.
An Introduction to the Low-Income Housing
Tax Credit
Mark P. Keightley
Specialist in Economics
Jeffrey M. Stupak
Research Assistant
November 7, 2014
Congressional Research Service
7-5700
www.crs.gov
RS22389
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
Summary
The low-income housing tax credit (LIHTC) program is one of the federal government’s primary
policy tools for encouraging the development and rehabilitation of affordable rental housing.
These non-refundable federal housing tax credits are awarded to developers of qualified rental
projects via a competitive application process administered by state housing finance authorities.
Developers typically sell their tax credits to outside investors in exchange for equity. Selling the
tax credits reduces the debt developers would otherwise have to incur and the equity they would
otherwise have to contribute. With lower financing costs, tax credit properties can potentially
offer lower, more affordable rents. The LIHTC is estimated to cost the government an average of
approximately $7 billion annually.
The LIHTC program was originally designed to provide a 30% subsidy for rehabilitated rental
housing via the so-called 4% credit, and a 70% subsidy for newly constructed rental housing via
the so-called 9% credit. To ensure that the 30% or 70% subsidies were achieved, the U.S.
Department of the Treasury designed a formula for determining the effective 4% and 9% LIHTC
rates. The formula depends in part on current market interest rates that fluctuate over time. These
fluctuations have caused the LIHTC rates to change over time, and typically have resulted in
effective LIHTCs below the 4% and 9% thresholds. Developers and investors have expressed
concern over the uncertainty that the variable LIHTC rate changes introduce into the program.
The Housing and Economic Recovery Act of 2008 (P.L. 110-289) temporarily changed the credit
rate formula used for new construction. The act effectively placed a floor equal to 9% on the new
construction tax credit rate. The 9% credit rate floor only applies to new construction placed in
service before December 31, 2013. The 4% tax credit rate that is applied to rehabilitation
construction remained unaltered by the act. The American Taxpayer Relief Act of 2012 (P.L. 112-
240) extended the 9% floor for credit allocations made before January 1, 2014. The Expiring
Provisions Improvement Reform and Efficiency Act (EXPIRE; S. 2260), introduced in the Senate
on April 28, 2014, would extend the 9% floor and introduce a 4% tax credit floor, both of which
would expire at the end of 2015. The 10-year revenue loss associated with this provision is
estimated to be $49 million.
On February 26, 2014, House Ways and Means Committee Chairman Dave Camp released a draft
of the Tax Reform Act of 2014, which proposes several changes to the LIHTC program. The most
significant change involves the method for distributing credits to developers. Currently, each state
is given an authorized credit amount equal to $2.30 per resident, with a minimum authority of
$2,635,000 for low-population states. State and local housing finance authorities (HFAs) then
allocate the credits to developers to offset a project’s qualified basis (certain eligible costs). Under
the reform proposal, HFAs would allocate qualified basis not credits to developers. Allocation
authority for each state would be limited to $31.20 per person, with a minimum authority of
$36,300,000. The reform also proposes repealing the so-called 4% credit, eliminating enhanced
financing for certain high-cost areas, extending the credit period from 10 years to 15 years, and
eliminating the national pool of unused LIHTCs, along with several other smaller changes. The
10-year revenue loss associated with this provision is estimated to be $10.4 billion.
This report will be updated as warranted by legislative changes.
Congressional Research Service
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
Contents
Overview .......................................................................................................................................... 1
The Allocation Process .................................................................................................................... 2
Federal Allocation to States ....................................................................................................... 2
State Allocation to Developers .................................................................................................. 2
Developers and Investors .......................................................................................................... 3
Recent Legislative Developments ................................................................................................... 5
Contacts
Author Contact Information............................................................................................................. 6
Congressional Research Service
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
Overview
The low-income housing tax credit (LIHTC) was created by the Tax Reform Act of 1986 (P.L. 99-
514) to provide an incentive for the development and rehabilitation of affordable rental housing.
These federal housing tax credits are awarded to developers of qualified projects via a
competitive application process administered by state housing finance authorities (HFAs).
Developers either use the credits or sell them to investors to raise capital for real estate projects,
which, in turn, reduces the debt or equity contribution that would otherwise be required of
developers. With lower financing costs, tax credit properties can potentially expand the supply of
affordable rental housing. The LIHTC is estimated to cost the government an average of nearly
$7 billion annually.1
Two types of LIHTCs are available depending on the nature of the rental housing construction.
The so-called 9% credit is generally reserved for new construction. Each year for 10 years a tax
credit equal to roughly 9% of a project’s qualified basis (cost of construction) may be claimed.
