The Low-Income Housing Tax Credit (LIHTC) is an important program created to help the development and rehabilitation of rented housing for low-income households. In this comprehensive guide, we’re diving into the intricacies of the program so you can learn everything about its mechanisms, benefits, and the profound impact it has on communities around the United States.
What Is LIHTC?
LIHTC stands for Low-Income Housing Tax Credit, and it is an initiative created by the federal government to incentivize private investors to develop and preserve affordable rental housing for low-income tenants. The program offers tax credits to private developers, thereby reducing the financial barriers associated with constructing and renovating designated low-income housing.
The key stakeholders in this initiative include developers interested in financing affordable housing projects, investors seeking tax benefits, and, most importantly, low-income families who would gain access to quality housing options.
History of the Low-Income Housing Tax Credit (LIHTC) Program
As part of the 1986 Tax Reform Act, the LIHTC helped answer the growing need for affordable housing in America. With numerous modifications over the years to address the changing economic and housing landscape, the LIHTC program has facilitated the development of over three million housing units since it began.
It saw the greatest increase in development from 2000 to 2016, with an average of 115,000 affordable units built or renovated per year, helping to fight the affordable housing crisis.
How LIHTC Works
In collaboration with the federal government, state agencies, developers, and state agencies, the LIHTC operates through a structured allocation process.
Step 1: Allocation of Credits
State housing finance authorities (HFAs) receive tax credits from the federal government based on their population.
Step 2: Awarding Credits to Developers
Developers create a detailed proposal for an affordable housing project and submit it to the state HFA. The HFA then evaluates each application based on several criteria, including project location, affordability levels, and how quickly the project can begin.
Step 3: Financing the Project
Once a developer is awarded credits, they usually sell them to an investor in exchange for equity, reducing the project’s debt burden. Further down the timeline, this helps keep rent affordable for low-income residents.
Step 4: Compliance and Monitoring
To make sure units remain affordable long-term, developers must abide by specific income and rent restrictions for at least 15 years (sometimes longer, depending on the state).
By leveraging private capital to meet public housing needs and generating generous tax benefits, the LIHTC program provides an advantageous outcome for all stakeholders involved.
Steps to Apply for LIHTC
Under the LIHTC, there are two types of tax credits available: four percent and nine percent, with nine percent being the most sought-after.
Nine Percent Tax Credits
Nine percent tax credits are awarded by state housing finance agencies based on their own qualified allocation plans (QAPs), which have a more competitive allocation process. A state’s QAP outlines the minimum requirements to be eligible for the credit and lists scoring criteria used to compare project applications.
More developers are after these credits because they cover more of the cost of the affordable housing project (about 70%). Investors can claim these tax credits for the first 10 years of the project. Essentially, the credit reduces the developers’ tax liability by approximately the same amount as the construction cost of affordable rental housing multiplied by nine percent.
The nine percent credit is more often allocated to new construction projects.
Four Percent Tax Credits
Four percent tax credits work similarly to nine percent tax credits, with some notable differences. For one, these tax credits are awarded by the federal government, not state HFAs. Secondly, they cover a smaller amount of the costs to build, around 40% of the construction costs. Additionally, the allocation is not as competitive as nine percent tax credits, making them more readily available. Furthermore, these tax credits are typically associated with acquiring and rehabilitating properties that already exist or projects financed by tax-exempt bonds.
A project cannot be awarded both credits. However, with nine percent credits being harder to come by, if a project qualifies for the four percent credit and meets the criteria outlined in the state’s qualified allocation plan, it will receive the credit.
Eligibility Criteria for LIHTC
There are specific requirements that a project must meet in order to qualify for the LIHTC program and be considered affordable housing. The eligibility criteria include guidelines on income limits for resideents, what percentage of units must be affordable, rent restrictions, property requirements, and more.
Income Limits
LIHTC projects use HUD’s (United States Department of Housing and Urban Development) Area Median Income (AMI) measurements to determine how many of a project’s units must be designated as affordable housing to qualify for the low-income housing credit. The minimum affordability requirements state that either 20% of the units must be affordable for residents at or below 50% AMI or 40% of the units must be affordable for households at or below 60% AMI.
Additionally, in 2018, LITHC was reformed by the Consolidated Appropriations Act to prevent income clustering around the higher AMI limit. The change allows a household earning up to 80% AMI to qualify for affordable rental housing if all of the subsidized units’ average income is below 60%.
Rent Restrictions
To ensure affordability for low-income households, the rent, including utilities, cannot exceed 30% of the resident’s adjusted gross income (AGI).
Property Requirements
New affordable housing and rehabilitated properties can both qualify for the tax credits. Because new construction usually costs more and requires a greater investment compared to rehabilitated properties, they’re usually considered and awarded the nine percent credit, with the rehabilitated properties more often being awarded the four percent credit.
For both, in order to be considered LIHTC properties, they must comply with habitability standards and other state regulatory criteria.
