LIHTC: Low-Income Housing Tax Credit
A Source of Funding for affordable housing
Overview: The Low-Income Housing Tax Credit (LIHTC) provides a dollar-for-dollar reduction in federal tax liability over a 10-year period for owners of qualified rental housing projects who agree to specific operating restrictions over a 15-year period. LIHTCs are sold to investors for equity, which acts as a subsidy for the project, reducing the amount of debt that developers would otherwise need to incur. The program was created under the Tax Reform Act of 1986 and has developed over 3 million units of affordable housing since its inception.
LIHTCs as a Catalytic Tool: Most projects are structured as limited partnerships, affording the for-profit investor with limited liability while providing the non-profit managing general partner with day-to-day control of operations. As a result, LIHTC projects are true partnerships, bringing together equity investors with mission-driven housing developers. LIHTC properties tend to have lower debt service payments, lower vacancy rates, and quicker lease-up rates due to the presence of the subsidy. Well-maintained, stable, rent-restricted affordable housing projects are vital to economically vibrant downtowns, allowing those with less means to live in and benefit the community.
How LIHTCs Work
9% and 4% Credits: Projects which have substantial rehabilitation or new construction are eligible for 9% credits. The credit for each year of the 10-year period is approximately 9% of the qualified development costs, or the “present value” of 70% of the qualified costs over 10 years. 9% credits are allocated to each state based on population and developers must apply for these credits annually. The 4% credit (30% present value) is available for building acquisition and minor rehabilitation and is an “automatic” credit not requiring application to an allocating authority.
Restricted Units: In general, projects need to designate at least 20% of their units for households at 50% of median family income (MFI), or at least 40% of their units for households at 60% MFI. The portion of the project which is not designated for low-income residents is not eligible for LIHTC.
Equity for Credits: Developers sell credits to investors in exchange for equity. There are essentially two types of LIHTC investors:
- Financial Institutions: LIHTC investing complements a bank’s underwriting practices for a real estate project. Banks also have goals under the Community Reinvestment Act (CRA), which requires lenders to deploy capital in projects that primarily benefit low and moderate-income neighborhoods.
- Economic Investors: While financial institutions with no CRA need may fall into this category, these companies invest primarily for tax benefits. Thus these investors are less concerned with project location.
Developers can either sell credits directly to an investor, who then enters into a partnership to own the project as a limited partner or investor member, or the credits are syndicated. Syndicators are intermediary institutions which make investments in multi-fund or single/proprietary equity funds. The syndicator manages these funds, underwriting the project for the investor and performing asset management and regular reporting.
15-Year Compliance: Once the project is built, state allocating agencies must ensure that LIHTC eligibility requirements are met throughout the 15-year compliance period. Property owners must certify annually that units are rented to qualified low-income tenants. Non-compliance can trigger loss of credits for the limited partner/investor.
How Can LIHTCs Help Your Project?
Today, in 2018, LIHTCs are utilized in 90% of all affordable housing development in the United States. A typical project can raise 40%-50% of capital needed through LIHTCs, with additional grants and below-market subsidies coming from e.g. HUD CDBG, HUD HOME, USDA Rural Development, Federal Historic Tax Credits, and the Federal Home Loan Bank Affordable Housing Program. Given such capital stacks, most LIHTC projects are able to minimize conventional debt, enabling lower rents and more robust replacement reserve set asides out of operations.