What is the 4 percent Low-Income Housing Tax Credit?

The Low-Income Housing Tax Credit (LIHTC) is one of the largest sources of federal funding for affordable housing. The credits are typically sold to investors, generating equity for qualifying rental developments serving families with incomes below 60 percent of the area median income. Although the LIHTC is a federal program, it is administered principally through state housing finance agencies, which have substantial discretion in setting priorities for allocating the valuable credits. Federal law provides for two different types of LIHTCs. The larger of the two credits -- the 9 percent credit -- is allocated to states on a per-capita basis. Because the credit is large and the supply is limited, competition for these credits tends to be fierce under normal market conditions, namely during times in which financial markets are functioning well and investors have taxable income to offset with credits.

The second, less well-known, type of Low-Income Housing Tax Credit is the 4 percent credit. The 4 percent tax credit is worth only about half as much as the 9 percent credit. (The 4 percent and 9 percent figures refer to the approximate annual percentage of the eligible project costs that investors may claim on federal tax returns for a 10-year period.) Nevertheless, the equity raised through the 4 percent credit can be substantial, and an important advantage of the 4 percent credit is that it is a renewable resource that is not subject to the same annual allocation caps that apply to the 9 percent credit. Any project that is financed through tax-exempt private-activity bonds, serves families with incomes below 60 percent of the area median income, and meets other eligibility criteria qualifies automatically for the 4 percent LIHTC. This means that states that succeed in generating additional projects that qualify for the 4 percent LIHTC can increase the amount of federal funding they receive each year for affordable homes. What problems does this policy solve? In general, both the 4 percent and the 9 percent LIHTC are designed to cover the gap between the costs of developing affordable rental homes and the amount of financing that may be raised based on the rents that low-income families can afford. Although the exact amounts vary substantially by project and market conditions, a good rule of thumb is that the 9 percent credit covers about half of a project's cost, while the 4 percent credit covers about one-quarter. By increasing their use of the 4 percent credit, states can overcome the limited availability of 9 percent credits. In addition,  some developers rely on the 4 percent credit as an alternate financing tool, given the competitive nature of the 9 percent credit. In addition,  some developers rely on the 4 percent credit as an alternate financing tool, given the competitive nature of the 9 percent credit.

Solutions in Action

Kunzelmann-Esser Loft Apartments, Milwaukee WI -- Photo courtesy of Gorman & Company The Kunzelmann-Esser Loft Apartments in Milwaukee, Wisconsin provide 67 loft apartment/studios for artists in a converted building that was formerly the home of the Kunzelmann-Esser Furniture Company. The property was renovated by Gorman and Company in 2003 using a mix of the 4 percent Low-Income Housing Tax Credit, historic tax credits, federal HOME funds and financing from the Wisconsin Housing and Economic Development Authority.

Where is this policy most applicable?

Because 4 percent tax credits generate less capital than 9 percent credits, they are often used for rehabilitation of older rental homes (whether or not they are subsidized) and the preservation of subsidized rental developments -- activities that tend to have lower development costs than new construction. Accordingly, areas where the affordable multifamily rental stock is aging may find 4 percent tax credits particularly useful.

Four percent tax credits can also be used for new construction, particularly if a state or locality is willing and able to commit matching funds to make the project work. By matching 4 percent credits with available federal funds, or with state and local matching funds, 4 percent credits can be used in almost any market under stable market conditions.

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