An Introduction to the Design of the Low-Income Housing Tax Credit
An Introduction to the Design of the
Low-Income Housing Tax Credit
Mark P. Keightley
Analyst in Public Finance
Government and Finance Division
Summary
The Low-Income Housing Tax Credit (LIHTC) is a federal provision that reduces
the income tax liability of taxpayers claiming the credit. These taxpayers are typically
investors in real estate development projects that have traded cash for the tax credits to
support the production of affordable housing. The credit is intended to lower the
financing costs of housing developments so that the rental prices of units can be lower
than market rates, and thus, presumably, affordable.
The Housing and Economic Recovery Act of 2008 (HERA), P.L. 110-289, includes
a number of provisions that make temporary or permanent changes to the LIHTC
program. For example, HERA increases the effective LIHTC rate applied to new
construction completed prior to 2014 and increases the LIHTC allocation to states from
$2.00 per capita to $2.20 per capita through 2009. The act also gives state housing credit
agencies the authority to designate certain buildings as qualified for the enhanced
LIHTC, clarifies the circumstances under which a building is to be considered federally
subsidized, and expands the size of the community common areas that may be included
in the eligible basis.
The Emergency Economic Stabilization Act of 2008 (EESA), P.L. 110-343,
includes a temporary change to the LIHTC with the intent of assisting victims of
Hurricane Ike and the severe weather and flooding in the Midwest. Specifically, EESA
allows certain states to allocate additional credits to affected areas for the years 2009,
2010, and 2011. For states located in the Midwestern disaster area the additional
allocation is equal to $8.00 multiplied by the state’s disaster area population. For the two
states most directly affected by Hurricane Ike, Texas and Louisiana, the additional
allocation is equal to $16.00 multiplied by the state’s population residing in affected
counties/parishes.
This report will be updated as warranted by legislative changes.
Overview
The LIHTC was created by the Tax Reform Act of 1986 (P.L. 99-514) to provide an
incentive for the acquisition (excluding land) and development or the rehabilitation of
affordable rental housing. These federal housing tax credits are awarded to developers of
qualified projects. Sponsors, or developers, of real estate projects apply to the
corresponding state housing finance authority for LIHTC allocations for their projects.
Developers either use the credits or sell them to investors to raise capital (or equity) for
real estate projects. The tax benefit reduces the debt and/or equity that the developer
would otherwise have to incur. With lower financing costs, tax credit properties can
potentially offer lower, more affordable rents.
The LIHTC was originally designed to deliver a 10-year subsidy equal to 30% or
70% of a project’s cost, dependent on the nature of a project. Rehabilitation and federally
subsidized construction is intended to receive the 30% subsidy, whereas new construction
is supposed to receive the 70% subsidy. Over time, the annual credit rate that has
delivered the 30% rehabilitation construction subsidy has approximately equaled 4% of
the project’s qualified basis, although the rate has fallen as low as 3.33%.1 At the same
time, the annual credit rate implied by the 70% new construction subsidy has
approximately equaled 9%, with a range of 7.89% to 9.27%.2 The method used to
determine the actual credit rate a project receives depends in part on the prevailing market
interest rate at the time the project is completed. Because the market interest rate changes
monthly, so do the LIHTC rates.3
The Housing and Economic Recovery Act of 2008 (HERA), P.L. 110-289, changed
the method used to determine the credit rate for new construction projects completed
before 2014. Under the new law, the credit rate assigned to new construction will not be
less than 9%. If the interest rate that prevails at the time a project is completed is such that
the credit rate as determined under the previous method is greater than 9%, then the
project will receive the higher rate. On the other hand, if the market interest rate is such
that the LIHTC rate is less than 9%, then the project will be assigned a credit rate of
exactly 9%. HERA made no changes to the credit rate that rehabilitation and federally
subsidized construction projects receive.
The Allocation Process
The process of allocating, awarding, and then claiming the LIHTC is complex and
lengthy. The process begins at the federal level with each state receiving an annual
1 U.S. Department of the Treasury, Internal Revenue Service, Revenue Ruling 2003-71, Table 4,
Appropriate Percentages Under Section 42(b)(2) for July 2003, Internal Revenue Bulletin 2003-
2 U.S. Department of the Treasury, Internal Revenue Service, Revenue Ruling 89-65, Table 4,
Appropriate Percentages Under Section 42(b)(2) for May 1989, Internal Revenue Bulletin 1989-
19, April 20, 1989; Revenue Ruling 2008-28, Table 4, Appropriate Percentages Under Section
3 See CRS Report RS22917, The Low-Income Housing Tax Credit Program: The Fixed Subsidy
and Variable Rate, by Mark P. Keightley.
