Key Issues in Tax Reform: The Low-Income Housing Tax Credit

Key Issues in Tax Reform: The Low-Income Housing Tax Credit

Updated September 27, 2017
Key Issues in Tax Reform: The Low-Income Housing Tax
Credit
The low-income housing tax credit (LIHTC) program is one
Upon receipt of an LIHTC award, developers typically sell
of the federal government’s primary policy tools for
the tax credits to investors in exchange for an equity
encouraging the development and rehabilitation of
investment in the project. The return investors receive is
affordable rental housing. The program is estimated to cost
determined in part by the market price of the tax credits,
approximately $9.0 billion annually in forgone federal tax
which fluctuates but typically ranges from the mid-$0.80s
revenue. Because of its importance as a housing policy tool
to mid-$0.90s per $1.00 tax credit. The larger is the
and its cost, Congress has continually expressed interest in
difference between the price of the credits and their face
modifying the program over the years, including as part of
value ($1.00), the larger the return to investors. The
recent tax reform discussions.
investor can also receive tax benefits related to any tax
losses generated by the project’s operating costs, interest on
This In Focus provides a brief overview of the LIHTC
its debt, and deductions such as depreciation.
program and associated economic considerations. For more
information on the LIHTC program, see CRS Report
Rent and Income Limits
RS22389, An Introduction to the Low-Income Housing Tax
LIHTC properties must satisfy two tests applied to the
Credit, by Mark P. Keightley.
income of tenants and the amount of rent that may be
charged. The “income test” for a qualified low-income
Overview of LIHTC
housing project requires that the project owner irrevocably
elect one of two income level tests, either a 20-50 test or a
Origin
40-60 test. In order to satisfy the first test, at least 20% of
LIHTC was created by the Tax Reform Act of 1986 (P.L.
the units must be occupied by individuals with income of
99-514) to replace various existing affordable housing tax
50% or less of the area’s median gross income (AMI). To
incentives that were viewed as inefficient and
satisfy the second test, at least 40% of the units must be
uncoordinated. The tax credits are given to developers over
occupied by individuals with income of 60% or less of
a 10-year period in exchange for constructing affordable
AMI. A qualified low-income housing project must also
rental housing. The LIHTC program was originally
meet the “gross rents test” by ensuring rents do not exceed
scheduled to expire in 1989, but was extended several times
30% of the elected 50% or 60% AMI threshold determined
before being made permanent in the Omnibus Budget
by the income test. The maximum rent a tenant can be
Reconciliation Act of 1993 (P.L. 103-66).
charged is based on 30% of the elected AMI threshold, and
not the income of the tenant.
The Mechanics of the Program
The mechanics of the LIHTC program are complex and
Types of Tax Credits
lengthy. The process begins at the federal level with each
One of two tax credits is available depending on the type of
state receiving an annual LIHTC allocation based on
rental housing construction. The so-called 9% credit is
population. In 2017, states received an LIHTC allocation
generally reserved for new construction. A developer who
equal to the greater of $2.35 per person, or $2,710,000.
is awarded these credits will receive a tax credit equal to at
State or local housing agencies then award credits to
least 9% of a project’s qualified construction costs each
developers. The process typically ends with developers
year for 10 years. For example, if a new affordable housing
selling the credits to investors.
complex costs $1 million (excluding land costs, which do
not qualify), the developer would receive credits equal to
Developers are awarded tax credits via a competitive
$90,000 per year for 10 years, or $900,000 in total.
application process administered by their state or local
housing finance authority (HFA). HFAs review developer
The so-called 4% credit is typically claimed for
applications to ensure that proposed projects satisfy certain
rehabilitated housing and new construction that is financed
federally required criteria, as well as criteria established by
with tax-exempt bonds. Like the 9% credit, the 4% credit is
each state. For example, some states may choose to give
claimed annually over a 10-year credit period. If, in the
priority to buildings that offer specific amenities such as
example above, the $1 million in qualifying costs were
computer centers or that are located close to public
associated with rehabilitating a building or constructing a
transportation, while others may give priority to projects
new building using tax-exempt bonds, the developer would
serving a particular demographic, such as the elderly.
receive credits equal to $40,000 per year for 10 years, or
Delegating authority to states to award credits gives each
$400,000.
state the flexibility to address its individual housing needs,
which is important given the local nature of housing
The use of the terms “4% credit” and “9% credit” has
markets.
created confusion. Historically, the credits have not been
https://crsreports.congress.gov

