LIHTC: Low-Income Housing Tax Credits
The LIHTC, or Low-Income Housing Tax Credit, is a federal tax credit which allows the developers of affordable housing to take a 10-year deduction on their federal income taxes. Find out more in our commercial mortgage quick reference guide.
- LIHTC (Low-Income Housing Tax Credits)
- Different Varieties of LIHTC Housing Projects
- How Does the LIHTC Program Work?
- Competition for the LIHTC Program
- Multifamily Financing Options for LIHTC Properties
- LIHTC Syndication: How It Works
- 4% vs. 9% LIHTC Credits
- How the LIHTC Process Works for Developers
- Developer and Investor Specifics for LIHTC Funded Projects
- LIHTC Compliance Periods and Selling an LIHTC Property
- The LIHTC Program and Opportunity Zones
- Get Financing
LIHTC (Low-Income Housing Tax Credits)
The LIHTC, or Low-Income Housing Tax Credit, is a federal government program which incentivizes developers to create low-income housing by offering them a 10-year credit on their federal income taxes. Without some kind of incentive, developers are unlikely to forgo the profits they would naturally lose by offering a property at below-market rent, so this program was developed to encourage the construction and maintenance of affordable units around the country.
Different Varieties of LIHTC Housing Projects
Affordable housing can be developed in a variety of different ways— acquisition and rehabilitation, new construction, and rehabilitation of a currently owned property. Fortunately, the LIHTC can be utilized for each of these different projects. These credits can also be utilized to preserve existing affordable housing (without any rehabilitation) in certain situations.
How Does the LIHTC Program Work?
The LIHTC program was initially created in 1986 as part of that year’s Tax Reform Act. The LIHTC is not a tax deduction (which would reduce a borrower’s taxable income). Instead, the credit provides a specific dollar amount tax discount, which can be applied to the investor or developer’s exact tax bill. In order to continue to take advantage of the tax credit, a developer must continue to keep their property in compliance. In 2016, the LIHTC program provided investors and developers approximately $8 billion in tax credits.
While the LIHTC program is technically federal in nature, in practice, the program is administered by individual states. Individual state Housing Finance Authorities (HFAs) are generally responsible for approving and LIHTCs to investors and developers on a by-project basis. Every state has what’s called a Qualified Allocation Plan (QAP), which details its exact requirements for LIHTC projects, which are typically stricter than the overall federal requirements. Some states have specific preferences towards one type of affordable housing, such as acquisition and rehabilitation or new construction, and may decide to allocate credits to one off these areas before others.
The federal government allocates a specific amount of credits to each state, based on the state’s population and a pre-determined multiplier. As both of these numbers can change, the amount of credits a state can get varies significantly. In 2018, the state multiplier was 2.40, so, for example, Florida, with a population of 20.98 million, would have a maximum of $50,352,000 in tax credits available for that year.
As of 2017, the minimum allocation for states was set at $2.69 million, to ensure that smaller states, like Wyoming and Alaska, would still effectively be able to make use of the program.
Competition for the LIHTC Program
In many states, competition for the LIHTC program can be intense— as there are a fixed number of credits per year and many developers/investors who want them. This means that developers are incentivized to make their projects particularly affordable in order to compete against others vying for the same credits.
Multifamily Financing Options for LIHTC Properties
While Low Income Housing Tax Credits fund a certain portion of an affordable housing project, the rest of will typically be financed with a loan. Common multifamily loan options for LIHTC properties include HUD multifamily loans, as well as Fannie Mae® and Freddie Mac® multifamily loans. Bank and CMBS loans can be used, but they don’t include additional affordability incentives as do agency and HUD financing.
For instance, HUD multifamily loans like the HUD 221(d)(4) and HUD 223(f) both permit LTVs of up to 87% for affordable properties, with LTVs up to 90% for properties with 90% or more low-income units. They also offer a discounted 0.45% annual MIP for LIHTC or Section 8 properties (market rate properties pay 0.65% annually).
In addition, Fannie Mae and Freddie Mac® also offer a wide swath of loan options for affordable properties, including some financing options specifically geared towards the LIHTC program. For instance, the Freddie Mac Bond Credit Enhancement with 4% LITHC is designed to provide forward commitments both new construction and substantial rehabilitation of LIHTC properties which are able to maintain at least 90% occupancy for 90 days. It also provides preservation rehabilitation funds for projects undergoing moderate rehab with tenants in place.
In addition, the traditional Freddie Mac LIHTC Enhancement provides a degree of protection for LIHTC investors in the case that an owner/operator defaults on their loan, which can make it substantially easier to attract LIHTC investors to a project. And, Freddie Mac Tax Exempt Loans provide up to 30 years of financing for 4% LIHTC projects. If your LIHTC property is also part of the HUD Section 8 program, as some are, you may wish to make use of Freddie Mac HUD Section 8 Financing, which permits LTVs up to 90% and DSCRs as low as 1.15x for LIHTC properties.
