The LIHTC program has been crucial in providing federal financing to create affordable housing for low to moderate-income families in America. Learn more about how it works and how developers can apply for it.

Section 1: Understanding the LIHTC Program

What is the purpose of the LIHTC program?

The Low-Income Housing Tax Credit (LIHTC) program is a policy tool introduced by the federal government to incentivize the private sector to invest in the development of affordable housing. The program was created by the Tax Reform Act of 1986 (TRA86) and is codified under Section 42 of the Internal Revenue Code. It has gone through several modifications over the years. The purpose of these tax credits is to secure funding for the construction, rehabilitation, and preservation of affordable housing units. Since the program’s inception, nearly 3 million such units have been placed in service (2.97M units across 45,905 projects between 1986 and 2015). Along with the rent voucher program, LIHTC is one way the federal government addresses the general shortage of housing units available for low- and moderate-income households.

How do developers and investors benefit from LIHTC?

Developers don’t usually keep the tax credits, so they don’t directly benefit from them, but selling the tax credits for equity investment reduces their debt considerably and makes the development of new affordable housing possible. The equity subsidizes the cost of development and lower rent income during the compliance period. For LIHTC projects, developers also claim a developer fee (typically 10% of the Total Development Cost (TDC)).

Investors directly benefit from the tax credits by receiving a dollar-for-dollar reduction in their payable federal income tax. Investors can claim these tax credits over a 10-year period once the housing project they invested in is completed, and is placed in service (PIS). Most investors are corporations (mainly large financial institutions) with substantial income tax liabilities and long enough planning horizons who are able to fully use these non-refundable tax credits. Large banks are also required to invest in the community under the Community Reinvestment Act (CRA). This law is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income (LMI) neighborhoods, consistent with safe and sound banking operations. So banks are able to reduce their tax burden but more importantly satisfy their CRA requirements. Individual investors are very rare (less than 10%).

Section 2: Type of Tax Credits, Allocation and Compliance

What type of tax credits can be requested?

There are two types of tax credits under the LIHTC program:

  • 9% tax credits for new construction or substantial rehabilitation projects
  • 4% tax credits for the acquisition of properties singled out for rehabilitation or for projects funded using tax-exempt bonds

It is possible to combine the two: for example, an older property can be acquired with 4% tax credits and then substantially rehabilitated with 9% tax credits. Where there is an extreme shortage of affordable rental housing, individual state HFAs may even allocate ‘extra’, enhanced tax credits to qualified projects. 

How are the tax credits allocated and used?

The federal government grants tax credits to state and territorial governments which hand over the task of allocating the credits to their respective housing agencies (various housing finance authorities or HFAs). The tax credits are awarded to selected property developers based on their project proposals and via a competitive LIHTC application process. Developers generally sell these credits to institutional investors (typically banks) in exchange for equity funding. The banks who take up ownership in these developments have to ensure that the properties are occupied by the eligible low and moderate income families for the tax allocation period (typically 10 to 12 years).

The cash that equity investors inject into the project is used along with other soft debt (usually) such as HOME Investment Partnerships or the national Housing Trust Fund to subsidize the creation of affordable housing. This does not cover the cost of development, but the infusion of equity reduces the debt, a developer borrows from commercial banks, Fannie, Freddie, etc as a construction loan. The bulk of the tax credit equity installment is used to pay down the large construction loan to a long term mortgage once the housing project is built and occupied.

For how long do LIHTC projects need to be kept affordable ?

To qualify for LIHTC, rents of such ‘set-aside units’ must be guaranteed to pass the income and rent test for 15 years else all tax credits are recaptured. After this 15-year compliance period, the units are usually kept affordable for another 15 years of ‘extended use period’. So the answer is: they remain affordable for usually 30 years with some states requiring even longer commitment periods.  

Monitoring compliance means to regularly check that only targeted income-eligible households live in the set-aside units and they pay compatible rents. There are further regulations on housing quality and the availability of basic amenities.

