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Low-Income Housing Tax Credit: The Basics

The Low-Income Housing Tax Credit (LIHTC) is one of the largest sources of federal funding for affordable housing. Over the life of the program, low-income tax credits have been responsible for the creation or rehabilitation of nearly 3 million apartment homes for low- and moderate-income families. The credits are typically sold to investors, generating equity for rental developments serving families with incomes below 60 percent of the area median income. (AMI)

The LIHTC program was established by the Tax Reform Act of 1986 to promote private development of affordable rental housing. The credit has been a leading source of financing for affordable rental housing, accounting for over a third of all multifamily housing starts each year.

The federal government (through the Department of the Treasury) allocates tax credits to states based on population. The tax credit program is typically administered by Housing Finance Agencies (HFAs), which are state-chartered institutions established to meet affordable housing needs of the state. Developers—both for-profit and nonprofit—compete for these tax credits through a process outlined in each state’s Qualified Allocation Plan (QAP).  The LIHTC, while a federal program, is administered by the states, giving them substantial discretion in setting priorities for allocating this valuable subsidy. Developers sell these tax credits to investors to raise capital for their projects.  As a result of this process, the debt required to build the housing development is lower, and the project can offer lower, more affordable rents and still be a financially viable project.  Investors buy these credits as a tax benefit; tax credits are subtracted directly from a taxpayer’s liability each year for 10 years.

Differences Between the 9 Percent and 4 Percent Credits

There are two types of tax credits—the 9 percent and the 4 percent—that support a range of opportunities for states and localities to increase and preserve the stock of affordable rental homes.
The 9 percent credit is generally available for new construction.  Each year for 10 years, a tax credit equal to roughly 9 percent of a project’s qualified costs of construction may be claimed.  The 4 percent credit is generally claimed by developers rehabilitating existing affordable housing projects or by developers doing new construction that is primarily financed with tax-exempt bonds. The tax credits yield different tax credit values, which results in developers typically seeking the larger 9 percent tax credit for more expensive new construction, and the 4 percent credit for less expensive rehab projects. Given the larger value of the 9 percent tax credit, the allocation process is very competitive. An important advantage of the 4 percent credit is that it is a much less limited resource that is not subject to the same annual allocation caps that apply to the 9 percent credit. Any project that is financed through tax-exempt private-activity bonds, serves families with incomes below 60 percent of the area median income, and meets other eligibility criteria, qualifies automatically for the 4 percent LIHTC. This means that states that succeed in generating additional projects that qualify for the 4 percent LIHTC can increase the amount of federal funding they receive each year for affordable homes. Like the 9 percent credit, the 4 percent credit is also claimed over a 10-year period.  

The 9 percent and 4 percent credits, as their names indicate, offer different tax credit values to investors. The 9 and 4 percent rates refer to the approximate value of a tax credit that investors can claim each year. The actual rate is recalculated monthly by the IRS based on Treasury Department interest rates. The actual tax credit rate for a development 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. The 9 percent credit typically yields a total tax credit worth approximately 70 percent of the qualified development costs, adjusted for expected inflation. The 4 percent credit yields a total tax credit value that is approximately 30 percent of the present eligible development costs by the end of the 10-year period. As a result, the tax credits are also sometimes referred to as the 30 percent and 70 percent tax credits. In order to strengthen the 9 percent tax credit and provide some certainty to the tax credit value, legislation passed in 2015 established a floor for the 9 percent rate, so that the tax credit could be higher than 9 percent, but never lower.

Although the exact amounts vary substantially by project and market conditions, a good rule of thumb is that the 9 percent credit covers about half of a project’s cost, while the 4 percent credit covers about one-quarter. By increasing their use of the 4 percent credit, states can compensate for the limited availability of 9 percent credits. In addition, some developers rely on the 4 percent credit as an alternate financing tool, given the competitive nature of the 9 percent credit.

How LIHTCs are Allocated to Housing Developments

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 2016, states received $2.35 in tax credits per person (with an overall state minimum of $2.69 million). . The state housing finance agencies distribute the credits among projects that best meet the housing goals laid out in their Qualified Allocation Plans (QAPs).  There are several federal regulations and priorities that must be part of a state’s QAP but states also have the ability to set their own criteria and priorities for the allocation of their tax credits.