LIHTC allocation in accordance with federal law. State housing agencies than allocate
credits to developers of rental housing according to federally required, but state created,
allocation plans. The process typically ends with developers exchanging allocated credits
for equity with outside investors. A more detailed discussion of each level of the
allocation process is presented below.
Federal Allocation to States. LIHTCs are first allocated to each state according
to its population and are typically administered by each state’s Housing Finance Agency
(HFA). For example, HFAs originally received annual tax credits equal to $2 per person
in 2008, with a minimum small population state allocation of $2,325,000.4 The Housing
and Economic Recovery Act of 2008 temporarily increases the per capita state allocation
by $0.20 for the years 2008 and 2009, and the minimum small population state allocation
by 10%. The state allocation limits do not apply in the case of development projects that
are financed with tax-exempt bond proceeds.5 Tax credits that are not allocated by states
are added to a national pool and then redistributed to those states that apply for the excess
credits. To be eligible for an excess credit allocation, a state must have allocated its entire
previous allotment of tax credits.
State Allocation to Developers. State Housing Finance Agencies (HFAs)
allocate credits to developers of rental housing according to federally required, but state
created, Qualified Allocation Plans (QAPs). Federal law requires that the QAP give
priority to projects that serve the lowest income households and that remain affordable
for the longest period of time. Many states have two allocation periods per year.
Developers apply for the credits by proposing plans to state agencies. On average, one
project out of five may receive an allocation of tax credits.
Developers of housing projects compete for tax credits as part of the financing for
the real estate development by submitting proposals to the HFA. Types of developers
include nonprofit organizations, for-profit organizations, joint ventures, partnerships,
limited partnerships, trusts, corporations, and limited liability corporations.
In order to be eligible for the LIHTC, properties are required to meet certain tests that
restrict both the amount of rent that is assessed to tenants and the income of eligible
tenants. The “income test” for a qualified low-income housing project requires that the
project owner irrevocably elect one of two income level tests, either a 20-50 test or a 40-
60 test. In order to satisfy the first test, at least 20% of the units must be occupied by
individuals with income of 50% or less of the area’s median gross income, adjusted for
family size. To satisfy the second test, at least 40% of the units must be occupied by
individuals with income of 60% or less of the area’s median gross income, adjusted for
4 From 1986 through 2000, the initial credit allocation amount was $1.25 per capita. The
allocation was increased to $1.50 in 2001, to $1.75 in 2002 and 2003, and indexed for inflation
annually thereafter. The initial minimum tax credit ceiling for small states was $2,000,000, and
was indexed for inflation annually after 2003.
5 Tax-exempt bonds are issued subject to a private activity bond volume limit per state. For more
information, see CRS Report RL31457, Private Activity Bonds: An Introduction, by Steven
Maguire.
family size.6 A qualified low-income housing project must also meet the “gross rents
test” by ensuring rents do not exceed 30% of the elected 50% or 60% of area median
gross income, depending on which income test the project elected.7
The types of projects eligible for the LIHTC are apartment buildings, single family
dwellings, duplexes, or townhouses. Projects may include more than one building. Tax
credit project types also vary by the type of tenants served. Housing can be for families
and/or special needs populations including the elderly.
Enhanced LIHTCs are available for difficult development areas (DDAs) and
qualified census tracts (QCTs) as an incentive to developers to invest in more distressed
areas: areas where the need is greatest for affordable housing, but which can be the most
difficult to develop.8 In these distressed areas, the LIHTC can be claimed for 130%
(instead of the normal 100%) of the project’s total cost excluding land costs. This also
means that available credits can be increased by up to 30%. P.L. 110-289 allows an HFA
to classify any building it sees fit as difficult to develop and hence, eligible for the
enhanced credit.
Developers and Investors. Upon receipt of a LIHTC allocation, developers
typically exchange the tax credits for equity. For-profit developers can either retain tax
credits as financing for projects or sell them; nonprofit developers sell tax credits.
Taxpayers claiming the tax credits are usually real estate investors, not developers. The
tax credits cannot be claimed until the real estate development is complete and operable.
This means that more than a year or two could pass between the time of the tax credit
allocation and the time the credit is claimed. If, for example, a project were completed
in June of 2008, depending on the filing period of the investor, the tax credits may not
begin to be claimed until some time in 2009.
Trading tax credits, or selling them, refers to the process of exchanging tax credits
for equity investment in real estate projects. Developers recruit investors to provide
equity to fund development projects and offer the tax credits to those investors in
exchange for their commitment. When credits are sold, the sale is usually structured with
a limited partnership between the developer and the investor, and sometimes administered
by syndicators who must adhere to the complex provisions of the tax code.9 As the general
partner, the developer has a very small ownership percentage but maintains the authority
to build and run the project on a day-to-day basis. The investor, as a limited partner, has
a large ownership percentage with an otherwise passive role.
