The Low-Income Housing Tax Credit program, which includes both 4 percent and 9 percent tax credit components, was established in the Tax Reform Act of 1986 to promote private development of affordable rental housing. The credit has been the leading source of financing for affordable rental housing, accounting for half of all
multifamily housing starts each year. On average, 50 percent of the total financing for 9 percent LIHTC projects comes from equity derived from the credit.
While 4 percent tax credits are essentially unlimited, each year the federal government allocates a set amount of 9 percent LIHTC authority to each state on a per-capita basis. In 2009, states received $2.30 in tax credits per person (with an overall state minimum of $2.7 million). This includes a 20-cent per person increase as part of HERA in 2008 to support the declining tax credit market . The state housing finance agencies distribute the credits among projects that best meet the housing goals laid out in their
Qualified Allocation Plans (QAPs). QAPs must give priority to projects that serve the lowest-income households and remain affordable for the longest period of time.
Determination of the 4 percent and 9 percent valuesThe 9 percent and 4 percent low-income housing tax credits are also known respectively as the 70 percent and 30 percent "net present value" credits. This terminology reflects the fact that the 4 percent credit, for instance, is designed to yield a total amount over the 10-year credit period that is worth 30 percent of the present eligible development costs, adjusted for expected inflation. The 4 and 9 percent rates refer to the approximate value that can be claimed each year. The actual rate is recalculated monthly by the IRS based on Treasury Department interest rates. For any given LIHTC project, the actual tax credit rate is set at the rate that prevails either when the developer signs the contract with the Housing Finance Agency or when the finished project is ready for occupancy. That rate represents the percentage of qualified project costs investors can claim against their tax liability each year for 10 years.
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"Qualified basis" for LIHTC projectsTo calculate the qualified costs -- or "qualified basis" -- eligible for the tax credit, non-depreciable costs such as land and grants are subtracted from the total project cost. If a project is located in a neighborhood identified by HUD as a
difficult to develop area where land and construction costs are high relative to median income or a
qualified census tract where at least 50 percent of residents have incomes below 60 percent of the area median and the poverty rate is higher than 25 percent, this calculation is adjusted to allow up to 30 percent more available credits. The result is then multiplied by the smaller of either the percent of total units set aside for low-income residents or the percent of total square footage set aside for low-income units. The qualified basis is multiplied by the prevailing federal tax credit rate to determine the maximum allowable tax credit allocation.
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The corporate structure of tax credit partnershipsWhen tax credits are sold, the developer and the investor typically form a limited partnership. The developer is the general partner, holding a small percentage of ownership (usually one percent or less) but controlling the construction and operation of the project. The investor is a limited partner, owning a large share in the project but uninvolved in day-to-day operations. Investors generally do not expect the projects to generate income, but rather consider their reduced tax liability to be the return on their investment.
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The role of tax credit syndicatorsMost investors in LIHTC projects are corporations rather than individuals because the amount of credit individuals can use is capped. In many cases, the developer sells the credits to a syndicator to serve as a broker. Syndicators pool several projects into one LIHTC equity fund and market the tax credits to investors, who buy a share in the fund. This structure diffuses risk across multiple projects. As the prevalence of syndicators has risen over the LIHTC's lifetime, the risk associated with buying tax credits has declined, increasing their popularity with investors. Nevertheless, the value of tax credits fluctuates. In March 2007, tax credits were selling for 95 cents per tax credit dollar [1], but during the downturn they sold for 60 to 68 cents on the dollar due to a substantial drop in tax credit investment.
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[1] The Low-Income Housing Tax Credit: A Framework for Evaluation. [PDF] 2007. By Pamela L. Jackson. Washington, DC: Congressional Research Service.