The applicable credit rate is not actually 9%; instead, the specific rate that a project will receive is
set so that the present value of the 10-year stream of credits equals 70% of a project’s qualified
basis.2 The formula used to ensure the 70% subsidy is achieved depends in part on current market
interest rates that fluctuate over time.3 These fluctuations have also caused the LIHTC rate to
change over time. When interest rates are relatively low, the 70% subsidy can be achieved with a
lower credit rate than when interest rates are relatively high. Since 1986, the 9% credit has ranged
between 7.35% and 9.27%.4
The so-called 4% credit is typically claimed for rehabilitated housing and new construction that is
financed with tax-exempt bonds.5 Like the 9% credit, the 4% credit is claimed annually over a 10-
year credit period. The actual credit rate fluctuates around 4%, but is set by the Treasury to
deliver a subsidy equal to 30% of a project’s qualified basis in present value terms. At one point,
the 4% credit rate had fallen to as low as 3.15%.6 For both the 4% and 9% credit it is the subsidy
levels (30% or 70%) that are explicitly specified in the Internal Revenue Code (IRC), not the
credit rates.
1 U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2014-2018,
committee print, 113th Cong., 2nd sess., August 5, 2014, JCX-97-14.
2 The concept of present value is used when it is necessary to value a stream of money that is expected to be received
over time. Because of the ability to earn a return on money received sooner rather than later, money received in the
future is less valuable than money received today. The present value concept accounts for this “time value of money”
by discounting money expected to be received at different points in time. Usually, discounting is carried out using an
interest rate because interest rates measure the time value of money.
3 See CRS Report RS22917, The Low-Income Housing Tax Credit Program: The Fixed Subsidy and Variable Rate, by
Mark P. Keightley for a detailed discussion of how the LIHTC rates are calculated.
4 The lower bound of this range is the rate that would have prevailed in absence of the 9% credit floor. U.S. Department
of the Treasury, Internal Revenue Service, Revenue Ruling 2012-24, Table 4, Appropriate Percentages Under Section
42(b)(2) for September 2012, Internal Revenue Bulletin 2012-36, September 4, 2012, and Novogradac & Company
LLP, “Appendix H: List of Monthly Credit Percentages,” in Low-Income Housing Tax Credit Handbook, 2006 ed.
(2006), p. 845.
5 A developer using federal tax-exempt bonds can qualify for the 9% credit if they reduce the project’s eligible basis by
the amount of the tax-exempt bond subsidy.
6 U.S. Department of the Treasury, Internal Revenue Service, Revenue Ruling 2012-24, Table 4, Appropriate
Percentages Under Section 42(b)(2) for September 2012, Internal Revenue Bulletin 2012-36, September 4, 2012.
Congressional Research Service
1
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
To understand the mechanics of the LIHTC, consider a new affordable housing apartment
complex with a qualified basis of $1 million. Since the project involves new construction it will
qualify for the 9% credit and generate a stream of tax credits equal to $90,000 (9% × $1 million)
per year for 10 years, or $900,000 in total. Under the appropriate interest rate the present value of
the $900,000 stream of tax credits should be equal to $700,000, resulting in a 70% subsidy. The
situation would be similar if the project involved rehabilitated construction except the developer
would be entitled to a stream of tax credits equal to $40,000 (4% × $1 million) per year for 10
years, or $400,000 in total. The present value of the $400,000 stream of tax credits should be
equal to $300,000, resulting in a 30% subsidy.
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 LIHTC allocation in
accordance with federal law. State housing agencies then allocate credits to developers of rental
housing according to federally required, but state created, allocation plans. The process typically
ends with developers selling allocated credits to outside investors in exchange for equity. 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. In 2014, states received a
LIHTC allocation of $2.30 per person, with a minimum small population state allocation of
$2,635,000.7 The state allocation limits do not apply to the 4% credits which are automatically
packaged with tax-exempt bond financed projects.8 The administration of the tax credit program
is typically carried out by each state’s Housing Finance Agency (HFA).
State Allocation to Developers
State 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. Types of developers include nonprofit organizations, for-
profit organizations, joint ventures, partnerships, limited partnerships, trusts, corporations, and
limited liability corporations.
An allocation to a developer does not imply that all allocated tax credits will be claimed. An
allocation simply means tax credits are set aside for a developer. Once a developer receives an
allocation it has several years to complete its project. Credits may not be claimed until a project is
completed and occupied, also known as “placed in service.” Tax credits that are not allocated by
7 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.
8 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.
Congressional Research Service
2
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
states are added to a national pool and then redistributed to 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. This use or lose feature gives states an incentive to allocate all of their
tax credits to developers.