Ensuring Ongoing Compliance
Owners of LIHTC properties must maintain the affordability criteria for a minimum of 30 years by submitting their compliance to the Internal Revenue Service (IRS) and their state housing finance authorities. As an enforcement measure, tax credits are not permanent for the first 15 years (known as the compliance period). During this time, the IRS can reclaim tax credits. The second 15 years are known as the extended use period. During this time, compliance goes through some changes. One of the most notable changes is owners no longer being required to report to the Internal Revenue Service and their state housing finance agencies. However, they are still expected to maintain affordability.
How LIHTC Benefits Developers and Investors
The benefits of affordable housing for low-income households are obvious, but you may be wondering what are the benefits or incentives for developers and investors.
For developers, the LIHTC program gives them an opportunity to finance projects with less debt by selling their tax credits to investors and raising more equity. In turn, they’re able to pass these savings on to low-income households in the form of lower rent.
For investors, the tax credits offer a valuable dollar-for-dollar reduction in their tax liability over a 10-year period and other tax benefits through depreciation and deductions. Affordable rental housing can also be a stable, long-term investment opportunity, often with predictable returns.
Overall, the LIHTC program serves as a public-private partnership model, demonstrating how we can leverage private capital to serve public needs by addressing the critical need for affordable housing.
Case Studies for Successful LIHTC Projects
Although not without its flaws and criticisms—which we’ll get to later—the LIHTC program is considered by many as the most successful tool to produce and preserve affordable rental housing.
In its almost four-decade history, the Low Income Housing Tax Credit program has financed more than 3.5 million affordable rental housing units, provided housing for approximately 8 million low-income households, supported an estimated 5.2 million jobs, and generated about $206 billion in tax revenue.
When it comes to the regional distribution of funding for LIHTC programs, housing studies show clusters are more likely to be located in highly developed central city locations with a high poverty rate, in qualified census tracts (QCTs), and in difficult development areas (DDAs).
Furthermore, a study from the National Library of Medicine database found that the LIHTC program has positive effects on housing values in both declining and stable neighborhoods.
Criticisms for LIHTC Projects
While successful in many areas, the LIHTC program also faces several significant challenges and criticisms regarding long-term affordability, barriers to smaller developers, and remedies to its limitations that would require reform and expansion of the program.
Many LIHTC projects transition to market rates after their 30-year compliance period expires, defeating the original purpose of their construction. Additionally, the competitive process of credit allocation and complex application process can be daunting for less-established developers and limit participation from smaller entities. Potential fixes to these issues include increasing the number of annual allocations and simplifying application procedures to improve accessibility and efficacy.
Common Misconceptions About LIHTC
Several myths and misconceptions surround the LIHTC program for various reasons, such as people’s preconceived notions about federal grants designed to help low-income households and the complex nature of government programs.
Myth: LIHTC is only for urban areas.
While units are more likely to be developed in densely populated areas, the LIHTC program is designed to be implemented in urban and rural areas to ensure affordable housing is available to a variety of communities.
Myth: LIHTC housing is low-quality or poorly maintained.
To ensure units are safe and well-maintained for residents, the LIHTC program has strict quality and compliance standards that owners must adhere to or else risk having their tax credits reclaimed.
Myth: Only large developers benefit from LIHTC.
Access to resources may make it easier for large developers to benefit from the LIHTC program. However, it aims to promote diverse involvement in affordable housing initiatives by providing access to a range of developers, including nonprofits and smaller entities.
FAQs About LIHTC
LIHTC stands for Low Income Housing Tax Credit.
Residents qualify for LIHTC housing by meeting certain income requirements set by the property. This criterion specifies residents earning at or below a certain amount of income and the number of household members that can be in one unit.
When people think of housing programs, they usually think of the Low Income Housing Tax Credit or Section 8, which are not the same. The main differences are their target audiences, how they’re funded, and the type of housing. Where LIHTC focuses on increasing the amount of affordable rental housing through developers and investors, Section 8 focuses on providing residents with subsidies for affordable housing.
Additionally, Section 8 provides rental assistance directly to residents while LIHTC allocates tax credits to developers to incentivize housing development. Lastly, the LIHTC program focuses on building new affordable housing or rehabilitating property specifically for low-income families. Section 8 residents can choose where they want to live, even if it’s in the private market. For this reason, Section 8 residents enjoy more flexibility in choosing their location and housing type.
Yes, LIHTC properties can be rented to mixed-income tenants. Developers can include 20–50, 40–60, and Income Averaging tests.
LIHTC properties must maintain compliance for a minimum of 30 years. To ensure owners stay compliant, they are required to submit proof to the IRS and state housing finance agencies for the compliance period, which is the first 15 years, or risk having their tax credits reclaimed.
Final Note
As the cornerstone of affordable housing development for nearly four decades, the Low Income Housing Tax Credit (LIHTC) has helped leverage private investment to address the affordable housing crisis since 1986. It has proven to be an effective public-private partnership, promoting economic growth, community revitalization, and long-term stability for millions of Americans.
With demand still far exceeding available supply, the LIHTC program is in need of stronger support now more than ever. Now is the time to invest in lasting solutions that benefit our nation’s people and communities.