The Low-Income Housing Tax Credit is a tax credit for real estate developers and investors who make their properties available as affordable housing for low-income Americans. It’s paid for by the federal government and administered by the states, according to their own affordable housing needs. Since the program’s inception, nearly 3 million affordable housing units have been constructed with the help of the tax credit.
Why a Tax Credit?
Tax credits and deductions reduce taxes for businesses and investors. Tax credits are used as incentives for businesses to do something. Most tax credits are for individual business owners. For example, a business can get a work opportunity tax credit for hiring new employees who live in certain areas or who have specific “barriers to employment.”2
What Is the Low-Income Housing Tax Credit?
The LIHTC gives real estate investors and developers an incentive to build or renovate buildings to increase the amount of affordable housing for low-income Americans. The program was created by federal law in 1986 (The Tax Reform Act of 1986), and it’s administered by the IRS.34 You may see an LIHTC credit called a “Section 42” tax credit because it’s based on Section 42 of the federal tax law.5 According to the Urban Institute, the process for allocating tax credits competitively is guided by federal regulation, uses federal dollars, and is controlled by states.6
What Is Affordable Housing? What’s Subsidized Housing?
The simple answer is that affordable housing doesn’t cost more than 30% of median income in a specifically designated area (called AMI).7 The LIHTC focuses on rental properties as affordable housing. The Consolidated Appropriations Act of 2018 updated this requirement: now, households earning as much as 80% of AMI are permitted in LIHTC-assisted units, provided that the average income of all households in assisted units falls at or under 60% of AMI.8 Affordable housing is sometimes referred to as subsidized housing, because low-income individuals may qualify to receive subsidies to help them afford a home.
Section 8 housing is one type of subsidized housing.
How Does the Low-Income Housing Tax Credit Work?
The federal government gives money to every state for low-income housing tax credits, based on population. Each state has a housing agency that awards the tax credit money to groups of developers according to a plan developed by the state. Real estate developers agree to construct buildings that are available to low-income individuals, and in return, the state gives developers tax credits. Developers then sell the credits to investors to raise the money needed to build. The credits can account for as much as 70% of project funding.9
State housing agencies handle the granting of tax credits and management of the process. They receive a specified amount of tax credit money each year. A common way to allocate is explained by California; the credits go to developers of affordable housing projects.10 Corporations are set up to get investors and equity to create qualified buildings in return for the tax credits.
Each state handles the requirements for these tax credits differently. Many states, have a developer experience requirement, for example; some, like Ohio, may permit newer developers to work with more experienced partners.11
Note: The U.S. Department of Housing and Urban Development (HUD) provides a list of state housing agencies to help you find the right agency for your state.
How Real Estate Developers Receive the Tax Credit
Usually, a group of investors creates a business entity (usually a corporation) to build or renovate structures to create housing that qualifies as affordable. In order to meet the requirements, the housing project must go through a qualification process, based on the availability of units in the project for use by low-income individuals.
To receive low-income housing tax credits, properties (buildings) must be “qualified.” To qualify, a building must:
- Include a specific minimum percentage of affordable units.
- Remain affordable for a minimum of 30 years.12
The tax credits come in two types:
- A 4% credit for new construction that involves other government assistance or buying an existing project.
- A 9% credit for new construction (or significant rehabilitation) with no government assistance.
The IRS Has LIHTC Forms to Fill Out
- Form 8586 is used to claim the credit on the company’s tax return.13
- Form 8609 is used to obtain a housing credit allocation for a building.14
- Form 8609-A is an annual report showing compliance with the requirements.15
You may see these forms described on a search page, but they are not for individuals who want to apply for a low-income housing tax credit. The real estate development company’s tax professionals must complete these forms.
Becoming Eligible for Low-Income Housing Tax Credits
Like every other tax situation, low-income housing tax credits are complicated and eligibility is limited. If you are interested in applying for a LIHTC, contact your state’s housing agency.
– Jean Murray