The Low Income Housing Tax Credit (LIHTC or Tax Credit) program was created by the Tax Reform Act of 1986 as an alternate method of funding housing for low and moderate income households and has been in operation since 1987. Each state receives tax credits based on the state’s population. These tax credits are then used to leverage private capital into new construction or acquisition and rehabilitation of affordable housing.
The tax credits are determined by the development costs and are used by the owner. However, often, because of IRS regulations and program restrictions, the owner of the property will not be able to use all of the tax credits, therefore many LIHTC properties are owned by limited partnership groups that are put together by syndicators. In this manner, a variety of companies and private investors participate in the LIHTC program, investing in housing development and receiving credit against their federal tax liability in return.
Most states determine the amount of tax credit an individual project receives based on it qualified basis. First, the total project cost is calculated. Second, the eligible basis is determined by subtracting non-depreciable costs, such as land, permanent financing costs, rent reserves and marketing costs, etc. If the development is located in a HUD designated high-cost area (HCA), the eligible basis receives a 130% HCA adjustment. These areas include both Qualified Census Tracts (QCT) and Difficult Development Areas (DDA). Finally, to determine the qualified basis, the eligible basis is multiplied by the applicable fraction, which is 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 the total units, to arrive at the qualified basis.
The qualified basis is multiplied by the federal tax credit rate, published monthly by the IRS, to determine the maximum allowable tax credit allocation. For projects that are new construction or rehabilitation, which are not financed with a federal subsidy, the rate is approximately 9%. For projects involving a federal subsidy (including projects financed more than 50% with tax-exempt bonds), the rate is approximately 4%. The 9% and 4% rates are used to determine a project’s initial tax credit reservation. A project’s final (placed in service) tax credit allocation is based on actual project sources and uses of funds, the financing shortfall, and the actual applicable federal rate. The rate applicable to a project is the rate published for the month each building is placed in service or in an earlier month elected by the sponsor. The allocation cannot exceed the initial reservation amount and may be reduced if an analysis determines that the maximum allowable amount would generate excess equity proceeds to the project.