Low-Income Housing Tax Credit (LIHTC): Overview & How It Works
The Low-Income Housing Tax Credit (LIHTC) is a tax subsidy to incentify real estate investors to construct or renovate buildings to then offer them as affordable rental housing for low and moderate income people. Created by the Tax Reform Act of 1986, the tax credit allowed for around 3.44 million of affordable housing units to be placed in service.
Read on as we take a closer look at exactly what the low-income housing tax credit is, and show you how it works.
Table of Contents
KEY TAKEAWAYS
- The low-income housing tax credit (LIHTC) is a tax incentive that subsidizes the creation of low-income housing.
- It works by offering a 10-year period tax credit to applicable projects.
- The LIHTC is managed by the federal government. Any funds are allocated to the State and local LIHTC-allocating agencies according to the population of each individual state.
- To qualify for the LIHTC, a project has to be committed to be rented to tenants earning less than the average median income.
What Is the Low-Income Housing Tax Credit (LIHTC)?
The low-income housing tax credit (LIHTC) is a tax incentive for housing developers to purchase, construct, or renovate housing for low-income families and individuals.
The incentive was written into the Tax Reform Act of 1986.
For those that invest in low-income housing projects, the Low-Income Housing Tax Credit offers an additional income incentive. Its goal is to encourage the construction of more affordable housing in areas that would otherwise be out of reach for low- and middle-income families. Multi-family homes most often qualify for the low-income housing tax credit.
Credits mostly fall into two categories. The first type of credit comes in the form of a 9% credit that may only be used if the building project won’t be receiving any other credits or financial assistance from the government. The second category includes a 4% credit that may be combined with additional tax benefits. These credits are applied to your taxable income over ten years.
The federal government distributes the money to State and local LIHTC-allocating agencies. Following that, each agency is free to decide which developers are eligible to use these credits for their housing developments. Since there are more applications than there are permits available for construction, not every developer or investor will be able to benefit from this program.
Qualifying for the Low-Income Housing Tax Credit
There are a wide variety of properties that can be eligible for the Low-Income Housing Tax Credit. On a state level, more projects are competing for credits than there are credits available. This is because they are allocated based on the population of the state.
In order to qualify for the LIHTC, any construction project must meet one of the following criteria:
- 20% or more of the rental units need to be rented to people making no more than 50% of the area median gross income (AMGI).
- At least 40% of the units must be rented to household earning 60% or less of the AMGI.
This election is made at application for the credit and cannot be changed and applies to all of the units in the property. It is often called the 20/50 or the 40/60 election or test.
All of the projects that are receiving the LIHTC have to continue to meet at least one of these income conditions for a 15-year initial compliance period. If the project doesn’t meet the criteria, the value of the tax credit can be reclaimed.
A common criticism of the tax credit is that many of the properties in more desirable locations become no longer accessible for low-income households once the 15-year credit period has passed.
The IRS requires the LIHTC recipients to file multiple forms with their tax returns. Some of the forms are Form 8609-A Annual Statement for Low-Income Housing Credit or Form 8586 Low Income Housing Credit.
Support for People Looking for Low-Income Housing
Low-income housing can refer to any residential project or housing building that rents out units to tenants who qualify below the low-income bracket. This is done by offering reduced rent based on the family size and income, or people that receive a federal stipend to help make their rental payments.
These residential units can be managed in two ways. They can be privately managed by landlords or rental agencies that accept a government-issued payment. This would be in conjunction with the rental payments from their tenants. Alternatively, they could be managed by a housing authority.
The low-income housing tax credit is intended to promote the creation of additional low-income housing. However, there are other types of support for people who are seeking low-income housing. There are a number of low-income housing subsidies that are offered through the Department of Housing and Urban Development (HUD).
The qualifications for income can be found on the HUD’s website. They are subject to change as the average wage declines or grows in any given area. A prospective renter has to earn less than 50% of the average income in their area in order to qualify.
The aid is available to families as well as single renters, however, there are qualifications for room counts in a prospective home. Single renters can be excluded from a housing project due to there not being enough properly sized units available.
Low-income housing shouldn’t be confused with affordable housing. This is for families who are spending more than 30% of their income on their rental expenses.
There are specific qualifications that any resident must fulfill in order to benefit from this type of housing project, including guidelines on maximum income.
Calculating Costs and Benefits of LIHTC
It is estimated that the LIHTC costs the federal government around $10.9 billion per year (as of 2021) in the United States. It is by far the largest federal program that encourages the creation of affordable rental housing for households with low incomes.
Supporters see it as a well-tuned program that increases the affordable housing stock considerably. The LIHTC addresses a major failure in the market, and that is the lack of quality, affordable housing for low-income communities.
Critics will argue that the federal subsidy per unit of new construction is actually higher than it needs to be. This is because of the wide range of intermediaries that are involved in its financing – each of which is compensated for their input. As a result of this, a lot of the tax subsidy doesn’t go directly into creating new rental housing stock.
Summary
The low-income housing tax credit is a good example of a strong government subsidy. Specifically, putting funding into creating quality housing for low-income communities. It benefits both the construction industry and the community. The construction industry receives a dollar-for-dollar reduction tax credit for their work. This helps them reduce their taxable income. It benefits the communities by opening up new housing avenues and access to rental properties.
As with any government program, it has its downsides. Making housing affordable units in a way that suits all parties is always going to be difficult. The LIHTC is one step closer to helping low-income families have a roof over their heads.
FAQS on Low-Income Housing Tax Credit (LIHTC)
The 50% test applies to tax-exempt bonds that can receive the 4% LIHTC under IRC Section 42. This is on 100% of the qualified low-income units. It applies to projects that are financed with at least 50% with tax-exempt bonds.
Tax credit funds are funds where federal tax credits are allocated. This is on a state-by-state basis in which the state will award these tax credits to individuals.
A great resource to learn more about the LIHTC is the website of the Office of Policy Development and Research https://huduser.gov as well as the IRS website.
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