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Tax Credits for Dummies

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Low income Housing Tax Credits 101

Guide to Tax Credit Projects

How Much Do I Get?

The tax credit program encourages owners to buy and rehabilitate or construct housing for low-income persons by providing a federal tax credit of up to 9% of the acquisition, construction or rehabilitation costs of the project, (does not include cost of land) each year for ten years. This credit applies only to housing costs for low-income units. In addition, a State Low- Income Housing Tax Credit may offer state tax credits often equal to a large percentage of the federal credit. Hawaii offers 30% of the Federal credit and waives their 4% state excise tax as well. Michigan provides additional incentives by providing low interest long term financing.
To receive the federal tax credit, the low-income units must be either newly constructed or substantially rehabilitated (at least $3,000 per unit or 10% of the building's adjusted basis). Owners constructing new units with tax-exempt financing receive a 4% tax credit.

History:

The Low Income Housing Tax Credit Program (LIHTC) was created by the Tax Reform Act of 1986. It is the primary housing construction or rehab program available to investors.

Under the LIHTC, rental housing must meet certain affordability tests to qualify for tax credits:

one-fifth of the units must rent at 50 percent of area median income
or two-fifths at 60 percent of area median income

If the standards are met and approval is granted (in advance of the project), investors receive a ten year stream of federal tax credits. Many developers sell their tax credits to offset or leverage their investment in the project.

Each state receives an annual tax credit allocation of $1.25 per capita. (recently raised and indexed to inflation) In addition, state tax exempt multifamily bond issues carry the credit with them outside of the cap. Demand for the housing credit outstrips supply by more than three to one.

States must reserve a minimum of 10 percent of the credits for nonprofit developers so many investors try to partner with local human services agencies to increase the chances for approval of their project.

The program is administered by the Internal Revenue Service within the Treasury Department. An average of 1,500 LIHTC projects and more than 60,000 units are placed in service each year. The average project size has increased over the years from 28 units in 1988 to more than 50 units in 1999.

How to:

1. Determine the State's priorities in awarding Tax Credits by checking their Qualified Allocation Plan. Talk to state housing agency staff and ask for copies of all relevant documents.

2. Find an appropriate property or building site based on a good and realistic market analysis. Then settle on the type and scope of a project that would be financially feasible.

3. Research the median income of the market in order to determine permissible rents. (You can obtain a copy of current Income Limits from HUD or a state or local housing agency.) Use the applicable Income limit for the following:

Efficiencies: 1 Person Limit
I Bedroom: Midpoint of 1 and 2 Person Limits
2 Bedroom: 3 Person Limits
3 Bedroom: Midpoint of 4 and 5 Person Limits
4 Bedroom: 6 Person Limit
In each case, multiply applicable Income Limit by 30 percent and divide by 12 to determine monthly rent limit. Then deduct the applicable utility allowance.

4. Make sure you are planning the appropriate size units to meet your market, then do a development budget and a 15 year operating pro forma (cash basis analysis).

5. Create a Source and Use of Funds Schedule using the development budget and pro forma and using the following methodology.

6. Determine the tax credit equity by:

(a) calculating qualified basis from the development budget.
(b) multiplying by the monthly credit percentage to determine the credit amount.
(c) multiplying the total 10-year credit by the market price for credits (e.g. 50 cents per credit dollar). The result is the equity part of the sources.

7. Determine the maximum first mortgage loan by taking a potential first mortgage interest rate and debt service factor, apply a debt service coverage ratio. Then, using the expected net income after expenses, calculate the maximum loan amount which can be serviced.

8. If, as is often the case, the Tax Credit equity and first mortgage are insufficient to meet all uses, determine the availability of "soft second" mortgages. Examples: State FLEA programs, Federal Home Loan Bank Affordable Housing Program loans, State/Local HOME funds, Community Development Block Grants (CDBG) funds.

9. Obtain an option to purchase land/building and written commitments for all financing and apply for Tax Credits.

10. Once the reservation or allocation is made, obtain a written commitment from a syndicator or a corporate investor.

To get really smart, read the statute from the IRS Code, Sec. 42. Low-income housing credit.

Also see:

Low-Income Housing Federal Tax Credit Program FAQ's
Low Income Housing Tax Credits Information

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