Qualified Basis for LIHTC Projects

Credits are awarded to developers based on the “qualified costs” of the project. To calculate these costs—or “qualified basis”—eligible for the tax credit, the total project cost is estimated, minus non-depreciable costs such as land and costs that are funded by grants or other federal subsidies.  If a project is located in a neighborhood identified by HUD as a difficult development area (DDA), where land and construction costs are high relative to median income, or a qualified Census tract (QCT), 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.

    Qualified basis = (development cost – land and costs covered by grants) x % of total units for low-income households or total square footage of low-income units

The Corporate Structure of Tax Credit Partnerships

When 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.

The Role of Tax Credit Syndicators

Most 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 who serves 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. The tax credit value in 2006 was $1.90 per capita, which was increased to $2.20 per capita during the housing crisis in 2008. As of 2016, the tax credit value as risen to $2.35 per capita.

Turning Tax Credits into Equity

In general, both the 4 percent and the 9 percent LIHTC programs are designed to cover the gap between the costs of developing affordable rental homes and the amount of financing that may be raised based on the rents that low-income families can afford. The project developers who receive tax credit allocations usually need equity, not tax credits, so the process of converting the tax credits to equity is an important part of the program. This process is known as syndication, and while it is a complicated process, the basic process includes an investor, or often a group of investors (usually large financial institutions), purchasing the tax credits at an agreed-upon price that reflects numerous economic factors. The credits are issued over a 10-year period so the dollar amount may be discounted although there are other factors, including the depreciation of the building, which could make the tax credits even more valuable than their face value.

The Role of State HFAs

State housing finance agencies (HFAs) are the part of state government responsible for administering affordable housing programs. Most HFAs allocate the state allotment of LIHTC awards, disburse federal block HOME grants and manage state housing bonds. HFAs conduct analysis of statewide housing needs and prioritize allocation of LIHTCs, grants and bonds to best meet those rental and homeownership needs in their state. Many HFAs also administer housing voucher and homelessness assistance programs in addition to creating new state programs. Some HFAs use excess reserves—funds held in reserve to maintain high bond ratings and cover unexpected funding shortfalls—to fund new or existing affordable housing programs instead of returning the unneeded funds to the state general fund. The National Council of State Housing Agencies, a nonprofit advocacy organization for HFAs, describes what HFAs do in more detail on its website.

Constraints of the LIHTC program

The number of affordable rental housing units developed and rehabilitated through the LIHTC program is primarily constrained by the preferences and set-asides described in the state’s QAP.  

Local development of affordable housing can also be constrained by costs.  The tax credit is allocated based on the “qualified costs” of the project—that is, the construction costs associated with the development of the affordable units in the project. There is no credit associated with the cost of land or with the cost of construction of any other parts of the development (including market-rate units, common facilities or community development space).  

Even with the tax credit, affordable housing projects in high cost areas can be very difficult because of the high cost of land.  Other subsidies—including grants and tenant rental assistance—are typically required to make projects in high cost areas financially feasible or to develop units that are affordable to very-low-income households.  

Furthermore, because the costs of construction of community or retail space are not eligible for the tax credits, it is more difficult to incorporate community and/or social services space in affordable housing projects.  It can also be more difficult to propose and develop mixed-income housing projects through the LIHTC program since different financing sources for the market rate and affordable units must be combined into one project.  

Key Resources


Danter Company, a national real estate consulting firm, maintains an extensive website on the LIHTC program, including basic information about the tax credit program, allocations by population, and links to additional resources.

Novogradac & Company maintains an Affordable Housing Resource Center with state-by-state information on allocating information, tax credit caps, and program deadlines.

Articles & Reports

Low-Income Housing Tax Credits: Affordable Housing Investment Opportunities for Banks.
2014. Community Developments. Comptroller of the Currency Administrator of National Banks, U.S. Department of the Treasury.

Tax Credits: Opportunities to Improve the Oversight of the Low-Income Housing Program.
1997. By James R. White. Washington, DC: United States General Accounting Office.

The Low-Income Housing Tax Credit Program Goes Mainstream and Moves to the Suburbs.
2006. By Kirk McClure. Housing Policy Debate 17(3): 419-446.

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