How to Navigate Multifamily Tax Credits
The wide range of tax incentives for multifamily properties are complicated, but they can provide incredible opportunities for investors and developers.
- Multifamily Tax Credits: A Brief History
- Types of Multifamily Tax Credits
- Low-Income Housing Tax Credit (LIHTC)
- New Markets Tax Credit (NMTC)
- Historic Preservation Tax Credit
- Other Tax Credits
- How to Get Tax Credits for Your Apartment Building
- Benefits of Multifamily Tax Credits
- Disadvantages of Multifamily Tax Credits
- The Final Word
- Related Questions
- Get Financing
For multifamily investors, navigating the complex world of tax credits can be a daunting task, especially if it’s your first time. However, understanding the various tax credits available to you can provide valuable opportunities for financing and reducing tax liabilities.
Let’s explore the world of multifamily tax credits. We’ll take a look at their history, benefits, and how to obtain them.
Multifamily Tax Credits: A Brief History
The use of tax credits as a means of financing affordable housing dates back to the 1980s. In 1986, the Tax Reform Act created the Low-Income Housing Tax Credit (LIHTC) program, which remains the primary source of financing for affordable rental housing in the United States. Since then, other tax credit programs have been introduced, including the New Markets Tax Credit (NMTC) and the Historic Preservation Tax Credit.
Types of Multifamily Tax Credits
Low-Income Housing Tax Credit (LIHTC)
The LIHTC program is a federal tax credit that provides an incentive to investors to finance the construction or rehabilitation of affordable rental housing for low-income households. Although the LIHTC program is federal, it is administered by state housing agencies. Each state awards credits to developers based on a competitive application process.
The LIHTC program provides a credit equal to a percentage of the cost of each qualified low-income building over a 10-year period. The credit amount is based on the cost of constructing or rehabilitating the building, along with the number of low-income units in the project. The credit can be sold to investors to provide equity financing for the project.
New Markets Tax Credit (NMTC)
The NMTC program is a federal tax credit designed to encourage investment in low-income neighborhoods. The program provides tax credits to investors who invest in qualified community development entities (CDEs) that finance business and real estate projects in low-income areas.
The NMTC program provides a credit equal to 39% of the total qualified investment over a seven-year period. The credit can be used to offset federal income taxes, and the remaining credit can be carried forward for up to 20 years.
Unlike the LIHTC, NMTCs cannot be used for purely multifamily properties. Instead, they are applicable for buildings with a minimum 20% commercial component — based on a property’s revenue, not square footage. This means they are ideally suited for mixed-use developments.
Historic Preservation Tax Credit
The Historic Preservation Tax Credit is a federal tax credit that provides an incentive to investors to rehabilitate historic buildings. The program provides a credit equal to 20% of the qualified rehabilitation expenditures incurred in rehabilitating a certified historic structure.
What are qualified rehabilitation expenditures? They generally cover the operational and maintenance parts of a building, from floors to doors, and from plumbing to chimneys. New appliances, fences, and the like are broadly excluded.
The credit can be used to offset federal income taxes, and any unused portion of the credit can be carried forward for up to 20 years. State historic tax credits may also be available to supplement the federal credit.
Other Tax Credits
The above list isn’t exhaustive. There are a number of other tax credits that may not be exclusively for multifamily but can provide serious tax savings for multifamily investors and developers.
One option is the Renewable Energy Tax Credit, or RETC. If your property installs solar panels or other renewable energy components, some of the installation and operating costs may be eligible, for example.
Another example is the Brownfields Tax Credit. This program is specifically for redeveloping properties (of any type) on sites that have been contaminated or otherwise environmentally damaged: Think former chemical plant sites and the like. These tax credits help finance the cleanup of the sites, and the credits can even be sold to other developers for a profit.
How to Get Tax Credits for Your Apartment Building
To obtain multifamily tax credits, developers must typically apply to their state housing agency or community development body. The application process is typically highly competitive. Developers must demonstrate the feasibility of the project, including the projected rent and operating expenses, the proposed financing structure, and the experience of the development team.
Developers must also comply with specific requirements related to tenant income and rent restrictions, as well as building and unit design and construction standards. In addition, developers must comply with ongoing compliance requirements related to rent and income restrictions, occupancy, and other program requirements.
Because of all these complicated requirements, it is always a good idea to seek legal advice throughout the application process. Also note that developers — especially in terms of LIHTCs — aren’t usually the ones claiming tax credits. In many cases, developers find one or more tax credit investors who provide funding for a development.
Benefits of Multifamily Tax Credits
Multifamily tax credits provide several benefits to investors and developers. The credits can be used to offset federal income taxes and provide equity financing for the project. In addition, the credits can reduce the cost of financing and provide a lower cost of capital for the project.
The use of tax credits also provides an opportunity to promote affordable housing and community development in low-income areas. Tax credits provide a valuable tool for developers to finance projects that may not otherwise be feasible, and to provide much-needed affordable housing to low-income households.
Disadvantages of Multifamily Tax Credits
Multifamily tax credits can be great for an investor or developer, but they aren’t without their drawbacks.
First, multifamily tax credits can be complicated to navigate. There are different types of credits available, each with specific eligibility requirements. Property owners and developers generally need to hire tax professionals or consultants to help them understand and take advantage of these credits.
Also, multifamily tax credits have limited availability, and not all projects or properties will qualify. For example, the LIHTC program has a limited amount of credits available each year per state, and there is often more demand for these credits than there is supply. This means that not all eligible projects will receive the tax credits they need to move forward, which can be a significant hurdle for developers and property owners looking to finance projects.
The Final Word
Navigating the complex world of multifamily tax credits can be challenging, but it is essential for investors and developers to understand the available programs, their benefits, and their drawbacks.
Obtaining tax credits requires careful planning and compliance with specific program requirements, including tenant income and rent restrictions, building design and construction standards, and ongoing compliance obligations.
However, the benefits of using tax credits can provide valuable financing and equity opportunities, promote affordable housing and community development, and provide a lower cost of capital for multifamily projects.
Even if your application for tax credits is unsuccessful, however, know that it’s not necessarily the end of the road for your planned community. There are many extremely competitive multifamily financing programs — especially those through HUD — which can significantly boost an existing or future property’s cash flows.
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Related Questions
What are multifamily tax credits and how can they benefit investors and developers?
- Multifamily tax credits are tax incentives for financing affordable housing. They can provide equity financing for projects, reduce tax liabilities, and promote community development in low-income areas.
How can developers obtain multifamily tax credits?
- Developers must apply to state housing agencies or community development bodies. The application process is highly competitive and requires demonstrating the feasibility of the project, complying with specific requirements related to tenant income, rent restrictions, building design, and construction standards.
What are the disadvantages of multifamily tax credits?
- Multifamily tax credits can be complicated to navigate, have limited availability, and not all projects or properties will qualify. Developers may need to hire tax professionals or consultants to help them understand the credits.