LIHTC- How the credit program works
The LIHTC is regulated under Section 42 of the Internal Revenue Code. Each state’s housing agency is allocated tax credits by the IRS based on the state’s population. The initial per capita LIHTC rate set in 1986 of $1.25 per person has been raised several times, and in 2003, was adjusted each year by applying a CPO factor to the 2002 amount of $1.75 per person. The Housing and Economic Recovery Act of 2008 (HERA) temporarily increased the 2008 and 2009 allocations to $2.20 per person. The current LIHTC rate for each state as of 2011 is the greater of $2.15 per person or $2,465,000. The state housing agencies are responsible for administering the allocation of the LIHTC in accordance with Section 42 of the Internal Revenue Code. A Qualified Allocation Plan (QAP) is created by each state housing agency to document and communicate the criteria they use for evaluating and allocating the LIHTC awards on a competitive basis. The underlying basis behind the QAP required by Section 42 must be to award those projects which serve the lowest income families and remain affordable for the longest period of time.
The tax credits are awarded by the states to owners developing affordable housing projects and are used to obtain investor capital by selling the rights to the future credits. The future credits are recognized over a 10 year period and are based on the original basis in the project. Tax Credits are more attractive than tax deductions as they provide a dollar-for-dollar reduction in a taxpayer’s federal income tax, whereas a tax deduction only provides a reduction in taxable income. Within the Tax Reform Act of 1986, changes to the “passive loss rules” significantly reduced the value of the LIHTC and deductions to individual taxpayers. As a result, the majority of current investors in LIHTC projects are corporations.
Many factors play into the structure of the LIHTC entity. The LIHTC is a very sophisticated and complex financing tool with various types of investors. Investors who purchase the rights to the future credits of a LIHTC project are also buying into the ownership of the project as the credits are allocated based on ownership. This lends to the typical LIHTC project being organized as a limited partnership or limited liability company, limiting the exposure of the investor in the transaction. While the majority of the LIHTC entities are profit motivated, Section 42 mandates that 10% of the Tax Credits are reserved for project owned by not-for-profit organizations.
The LIHTC provides affordable housing by reducing the need for additional funding which the project would have to borrow by replacing it with the capital raised from selling the future credits allocated to the project. Many times the LIHTC project will still require additional funding sources in order to make the project affordable. The LIHTC has proven to be a versatile financing tool which can be combined with numerous funding sources in the form of project loans or tenant assistance thorough the United States Department of Housing and Urban Development (HUD), United States Department of Agriculture Rural Development (RD), and various conventional institutions. This flexibility and integration between organizations has added to the success and longevity of the LIHTC program.
The total tax credits awarded to an individual project are based on a calculation of its qualified basis times the federal tax credit rate. There are many variables that impact this calculation and several costs which are excluded from the calculation. Starting with the total costs incurred on the project, qualified basis is arrived at by:
- First, non-depreciable costs are subtracted from total costs to arrive at eligible basis
- Second, the eligible basis number can be increased by 30% if the project is determined to be in a Qualified Census Tract or Difficult Development Area
- Finally, the eligible basis is multiplied by the applicable fraction, or the smaller of (1) the percentage of low income units to total units, or, (2) the percentage of square footage of the low income units to the square footage of total units , to arrive at qualified basis
As with any Government assisted and funded program, the LIHTC program does not come without its share of restrictions and continuing compliance requirements. Two of the largest and most prominent continuing eligibility restriction relate to the tenant eligibility and longevity of the project. Projects receiving LIHTC are restricted by who they can rent to and how much they can charge for rent. Rent limits are set based on a percentage of the area median income and are adjusted by unit size. The rent is based on the tenants paying no more than 30% of their income for housing. Who projects can rent to is restricted by what is called minimum set asides or the requirement to rent a minimum amount of its units to tenants who earn less than a certain percentage of the Area Median Income. The projects must follow one of two minimum set aside classifications:
- 20-50: A minimum of 20% of the units must be leased to tenants at or below 50% of the Area Median Income
- 40-60: A minimum of 40% of the units must be leased to tenants at or below 60% of the Area Median Income
Finally, projects in the LIHTC program are required to maintain a minimum 30 year affordability period. The first 15 years being know as the compliance period and the second 15 years as the extended use period. Many states my required even longer affordability periods; however, even though the affordability period may be longer they are only required to monitor compliance during the federally required 30 year period.