Key Issues in Tax Reform: The Low-Income Housing Tax Credit
exactly 4% and 9%. Instead, the actual credit rates are set to
community that the transportation burden for low-income
ensure that the present value of the 10-year stream of
workers is too high and that affordable housing is not
credits equals 30% of construction costs for rehabilitation
located in safe neighborhoods with access to quality
and bond-financed projects, and 70% of construction costs
schools. The LIHTC program is one way to encourage
for new construction. Because present value calculations
affordable housing more closely situated to tenants’ jobs,
depend on interest rates, and because interest rates fluctuate
and in better neighborhoods and school districts.
over time, so do the tax credit rates. Typically, the actual
Alternative policy approaches, however, could be more
credit rates have been below the 4% and 9% nominal
effective or cost efficient, such as encouraging construction
thresholds. Beginning in 2008, a temporary “floor” was
in less densely populated markets and providing a transit
placed under the credit for new construction so that the rate
subsidy, or supplementing renters’ incomes with vouchers
could not fall below 9%. It was later made permanent. No
so they may choose where they live.
such floor exists for the 4% credit. Regardless, it is the
subsidy levels (30% or 70%) that are explicitly specified in
Reform Proposal
the Internal Revenue Code (IRC), not the credit rates.
The Unified Framework for Fixing Our Broken Tax Code,
issued by the Office of the Speaker on September 27, 2017,
Economic Considerations
states that it would preserve the LIHTC program. In the
The LIHTC program has supported the development of
113th Congress, the Tax Reform Act of 2014 (H.R. 1)
45,905 projects and 2.97 million housing units between
proposed eliminating the 4% credit and extended the credit
1987 and 2015. Industry experts often cite figures such as
period from 10 years to 15 years. Additionally, the reform
these as evidence of the credit’s success. But for the LIHTC
would have changed the method for allocating tax credit
program to increase the stock of affordable housing, it must
financing to states.
result in a net increase in the housing supply. The question
is then: how much of the affordable housing financed with
A number of other recent proposals could be included as
LIHTCs would have been provided by the market, either
part of reform. For example, some have proposed using an
via new construction or from the depreciation of existing
income “averaging” approach to determine tenant eligibility
housing, had the LIHTC not existed?
so the program targets households further down the income
distribution. Specifically, individuals with incomes up to
The economic literature suggests that LIHTC-financed
80% of AMI could qualify for LIHTC housing, as long as
additions to the affordable rental housing stock are at least
the average income of all tenants did not exceed 60% of
somewhat, and in the extreme case fully, substituting for
AMI. Thus, renting to someone with an income equal to
market-provided affordable housing. The degree of
80% of AMI would also require renting to someone with an
substitution is important as it indicates how effective the
income equal to 40% of AMI. The belief is this would
LIHTC program is at achieving its prime policy objective
promote greater income mixing and help those further down
of increasing the supply of affordable housing. The results
the income distribution obtain affordable housing.
in the literature are limited due to the wide variability of
estimates, which is driven in part by the local nature of
Recent proposals have also included increasing the amount
housing itself and data availability.
of credits states receive by up to 50% and installing a 4%
“floor” below which the credit for rehabilitation could not
Other policy justifications may exist for the LIHTC
fall. It has also been proposed that states be allowed to
program (or construction subsidies generally) other than its
convert private activity bond volume cap into LIHTCs to
effect on the overall housing supply that policymakers may
assist in meeting the demand for the credits. There have
want to consider. For example, new LIHTC construction
also been calls for more information reporting by tax credit
may result in higher-quality affordable housing than
syndicators and participants more generally in order to
provided by the market. One could argue that a minimum
better understand the role these intermediaries play in
standard of housing is a fundamental feature of a
arranging LIHTC deals.
prosperous society, and if the LIHTC program promotes
such a standard, then society should subsidize affordable
It is important to consider the indirect effects of tax reform.
housing construction.
Most reforms propose lowering tax rates. Lower tax
liabilities will naturally lower the demand for tax credits,
The LIHTC program could also be a useful strategy to
which means less private capital financing for credit-
reduce poverty and social isolation among lower-income
financed housing. Tax credit prices have fallen in recent
individuals, since it allows mixed-income housing.
months, suggesting that markets already appear to be
Therefore, policymakers could justify the LIHTC to the
pricing in lower demand for the credit and uncertain future
extent that mixed-income housing is effective at addressing
taxes.
these two concerns. The most recent LIHTC data available,
however, show that LIHTC developments almost
This In Focus is part of a series of short CRS products on
exclusively house eligible low-income tenants as opposed
tax reform. For more information, visit the “Taxes, the
to a mixture of tenants across income levels.
Budget, & the Economy” Issue Area page at www.crs.gov.
Lastly, the LIHTC program may promote more ideally
Mark P. Keightley, Specialist in Economics
located affordable housing. Oftentimes there is a tradeoff
between affordability and convenience or desirability of
IF10725
location. There is a concern in the affordable housing
https://crsreports.congress.gov

Key Issues in Tax Reform: The Low-Income Housing Tax Credit

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.

https://crsreports.congress.gov | IF10725 · VERSION 3 · UPDATED