University.
For professional file reviews on your LIHTC property, visit our File Review Department.