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What is a LIHTC? How does it work?


Under the Tax Reform Act of 1986, Congress enacted the low-income housing tax credit (LIHTC) to encourage private development of affordable housing.  Through this supply side initiative, the federal government offers tax incentives to bring the private sector into the affordable housing business and to alleviate the federal government’s burden of developing affordable housing for the nation’s low-income citizens.  This program differs from previous demand side governmental incentives, such as the Section 8 voucher program, which require that qualified individuals find their own housing but enhances their purchasing capability.

The program’s structure as part of the tax code ensures that private investors bear the financial burden if properties are not successful. This pay-for- performance accountability has driven private sector discipline to the LIHTC program, resulting in a foreclosure rate of less than 0.1% – a percentage far less than that of comparable market-rate properties. As a permanent part of the tax code, the LIHTC program necessitates public-private partnerships, and has leveraged more than $75 billion in private equity investment for the creation of affordable rental housing.

QAP’s and Competitive Awards

In allocating tax credits, states are required to adopt a Qualified Allocation Plan (QAP) that sets forth, for the coming year, the priorities and scoring methods the state will use in selecting credits.  QAPs are intended both to seek out areas of genuine housing needs, and to select the most deserving properties from the public’s point of view.  The credits are usually awarded to projects in a few “allocation rounds” held each year, on a competitive basis. Typically, the top ranked project will get credits, then the second, and so on until the credits are exhausted for the round. A portion of each state’s credits must be “set aside” for projects sponsored by non-profit organizations, although non-profits more typically apply for credits under the “general” rules, without regard to the set-aside.

This allows each state to set its own priorities and address its specific housing goals. It also encourages developers to offer benefits that are better than the established minimums when competing against other projects (e.g., charging lower rents, or maintaining the low income requirements for a longer number of years, will often improve a project’s rank in the competitive process; it is important to check the particular state’s QAP and application to see how it makes these judgments).

QAPs were imposed by Congress in the 1989 amendments because Congress, noting that the program had by then reached 95% or greater utilization, had become concerned that awards were being influenced by favoritism rather than merit.  The QAP system has now been established for more than a decade and such charges are now extremely rare.

Application Process

The first step in the process is for a project owner to submit an application to a state authority, which will consider the application competitively. The application will include estimates of the expected cost of the project and a commitment to comply with either of the following conditions, known as “set-asides”:

At least 20% or more of the residential units in the development are both rent restricted and occupied by individuals whose income is 50% or less of the area median gross income.

At least 40% or more of the residential units in the development are both rent restricted and occupied by individuals whose income is 60% or less of the area median gross income.

Typically, the project owner will agree to a higher percentage of low income usage than these minimums, up to 100%. Low income tenants can be charged a maximum rent of 30% of the maximum eligible income, which is 60% of the area’s median income adjusted for household size as determined by HUD. There are no limits on the rents that can be charged to tenants who are not low income but live in the same project.

Determination of LIHTC Amount

The amount of equity that can be raised for a project is a function of how much “qualified basis”  there is in the project. “Basis” is simply the project costs that are subject to depreciation – like construction, appliances and traditional soft costs (e.g., professional fees). Costs that are not depreciable, such as the land value or operating reserves, are not included in basis. Also not included in basis are costs that are funded by ineligible sources such as grants and federal subsidies.

The qualified basis is calculated by multiplying the total eligible basis by the percentage of tax credit units in the project (or their percentage of square footage if this is lower). The portion of tax credit units is known as the “applicable fraction.” For example, if the “total eligible basis” is $1,000,000, and the “applicable fraction” is 80% (80 out of 100 units are tax credit units), then the”qualified basis” would be $800,000.

The outcome of the above calculation (qualified basis) is then multiplied by the appropriate tax credit rate. This rate is either 4% or 9%, depending on the financing source and structure. Most supportive housing projects will use the 9% credits. The exact tax credit rates fluctuate, and are published monthly by the federal government. An additional 30% “basis boost” is also offered in neighborhoods that are considered high cost.

– Total Eligible Basis x Applicable Fraction = Qualified Basis

– Qualified Basis x Tax Credit Rate = Annual Tax Credits

– Annual Tax Credits x 10 (years) = Total Value of Tax Credits

– Total Value of Tax Credits x Investment Per Tax Credit Dollar = Net Equity Investment

The qualified basis times the tax credit rate equals the amount of annual tax credits for which the project is eligible to apply. And depending on the amount that investors are willing to pay for a tax credit dollar, you can translate the annual amount into a net equity number that the project would likely receive.

