Low-Income Housing Tax Credits
The demand for affordable housing remains strong and provides economic benefits to communities. The Low-Income Housing Tax Credit (LIHTC) is an investment incentive for affordable housing to help meet the demand. It offers tax credits and subsidies to investors who build housing for residents that meet certain income level requirements. The maximum rent for affordable housing is based on the area’s median income. The LIHTC program has been in effect for 31 years and funds roughly 90% of the country's affordable housing projects.
Under LIHTC, investors receive subsidies of 30% or 70% for a development, depending on the type of tax credit used. The affordable housing properties retain high occupancy levels and low foreclosure ratings of less than 1%, according to Reis. LIHTC is also referred to as Section 42. It encourages investment in the development, acquisition, and rehabilitation of affordable rental housing.
Risks in Low Income Housing
States allocate LIHTCs to affordable housing developers. Investors bid on those tax credits, and in return for their investments, reap tax benefits over the course of 10 years. In general, tax credits are more attractive than tax deductions because tax credits offer a one-to-one, dollar-for-dollar deduction in federal income tax, whereas deductions only reduce taxable income.
While LIHTC has its benefits, there are some risks involved.
The LIHTC is an indirect federal subsidy that finances low-income housing. This allows investors to claim tax credits on their federal income tax returns. The principal risk of LIHTC is the loss of the tax credit itself and its recapture by the IRS. LIHTC property owners must meet specific requirements during the planning, construction, and operation to claim tax credits. If the requirements are not met, the properties will lose all or most of their potential tax credits.
For example, an LIHTC property could lose its tax credits through failure to maintain the necessary minimum number of low-income units with tenants earning no more than 60% of the area median income. Failure to maintain its low-income status for the full 15-year compliance period is another risk that could result in paying a penalty.
LIHTC Impact from Cutting Tax Rates
The recent election of President Trump last November has caused some uncertainty. Investors have been reluctant to purchase LIHTCs primarily due to the calling for reducing the corporate tax rate from 35% to 15-20%. Cutting corporate tax rates would bring down investor demand for the LIHTC. Speculation around these impending tax cuts have already created credits to be priced 15 to 20% lower. This makes it harder for developers to finance affordable housing deals.
These lower rates would lead to 2.9% to 8.5% less equity for 9% new construction/rehab tax deals and 3.1% to 8.6% less equity for 4% deals. Subsequently, if the corporate tax rate is dropped from 35% to 15%, the equity price per credit will fall from $1 to $.83, or about a 17% drop.
This period of uncertainty may result in reductions in affordable housing production, especially at a time we need it the most. Tax policy reform may make it harder to finance affordable housing projects. Developers and investors have either slowed or in some cases stopped investing in housing credits while they wait to see what happens with corporate tax reform. Although, Congress determines control over the level of funding for the LIHTC program. We should not only advocate more credits, but also find ways to prop up the value of the credits.