LIHTC - Low Income Housing Tax Credits
The LIHTC Program is an indirect Federal subsidy used to finance the development
of affordable rental housing for low-income households. The LIHTC Program may be
complicated, but many local housing and community development agencies are effectively
using these tax credits to increase the supply of affordable housing in their communities.
The LIHTC Program, which is based on
Section 42 of the Internal Revenue Code, was enacted by Congress in 1986
to provide the private market with an incentive to invest in affordable rental housing.
Federal housing tax credits are awarded to developers of qualified projects. Developers
then sell these credits to investors to raise capital (or equity) for their projects,
which reduces the debt that the developer would otherwise have to borrow. Because
the debt is lower, a tax credit property can in turn offer lower, more affordable
rents. Provided the property maintains compliance with the program requirements,
investors receive a dollar-for-dollar credit against their Federal tax liability
each year over a period of 10 years. The amount of the annual credit is based on
the amount invested in the affordable housing.
Allocating Housing Tax Credits
Each year, the IRS allocates housing tax credits to designated state agencies-typically
state housing finance agencies - which in turn award the credits to developers of
qualified projects. Each state is limited to a total annual housing tax credit allocation
of $1.95 per resident, with only the first year of the 10 years of tax credits counting
against the allocation. Beginning in 2003, this limit will be adjusted for inflation.
States allocate housing tax credits through a competitive process. The state allocating
agency must develop a plan for allocating the credits consistent with the state's
Consolidated Plan. Federal law requires that the allocation plan give priority to
projects that (a) serve the lowest income families; and (b) are structured to remain
affordable for the longest period of time. Federal law also requires that 10 percent
of each state's annual housing tax credit allocation be set aside for projects owned
by nonprofit organizations. For additional information, contact your
state tax credit allocating agency for a copy of its Qualified Allocation
Plan (QAP).
The credit amount for a project is calculated based on the costs of development
and the number of qualified low-income units, and cannot exceed the amount needed
to make the project feasible.
A State has two years to award housing tax credits to projects. Tax credits not
awarded in a year may be carried forward to the next year. If a state is unable
to use its tax credits over a two-year period, they are returned to a national pool
for re-allocation. If a state awards tax credits to a project that is not completed
and the tax credits are returned, the state has an additional two years to award
the tax credits to another project within that state.
Eligibility
To be eligible for consideration under the LIHTC Program, a proposed project must:
- Be a residential rental property.
- Commit to one of two possible low-income occupancy threshold requirements.
- Restrict rents, including utility charges, in low-income units.
- Operate under the rent and income restrictions for 30 years or longer, pursuant
to written agreements with the agency issuing the tax credits.
Residential Rental Property
Typical rental properties that are eligible under HOME will also be eligible under
LIHTC. However, the LIHTC program is not as flexible as the HOME program concerning
service-enriched housing, or concerning group homes and transitional housing.
The LIHTC program requires that rehab be performed, if the developer is acquiring
an existing building. Tax credits may be earned on the acquisition of an existing
development provided the owner meets the 10-year previous ownership rule. This rule
states that the property to be acquired must not have changed ownership and been
placed in service during a 10-year period prior to the acquisition. A building that
has not been used in ten or more years can claim the acquisition credit even if
its ownership has changed, given that it has not been placed in service during that
period.
Occupancy Threshold Requirements
Projects eligible for housing tax credits must meet low-income occupancy threshold
requirements. Project owners may elect one of the following two thresholds:
- 20-50 Rule: At least 20 percent of the units must be rent restricted and occupied
by households with incomes at or below 50 percent of the HUD-determined area median
income (adjusted for household size).
- 40-60 Rule: At least 40 percent of the units must be rent restricted and occupied
by households with incomes at or below 60 percent of the HUD-determined area median
income (adjusted for household size).
The 20-50 Rule is conceptually similar to - although not exactly the same as - a
20 percent Low HOME requirement. Similarly, the 40-60 Rule is comparable to a 40
percent High HOME requirement.
Typical state QAPs encourage applicants to provide more than the minimum number
of affordable units, and to provide greater than the minimum level of affordability.
Moreover, credits are available only for the affordable units. As a result, many
applications provide for 100 percent of the units to be affordable, and many applications
provide for some units to be affordable well below 50 percent of AMI.
Rent Limits
The rent for each unit is established so that tenant monthly housing costs, including
a utility allowance, do not exceed the applicable LIHTC rent limit. These limits
are based on a percentage of area median income, as adjusted by unit size. Of course,
rents cannot exceed local market limits.
Affordability Requirements
The LIHTC program requires a minimum affordability period of 30 years (i.e., a 15-year
compliance period and subsequent 15-year extended use period). Some states require
a longer affordability period for all LIHTC properties, and other states may negotiate
longer affordability periods on a property-specific basis. Tenant incomes are recertified
annually to ensure their continued eligibility. The allocating agency is responsible
for monitoring compliance with the provisions during the affordability period and
must report the results of monitoring to the IRS.
Syndication
Developers may claim housing tax credits directly, but most sell the tax credits
to raise equity capital for their housing project. The developer can sell the tax
credits:
- Directly to an investor; OR
- To a syndicator, who assembles a group of investors and acts as their representative.
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.
The credit purchaser must be part of the property ownership entity; usually this
is accomplished by creating a limited partnership (in which the credit purchaser
is a 99%+ limited partner) or a limited liability company (in which the credit purchaser
is a 99%+ non-managing member). The general partner is responsible for managing
the project and the partnership, while the limited partners are typically limited
to a passive investment role.
Typically, profits and losses and housing tax credits are shared according to the
partners' (members') percentage ownership interests. However, each Limited Partnership
Agreement (or LLC Operating Agreement) also provides for a carefully-negotiated
"waterfall" that describes how any positive cash flow of the property is to be distributed.
Typically, the general partner (managing partner) receives a large share of any
positive cash flow, often structured in the form of fees for services such as partnership
management, incentive management, or investor services.
A Closer Look at Syndication
Syndication is a complex and expensive process. By law, syndicators must offer prospectuses to potential tax credit purchasers, fully disclosing the terms and risks of the investment. Sales of tax credits to multiple investors in the general public are referred to as public placements and have the highest disclosure requirements. Private placements are sales to a few knowledgeable investors. They have lower disclosure requirements and sales costs.
Of course, developers are interested in the highest possible price paid by investors, and the lowest possible syndication costs. Similarly, investors are interested in paying the lowest possible price, at the lowest possible level of risk. Syndicators are interested in earning high fees, and potentially future business with the developer and investors. To-be-developed properties are not easy to evaluate. These factors mean that the market for housing tax credits is as complicated and sophisticated as the market for stocks and bonds. It is also quite competitive.
*Source: U.S. Department of Housing and Urban Development
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