Low Income Housing Tax Credits

A Brief History

Over 35 years ago, Congress passed (and the President signed) the Tax Reform Act of 1986. Among many other things, the Act created the Low Income Housing Tax Credit (Housing Credit) program, whose purpose was to spur private investment in affordable housing throughout the country. This program is one of the most successful affordable housing initiatives ever launched by the federal government and to date is the longest tenured federal housing program. The Housing Credit (also referred to as “Section 42” – its IRS code section) provides a dollar-fordollar credit against a taxpayer’s federal income tax liability. It stimulates the bulk of all affordable rental housing developed in the U.S. today. The program is a highly effective public-private partnership that harnesses the discipline of the marketplace to efficiently build safe, decent and affordable housing.

Housing Credits are very attractive to banks, insurance companies and corporations with taxable income. As stated, the credits provide a dollar-for-dollar reduction in federal income tax liability, providing an efficient and socially responsible means for taxpayers to reduce their effective tax rate. And for financial institutions, investment in Housing Credits can be an effective way to satisfy Community Reinvestment Act requirements.

Over the past few decades, the Housing Credit has become an extremely important tool for developing affordable housing. The program has helped finance more than 3.6 million quality, affordable housing units, leveraging almost $100 billion in private capital, providing homes for millions of low-income families, seniors, veterans, Native Americans, farm workers and people with disabilities.

So How Does It Work?

Each State receives a fixed amount of Housing Credits from the U.S. Treasury Department based on its population. For 2023, the Housing Credit amount is equal to a State’s population multiplied by $2.75 (with each State receiving a minimum of $3,185,000 in credits). In addition, properties financed in substantial part with the proceeds of taxexempt bonds are eligible for Housing Credits, the amount of which is not subject to the above formula.

Each State has a Housing Finance Agency (HFA) that administers the Housing Credit program. Credits are generally awarded to affordable housing developers by the HFAs on a competitive basis through an application and allocation process. The HFAs are permitted to identify and prioritize their State’s unique housing needs and goals and have wide discretion in determining which developers receive Housing Credit awards (these priorities and goals are embodied in a “Qualified Allocation Plan” or “QAP”). Once a QAP is issued, developers apply to the HFAs for credits. HFAs review and score the applications and award Housing Credits to those developments that best meet the needs of the particular State. It’s a great example of local control over a national resource.

The amount of the Housing Credit available to a property is based on a variety of factors, including (i) actual cost of construction, (ii) number of units in a development that will be rented to lowincome tenants, and (iii) the amount of credits necessary to make the property financially feasible. HFAs conduct a rigorous review of each application to ensure that developments only receive enough Housing Credits to make them both financially feasible and affordable. In addition to any prerequisites set forth in a QAP, a property must also satisfy one of the following federal income test requirements:

• At least 20% of the development’s units are occupied by individuals whose income is 50% or less of the area median income adjusted for family size (AMI).

• At least 40% of the development’s units are occupied by individuals whose income is 60% or less of AMI.

• At least 40% of the development’s units are occupied by individuals with income averaging no more than 60% of AMI, and no units are occupied by individuals with income greater than 80% of AMI.

And satisfy the following rent test requirements: A unit is “rent restricted” if the rent charged to the tenant is not more the 30% of the income limit applicable to the unit (generally the 60% AMI or 50% AMI limit referenced above).

Section 42 also requires that Housing Credit properties remain income-restricted and rent-restricted for an initial 15-year “Compliance Period” plus a subsequent 15year “extended use” period. HFAs may impose lengthier affordability periods if they desire.

While the HFAs are busy reviewing applications and awarding Housing Credits, Midwest Housing Equity Group (MHEG) creates and capitalizes investment funds (“Investment Funds”) comprised of institutional investors. When developers receive credit awards, the Investment Fund will partner with them to provide equity capital to their properties. In exchange for the equity investment, the Investment Fund (and ultimately the investors) receives the Housing Credits awarded to the underlying property (the credits flow for a period ten years). Investors thus earn a market rate of return on their investment. And, as a result of receiving the equity investment to pay for construction costs, properties need less debt, thereby allowing property owners to charge lower rents while still developing a financially viable property.