In order to be eligible for a LIHTC allocation, 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 family size.9 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.10
The types of projects eligible for the LIHTC are apartment buildings, single family dwellings,
duplexes, and 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 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.11 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%. HERA (P.L. 110-289) enacted changes that allow 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 to investors;
nonprofit developers sell tax credits. Taxpayers claiming the tax credits are usually 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
2014, depending on the filing period of the investor, the tax credits may not begin to be claimed
until some time in 2015.
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
9 Internal Revenue Code (IRC) §42(g)(1).
10 IRC §42(g)(2).
11 IRC §42(d)(5).
Congressional Research Service
3
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
between the developer and the investor, and sometimes administered by syndicators who must
adhere to the complex provisions of the tax code.12 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. Syndicators charge a fee for overseeing the investment transactions.
Typically, investors do 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
return investors receive is determined in part by the market price of the tax credits. The market
price of tax credits fluctuates, but in normal economic conditions the price typically ranges from
the mid-$0.80s to low-$0.90s per $1.00 tax credit. The larger the difference between the market
price of the credits and their face value ($1.00), the larger the return to investors. 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.
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.13
Different types of investors have different motivations for investing in tax credits. Some investors
are motivated by the Community Reinvestment Act (CRA), which considers LIHTC investments
favorably.14 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.15
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.
12 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.
13 HousingFinance.com, “Corporate Investment and the Future of Tax Credits: What Should You Expect,” at
http://www.housingfinance.com/housingreferencecenter/Corporate_Investment.html, June 19, 2008.
14 In 2005, an estimated 43% of LIHTC investors were subject to the CRA. 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, June 19, 2008.
15 Jean L. Cummings and Denise DiPasquale, “Building Affordable Housing: An Analysis of the Low-Income Housing
Tax Credit,” City Research, 1998, p. 33.
Congressional Research Service
4
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
Recent Legislative Developments
The Housing and Economic Recovery Act of 2008 (HERA, P.L. 110-289) temporarily changed
the formula used to determine the applicable credit rate for new construction. The act effectively
placed a floor equal to 9% on the new construction tax credit rate. The 9% credit rate floor had
originally been scheduled to apply only to new construction placed in service before December
31, 2013. The 4% credit remained unaltered by HERA. The American Taxpayer Relief Act of
2012 (P.L. 112-240) extended the 9% floor for credit allocations made before January 1, 2014.
Senator Cantwell introduced legislation in 2013 (S. 1442) that would have permanently extended
the 9% floor and would have also provided a permanent 4% floor for the rehabilitation credit. A
proposed one year extension of the 9% floor was also included in “tax extender” legislation (S.
1859) introduced by Senator Reid on December 19, 2013. The Expiring Provisions Improvement
Reform and Efficiency Act (EXPIRE; S. 2260), introduced in the Senate on April 28, 2014,
would extend the 9% floor and introduce a 4% tax credit floor, both of which would expire at the
end of 2015. The JCT estimates the 10-year revenue loss associated with this provision to be $49
million.16
On February 26, 2014, House Ways and Means Committee Chairman Dave Camp released a draft
of the Tax Reform Act of 2014, which proposes several changes to the LIHTC program. The most
significant change involves the method for distributing credits to developers. As discussed
previously, currently, each state is given an authorized credit amount equal to $2.30 per resident,
with a small state minimum authority of $2,635,000. State and local housing finance authorities
(HFAs) then allocate the credits to developers to offset a project’s qualified basis (certain eligible
costs). Under the reform proposal, HFAs would allocate qualified basis not credits to developers.
Allocation authority for each state would be limited to $31.20 per person, with a minimum small
state authority of $36,300,000. The reform also proposes repealing the so-called 4% credit,
eliminating enhanced financing for certain high-cost areas, extending the credit period from 10
years to 15 years, and eliminating the national pool of unused LIHTCs, along with several other
smaller changes. The JCT estimates the 10-year revenue loss associated with this provision to be
$10.4 billion.17
16 U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of the Chairman’s Mark of the “Expiring
Provisions Improvement Reform and Efficiency Act of 2014,” 113th Cong., 2nd sess., April 1, 2014, JCX-27-14
(Washington: GPO, 2014).
17 U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of the “Tax Reform Act of 2014,” 113th
Cong., 2nd sess., February 26, 2014, JCX-20-14 (Washington: GPO, 2014).
Congressional Research Service
5
c11173008
.
An Introduction to the Low-Income Housing Tax Credit
Author Contact Information
Mark P. Keightley
Jeffrey M. Stupak
Specialist in Economics
Research Assistant
mkeightley@crs.loc.gov, 7-1049
jstupak@crs.loc.gov, 7-2344
Congressional Research Service
6
c11173008