Key Elements of the U.S. Tax System

The Low-Income Housing Tax Credit (LIHTC) subsidizes the acquisition, construction, and rehabilitation of affordable rental housing for low- and moderate-income tenants. The LIHTC was enacted as part of the 1986 Tax Reform Act and has been modified numerous times. It has generated over 3.5 million units in all since its inception. From 2000 through 2016, LIHTCs supported the construction or rehabilitation of an average of 115,000 affordable rental units each year. Since that point, annual production has dipped, averaging roughly two-thirds those levels.

The federal government issues tax credits to state and territorial governments. State housing agencies then award the credits to private developers of affordable rental housing projects through a competitive process. Developers generally sell the credits to private investors to obtain funding. Once the housing project is placed in service (essentially, made available to tenants), investors can claim LIHTCs over a 10-year period.

Qualifying for the Credit

Many types of rental properties are LIHTC eligible, including large apartment buildings, single-family homes, or two- to four-unit buildings.

Owners or developers of projects receiving LIHTCs agree to meet an income test for tenants and a gross rent test. There are three ways to meet the income test:

• At least 20 percent of the project’s units are occupied by tenants with an income of 50 percent or less of area median income adjusted for family size (AMI).
• At least 40 percent of the units are occupied by tenants with an income of 60 percent or less of AMI.
• At least 40 percent of the units are occupied by tenants with income averaging no more than 60 percent of AMI, and no units are occupied by tenants with income greater than 80 percent of AMI.

The gross rent test requires that rents do not exceed 30 percent of either 50 or 60 percent of AMI, depending upon the share of tax credit rental units in the project.

All LIHTC projects must comply with these aforementioned income and rent tests for 15 years, or the amount of the tax credits is recaptured (paid back). In addition, an extended compliance period (30 years in total) is generally imposed by state housing agencies.

Computing the Credit

The annual credit claimed by a taxpayer equals a credit percentage multiplied by the project’s qualified basis. The percentage is larger for new construction or substantial rehabilitation (roughly 9 percent but specified in the law as a 70 percent present value credit) than for properties acquired for rehabilitation or for projects funded using tax-exempt bonds (roughly 4 percent but specified as a 30 percent present value credit). The qualified basis equals the fraction of the cost of the housing project rented to tenants meeting the income tests. For many LIHTC projects, the owners or developers aim to rent 100 percent of the units to qualifying tenants.

State housing finance agencies may allocate enhanced tax credits to qualified projects in areas where the need is greatest for affordable rental housing or development is the most difficult. Under the program, these “difficult development areas” or “qualified census tracts” can get a 30 percent boost in available credits. So too can developments that are not financed with tax-exempt bonds.

Allocating the Credit

Congress sets a limit on the amount of LIHTC that can be allocated in any year. For 2023, each state was allocated $2.75 per capita. There is a floor of $3,185,000 million, which means states with low populations get a somewhat larger award on a per capita basis. Both the per capita allocation and small state floor dollar amounts are adjusted for inflation.

States then competitively allocate these credits (generally through state housing finance agencies) to developers, based on state-created qualified allocation plans (QAPs). These plans are required to give priority to projects that serve very low income households and that provide affordable housing for longer time periods.

Projects financed by private activity tax-exempt bonds do not need to obtain a separate credit allocation from the state housing finance authority. This means they do not count towards the state allocation limits for the 70 percent present value (“nine percent”) tax credit.  The state, however, must approve the use of these bonds, which acts as a check on developers’ ability to access 30 percent present value (“four percent”) LIHTCs.

Developers generally sell the tax credits to investors, who may be better able to use the tax credits and other tax benefits of the housing project (e.g., depreciation, interest paid, net operating losses). Investors also contribute equity, often through a syndication or a partnership. The investors or limited partners usually play a passive role, receiving the tax benefits associated with the project but not participating in day-to-day management and oversight.

Most investors in LIHTC projects are corporations that have sufficient income tax liability to fully use nonrefundable tax credits. Financial institutions traditionally have been major investors, because they have substantial income tax liabilities, have a long planning horizon, and often receive Community Reinvestment Act credit from their regulators for such investments. Taxpaying investors cannot claim credits until the project is placed into service.

Calculating Costs and Benefits

The Joint Committee on Taxation estimates LIHTC will cost around $13.2 billion in 2023, increasing to $15.2 billion by 2025. It is by far the largest federal program encouraging the creation of affordable rental housing for low-income households. Supporters see it as an effective program that has substantially increased the affordable housing stock for more than 30 years. LIHTC addresses a major market failure—the lack of quality affordable housing in low-income communities. Efficiencies arise from harnessing private-sector business incentives to develop, manage, and maintain affordable housing for lower-income tenants.

Critics of the LIHTC program argue that the federal subsidy per unit of new construction is higher than it needs to be because of the various intermediaries involved in its financing—organizers, syndicators, general partners, managers, and investors—each of whom are compensated for their efforts. As a result, a significant part of the federal tax subsidy does not go directly into the creation of new rental housing stock. Critics also identify the complexity of the statute and regulations as another potential shortcoming. Another downside is that some state housing finance authorities tend to approve LIHTC projects in ways that concentrate low-income communities where they have historically been segregated and where economic opportunities may be limited. Finally, while the LIHTC program may help construct new affordable housing, maintaining that affordability is challenging once the required compliance periods are over.