Equity Syndication

Tax credits can be claimed annually over a 10-year period by the property owner. However, the developer needs the money immediately to pay for development costs, not 10 percent annually for 10 years. Accordingly, the developer typically syndicates the credits – i.e., sells the rights to the future credits in exchange for up-front cash.  Developers typically “sell” the credits by entering into limited partnerships (or limited liability companies) with an investor, with 99% or more of the profits, losses, depreciation, and tax credits being allocated to the investor as a partner in the partnership. The developer serves as the general partner/managing member, and receives a majority of the cash flow (either through the payment of fees, or through distributions). The funds generated through the syndication vary from market to market and year-to- year.

Two groups of participants are thus involved:

–    Investors-Those seeking tax savings for earnings and cash flow management and investment return.

–    Syndicators-Specialized real estate financial- services firms who raise capital from investors and structure transactions to place in a fund.  Some syndicators also directly place credits with investors that are seeking specific locations (typically banks seeking CRA credit)


In an equity syndication, the syndicator or investor prices the transaction by stating how much capital, on what terms and timing, it will pay assuming that the Credits flow as expected.  Equity syndicators also negotiate economic provisions (how cash flow and residuals are shared, directly or indirectly via fees) and control/ protection provisions (guarantees, contingent rights).

The net effect, therefore, is that the sponsor acquires a commitment for cash, on a particular timetable and subject to obligations and future events, by swapping rights to 99% or more of the Credits-the ten-year after-tax receivable is factored into a cash commitment.

An investor will typically stay in the partnership for at least the compliance period, because a reduction in its interest can also result in recapture of the credits. A major improvement contained in the HERA 2008 law is the repeal of the requirement that a recapture bond be posted upon the disposition of an investment in a low-income housing building or investment therein. The repeal of the bond posting requirement should help allow for the free transfer of LIHTC investments where the original investor finds themselves in the position of not being able to take advantage of the tax benefits that inure to the holder of such an investment.

Terms & Conditions

The project owner must agree to comply with Section 42 and maintain an agreed percentage of low income units in a “Land Use Restriction Agreement” (LURA) which is recorded. Under the LURA, the project is required to meet the particular project’s low income requirements for a 15-year initial “compliance period” and a subsequent 15-year “extended use period” (or longer, if required by the local authority; the extended use rules were added in 1989, and do not apply to projects developed in the first few years of the program.) The credits are subject to “recapture” if the project fails to comply with the requirements of Section 42 of the Tax Code during the 15-year compliance period. Rules that required a taxpayer to post a “bond” if a recapture event occurred were repealed in 2008.

Construction, Completion, and Credit Delivery

Once the property completes its financing, it goes into construction.  Not all of the equity is invested upfront at closing.  A typical Operating Agreement dictates milestones for the syndicator to contribute its equity into the transaction.  An example of equity installments in a Contribution Agreement could be 30% at the construction loan financing closing, 20% at 50% completion, 20% when the building receives its certificate of occupancy, 15% when the property is stabilized and 15% at the permanent financing closing.

Upon completion and qualified occupancy, the owner files IRS Form 8609, signaling start of tax credit flow.  At that stage, the tax credits are determined precisely based on the lesser of i) Credit Percentage (9% or 4%) * Eligible Basis; or ii) Maximum tax credits allocated by the agency.

Once the Credit basis is established and the first year’s Credit delivered, it continues to flow for the full ten years, unless interrupted by a non-compliance event, or “Recapture”.

The credits are not provided in a lump sum but instead are claimed in equal amounts over a 10-year “credit period” (many projects claim credits over 11 years, due to the rules governing how many credits can be claimed in the first year of the credit period).

Rents and Operations

By Section 42 of the Tax Code, rents are capped at a maximum of 30% of 60% of median income (adjusted for family size).

Affordable 30% of family income for rent
Credit-eligible 60% of median income, adjusted for family size
Assumed occupancy 1/ people per bedroom


States are also responsible for monitoring the ongoing development costs, quality and operation of approved projects, as well as the enforcement threat of notifying the IRS of “noncompliance” if the project deviates from the applicable requirements of the Code and the LURA, described above. Such a notice can lead to recapture of previously taken credits and inability to claim credits from the project in the future. The IRS has published Form 8823 for the purpose of reporting possible problems with the project, and its Guide to the Form 8823 that details the IRS view on various issues related to noncompliance.


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