In comparison, Fannie Mae offers LIHTC-focused products including Fannie Mae MBS as Tax-Exempt Bond Collateral (M.TEB), which can be utilized for existing bond refunding and new issues for 4% LIHTC properties. This financing product allows LTVs up to 90%, and even permits interest-only financing for eligible borrowers. Another similar option is the Fannie Mae Credit Enhancement of Variable Rate Tax-Exempt Bonds (Index Bonds), which also permits LTVs up to 90% for eligible 4% LIHTC properties.
LIHTC Syndication: How It Works
While many developers seek out individual LIHTC investors, in other cases, they partner with a syndicator, which pools multiple real estate projects into one LIHTC fund. The syndicator will then sell these tax credits to investors, which reduces risk for individual investors that a single project will go out of compliance. Additionally, investment into LIHTCs is popular due to the fact that LIHTC properties have foreclosure rates significantly lower than the average rate for multifamily properties.
4% vs. 9% LIHTC Credits
A LIHTC can subsidize either 30 percent or 70 percent of the costs to create low-income units in a development project. A 30% subsidized LIHTC, also referred to as a 4% LIHTC, is typically used for property acquisition and rehabilitation, while the 70% subsidized LIHTC, or 9% LIHTC is usually reserved for new construction.
How the LIHTC Process Works for Developers
In order to secure LIHTC credits for their development, a developer must first propose a project and apply with a state’s Housing Finance Authority (HFA). If the HFA agrees to approve the credits, then the developer and the HFA can begin the negotiation process for the project’s Land Use Restriction Agreement, or LURA. A LURA limits the maximum rent that the owner of a property can charge, usually to a specific percentage of the area median income (AMI), a statistic published by HUD that attempts to estimate the average income in a specific area. After this, the project can actually be built or rehabilitated, and can be certified by the HFA, after which the property will actually be leased to residents. Properties must annually be re-certified in order for investors/developers to continue to receive tax credits.
In order to get tax credits in the first place, an investor needs to own shares in the project itself, which usually occurs through them owning a part of an LLC or being in a direct partnership with the developer. Developers often want the investor to own as much of the LLC or partnership as possible, as this means that they will be investing significantly more into the property. To determine the exact amount of an investor contribution, the developer will create a projected cost for the credits, and apply a specific discount rate (a rate agreed upon by both parties). Those numbers will be multiplied by the share of the LLC/partnership an investor actually owns.
For instance, if a developer projects the credit at $1 million, the investor owns 90% of the LLC (or other ownership vehicle), and the investor and developer have agreed to a discount rate of 75%, the investor’s contribution will be $1 million* 90% * 75% = $675,000. The discount exists because an investor would not be incentivized to put their money into a project unless they were actually going to make a profit.
Developer and Investor Specifics for LIHTC Funded Projects
Before, we mentioned that an investor/developed would need to set aside a certain number of units for borrowers making no more than a certain percentage of the area median income (AMI) in the area in which the property is located. Usually, they must either set aside 20% of the units for borrowers who make equal to or less than 50% of the AMI, or set aside 40% of the units for borrowers who make 60% or less of the AMI. These, however, are federal minimums, and many states require stricter set-asides (i.e. larger percentages of units at lower percentages of the AMI). The higher percentage of units set-aside, the more credits an investor will be eligible for. However, since there is a limited amount of LIHTC credits in each state, states may also institute a ceiling on how many affordable units a property may have.
LIHTC Compliance Periods and Selling an LIHTC Property
After an LIHTC project is built or rehabilitated, it must typically stay in compliance for an additional 15 years, even though the length of the LIHTC credit period is only 10 years (for a total of 25 years). This additional 15-year period is called an EUP (Extended Use Period). While 15 years is a general minimum, some states may require projects to stay in compliance longer, and, in certain cases, this period can last several decades. EUP compliance requirements are typically less stringent than compliance requirements for the initial 10-year period, but can vary significantly by state and by individual project.
If a project falls out of compliance during the initial 10-year period, borrowers may lose future credits, and, if it falls out of compliance after (meaning that they have already received all their credits) they can be forced to repay their credits retroactively in a process called recapture.
In most cases, LIHTC developers can sell a project after 14 years, with the developer typically requesting that the state HFA locate a suitable buyer who will maintain the project’s affordability for the remaining portion of its EUP (Extended Use Period). If the HFA finds a willing buyer, but the buyer and developer cannot agree on terms, the developer must continue keeping the property affordable for the rest of the EUP, but if the HFA cannot locate a buyer, the developer can usually be released from their LURA agreement/EUP.
The LIHTC Program and Opportunity Zones
In 2017, the Tax Cuts and Jobs Act authorized the creation of a new federal tax credit program, the Opportunity Zones program. This program allows individuals and corporations to defer their capital gains taxes for between 5-7 years if they invest in an Opportunity Fund, a fund which plans to invest at least 90% of its assets in qualified opportunity zones, economically distressed areas of the U.S. with particularly high poverty rates.
Opportunity Funds can also invest in LIHTC properties, though, in practice, the property must generally be a new construction. If the property is an acquisition/rehabilitation, the fund must invest more money in improvements than the amount of money that was used to originally acquire the property— and this is not likely to occur in the case of LIHTC-funded properties.
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