What Is the Low-Income Housing Tax Credit (LIHTC)?
Why the LIHTC Was Established
The LIHTC program aims to make affordable housing attractive to investors and builders alike.
The shortage of affordable and attractive housing has been a perennial American problem since the post-war era, and not for lack of federal assistance. Even in recent times, the Government Accountability Office (GAO) estimates that over 48 million American renters are moderately or severely “housing cost- or rent-burdened.” This term describes households that pay over 30% of their income for rent and related housing costs.
This issue creates a ripple of negative effect on communities. For instance, cost-burdened families experience greater mental and financial stress regarding basic living expenses. Left unchecked, this results in increased poverty, homelessness, unhygienic conditions, and heightened crime rates.
While the obvious solution is to build more low-income houses, the reality is rarely so simple. One of the biggest obstacles to this solution is that most property developers are unwilling to invest in low-income housing projects because these are seldom profitable.
The LIHTC can offer a compromise between affordable housing and attractive returns for property builders and investors.
How the LIHTC Works
The LIHTC program subsidizes the acquisition, construction, and renovation of rental properties for low- to moderate-income households. This subsidy is in the form of tax credits awarded to the developers and investors. Tax credits are a dollar-for-dollar reduction of income taxes owed to the federal and state governments. LIHTC tax credits are transferable but not refundable.
Reduced taxes means more disposable income for investors and property developers, incentivizing them to create more low-income housing projects. This way, it attempts to minimize the effects of the housing crisis by making it easier for low-income families to afford rent.
Since its enactment as part of the 1986 Tax Reform Act, the LIHTC program has been updated numerous times. To date, the program has created or preserved over 2.3 million affordable housing rental units across more than 37,000 properties in the U.S..
On average, the LIHTC costs the government $8 billion in foregone revenue annually.
Types of Tax Credits Awarded Under LIHTC
There are two main types of tax credits available for LIHTC purposes.
- 9% Credit — This type of tax credit applies to housing projects not scheduled to receive any other type of credit or government subsidy.
- 4% Credit — This tax credit can be used with other types of credits and government subsidies.
The Internal Revenue Service allocates tax credits under the LIHTC program to each state. At the state level, Housing Finance Authorities (HFAs) determine how the credits are granted to eligible developers using the minimum affordability requirements outlined in the U.S. §42 Code.
Developers can raise funds further by selling LIHTC tax credits to private investors. Once the project is complete and the housing units are available for occupancy, the investors can claim the tax credits and apply them to their own income tax obligations over a 10-year period.
Qualifying for Low-Income Housing Tax Credits
Developers and owners of rental properties designated for affordable housing may qualify for the LIHTC program provided they meet the specific qualification requirements set forth by the HFA in their state of operation.
Generally speaking, qualifying for the LIHTC means meeting the following conditions:
To ensure that available housing units are actually rented out to low-and moderate-income families, project owners must agree to allocate occupancy based on an income test.
- 20-50 — A minimum of 20% of the rental units must be occupied by tenants whose income is 50% or less than the median income in the area. For example, if the median income in the area is $40,000, at least 20% of the renters must be earning $20,000 or less.
- 40-60 — A minimum of 40% of the rental units must be occupied by tenants whose average income is 60% or less than the median income in the area. Plus, no units may be occupied by tenants whose income is 80% greater than the area’s median income. Using the same example above, this test states that at least 40% of the renters must be earning $24,000 or less.
Gross Rent Test
This test regulates how much rent can be charged on low-income housing properties. Rent may not be 30% of either 50% or 60% of the median income in the area.
For example, if the median income is $60,000, then 50% of that is $30,000, while 60% is $36,000. Under the gross rent test, the rent charged on LIHTC units cannot exceed 30% of these figures.
The maximum gross rent will then be 30% of $30,000 = $9,000 yearly ($750/month) for the 50% of the median income, while $10,800 yearly ($900/month) for the 60% median income.
How Long Can a Developer Stay Qualified for LIHTC?
To earn and retain low-income housing tax credits, property developers must ensure that the properties meet the requirements of the income and gross rent tests for no less than 15 years.
One thing to keep in mind is that tax credits are not unlimited. And because an increasing number of low-income housing projects compete for the available tax credits, allocations are made based on state population. As a result, rental properties that cater to low-income families or provide affordable housing for longer periods often get priority.
How to Qualify As a Tenant for LIHTC Housing
Low-income families who want to qualify for LIHTC housing must meet income requirements of the specific property. In other words, their income level must be below a certain amount. Usually, this means earning less than 60% of the median income in the area.
However, this requirement also depends on the type of property and the number of members in the household. Many property types can be eligible for LIHTC, including apartment buildings, single-family homes, and even townhouses.
Even after meeting this requirement, tenants may still be deemed ineligible to occupy LIHTC-enabled housing if they have a poor rental history, abysmal credit report, or criminal record.
- The Low-Income Housing Tax Credit (LIHTC) program incentivizes investments into affordable rental housing projects for low-income families by providing tax credits to developers and investors.
- LIHTC allows investors to contribute capital to or invest in affordable housing projects that enable low-income families to live in quality housing while paying less than the fair market rent.
- To qualify for the LIHTC program, developers and rental property owners must meet the income and gross rent tests.
- Blount, J. (2016). Housing, not unemployment, major concern when World War II veterans returned home. Historical Collection at the Lane. Retrieved from https://sites.google.com/a/lanepl.org/columns-by-jim-blount/2016-articles/housing-not-unemployment-major-concern-when-world-war-ii-veterans-returned-home
- Government Accountability Office. (2020.) As More Households Rent, the Poorest Face Affordability and Housing Quality Challenges. Retrieved from https://www.gao.gov/assets/gao-20-427.pdf
- Congress.gov. (1986.) H.R.3838 – 99th Congress: Tax Reform Act of 1986. Retrieved from https://www.congress.gov/bill/99th-congress/house-bill/3838
- Department of Housing and Urban Development. (n.d.) LOW-INCOME HOUSING TAX CREDIT (LIHTC). Office of Policy Development and Research. Retrieved from https://www.huduser.gov/portal/datasets/lihtc.html
- Scally, C.P., Gold, A., Hedman, C., Gerken, M., and DuBois, N. (2018). Research Report on The Low-Income Housing Tax Credit – Past Achievements, Future Challenges. Urban Institute. Retrieved from https://www.urban.org/sites/default/files/publication/98761/lithc_past_achievements_future_challenges_final_0.pdf
- Legal Information Institute. (n.d.) U.S. Code § 42 – Low-income housing credit. Cornell Law School. Retrieved from https://www.law.cornell.edu/uscode/text/26/42
- Congressional Research Service. (2021). An Introduction to the Low-Income Housing Tax Credit. Retrieved from https://sgp.fas.org/crs/misc/RS22389.pdf