6 U.S. Department of Treasury, Internal Revenue Service, Internal Revenue Code, Section
7 U.S. Department of Housing and Urban Development, Office of Policy Development and
Research, Updating the Low-Income Housing Tax Credit (LIHTC) Database Projects Placed in
Service Through 2003 (Washington: January 2006), p. 1.
8 Internal Revenue Code Section 42(d)(5)(C).
9 Syndicators are intermediaries who exist almost exclusively to administer tax credit deals. In
the early years of the LIHTC, syndicators were more prevalent. In later years, as the number of
corporate investors in the LIHTC grew and interacted directly with developers, the role of
syndicators diminished.
Typically, the investor does not expect the project to produce income. Instead,
investors look to the credits, which will be used to offset their income tax liabilities, as
their return on investment. The investor can also receive tax benefits related to any tax
losses generated through the project’s operating costs, interest on its debt, and deductions
such as depreciation and amortization.
The type of tax credit investor has changed over the life of the LIHTC. Upon the
introduction of the LIHTC in 1986, public partnerships were the primary source of equity
investment in tax credit projects, but diminished profit margins have driven some
syndicators out of the retail investment market. Although there are individual tax credit
investors, in recent years, the vast majority of investors have come from corporations,
either investing directly or through private partnerships.10 Neither individuals nor
corporations can claim the LIHTC against the alternative minimum tax.
Different types of investors have different motivations for investing in tax credits.
An estimated 43% of investors are subject to the Community Reinvestment Act (CRA),
and investment in LIHTCs is favorably considered under the investment test component
of the CRA.11 Other investors include real estate, insurance, utility, and manufacturing
firms, many of which list the rate of return on investment as their primary purpose for
investing in tax credits. Tax sheltering is the second-most highly ranked purpose for
investing.12
The LIHTC finances part of the total cost of many projects rather than the full cost
and, as a result, must be combined with other resources. The financial resources that may
be used in conjunction with the LIHTC include conventional mortgage loans provided by
private lenders and alternative financing and grants from public or private sources.
Individual states provide financing as well, some of which may be in the form of state tax
credits modeled after the federal provision. Additionally, some LIHTC projects may have
tenants who receive other government subsidies such as housing vouchers.
Legislative Developments
The Housing and Economic Recovery Act of 2008 (HERA), P.L. 110-289, includes
a number of provisions that made temporary or permanent changes to the LIHTC
program.13 As discussed earlier in this report, HERA guarantees that the LIHTC rate
applied to non-federally subsidized new buildings completed prior to 2014 will not be less
than 9%. The act also increases the LIHTC allocation to states from $2.00 per capita to
10 HousingFinance.com, “Corporate Investment and the Future of Tax Credits: What Should You
Expect,” at [http://www.housingfinance.com/housingreferencecenter/
Corporate_Investment.html], visited June 19, 2008.
11 U.S. Department of the Treasury. Office of the Comptroller of the Currency, Low Income
Housing Tax Credits: Fact Sheet August 2005, pp. 1-2, at [http://www.occ.treas.gov/Cdd/
fact%20sheet%20LIHTC.pdf], visited June 19, 2008.
12 Jean L. Cummings and Denise DiPasquale, “Building Affordable Housing: An Analysis of the
Low-Income Housing Tax Credit,” City Research, 1998, p. 33.
13 The Housing and Economic Recovery Act of 2008 (H.R. 3221) was passed in the Senate on
July 11, 2008 and in the House on July 23, 2008.
$2.20 per capita for 2008 and 2009. P.L. 110-289 changes the LIHTC program to allow
state housing credit agencies to designate certain buildings as qualified for the enhanced
LIHTC. Lastly, the act clarifies the circumstances under which a building is considered
to be federally subsidized and expands the size of the community common areas that may
be included in the eligible basis.
The Emergency Economic Stabilization Act of 2008 (EESA), P.L. 110-343, includes
a temporary change to the LIHTC with the intent of assisting victims of Hurricane Ike and
the severe weather and flooding in the Midwest. Specifically, EESA allows certain states
to allocate additional credits to affected areas for the years 2009, 2010, and 2011. For
states located in the Midwestern disaster area the additional allocation is equal to $8.00
multiplied by the state’s disaster area population. For the two states most directly affected
by Hurricane Ike, Texas and Louisiana, the additional allocation is equal to $16.00
multiplied by the state’s population residing in affected counties and parishes: the
counties of Brazoria, Chambers, Galveston, Jefferson, and Orange in Texas, and the
parishes of Calcasieu and Cameron in Louisiana.