In states where the 30 year period is not mandated, the property owner can decide to convert the units to market-rate rentals after the 15-year compliance period is over, but needs to first send a request to the HFA. If the HFA wants to make sure the rents stay at affordable rates, they have one year to find a buyer (called a ‘preservation purchaser’) who is willing to keep the rents low for another 15 years. If there aren’t any buyers, the owner can adjust the rents to market-rate, but the original LIHTC eligible tenants can stay for another 3 years and receive rent vouchers to be able to pay the higher rents.  

Section 3: Step-by-step guide on how to apply for LIHTC

Step 1: Understanding the State QAP

The first step is to read and understand the Qualified Allocation Plan (QAP) for the State you are applying to. The QAP is released anew each year, by each state’s affordable housing agency. It typically consists of the allocation criteria for LIHTC (the threshold eligibility for developers) for that year. It also states the acceptable combinations for the mix of affordable housing and regular housing units that developers can pick in their application.

The State HFA also has a duty to measure compliance of your property with the regulations set aside in the QAP. Therefore, you can find the minimum operation standards that your project will need to meet, to remain compliant with the regulations.

You can find the latest QAP for your State HFA on their website. It is very important for all developers to carefully study and understand the QAP. It’s meant to be a guide for you as a developer, to navigate the LIHTC application process of that state, for that year.  

Step 2: Assessing your project's eligibility for LIHTC application

A typical affordable housing project is a multi-story apartment complex with managed rental units, but LIHTC is not limited to that (single-family units, townhouses, and duplexes are also eligible, although rare). In the majority of affordable housing projects, all the units are set aside to be rented out at affordable rates, but it is possible to have mixed-income or mixed-use projects under the LIHTC program. The primary target of the program are low- and moderate-income families, but it also supports the construction and rehabilitation of senior housing, homes for people with special needs and permanent supporting housing for the homeless.

A housing unit is considered affordable if the occupants are spending no more than 30% of their combined household income for housing (rent and utilities). To be eligible for LIHTC, the developer must agree to meet a gross rent test and an income test for tenants. 

To pass the income test, the units are set aside for tenants whose household income (as adjusted for family size) is below a certain percentage of the area median income (AMI). The units need to be allocated in one of these three ways:

  • Min. 20% of the units are set aside for tenants with max. 50% AMI 
  • Min. 40% of the units are set aside for tenants with max. 60% AMI
  • Min. 40% of the units are set aside for tenants with an income average of max. 60% AMI.

To pass the gross rent test, rents cannot exceed 30% of either 50% or 60% AMI, depending on the share of LIHTC units within the building.

Step 3: Demonstrating the financial viability of the project

When you approach your State HFA or another allocating body with your LIHTC application, you will be required to demonstrate the financial viability of your development project. You will therefore need to have your sources of funding figured out already and will need to show how your deal will pencil in. When conducting this analysis, assessing the project’s operating revenue and expenses is a crucial step. In order to correctly estimate the project's financials, take a look at these key metrics:

  1. Gross Potential Income (GPI): What is the maximum revenue your property could generate if every unit was rented out at the optimal rate? This theoretical maximum will serve as your Gross Potential Income (GPI). This metric is key to assessing the the property's revenue potential. You can calculate this by dividing the total rentable square footage by the rent per square foot. For example, if you own an apartment building with 20 units, each with a rentable area of 1,000 square feet and an optimal rent per square foot of $1.50, your GPI will be $30,000.
  2. Effective Gross Income (EGI): While GPI is a more rosy estimation, Effective Gross Income (EGI) offers a much more realistic perspective on the potential revenue generating capacity of your property. EGI represents the actual expected revenue after accounting for inevitable factors such as vacancies and credit loss (instances of tenants not paying their rent). By subtracting Vacancy and Credit Loss from Gross Potential Income, typically estimated at around 5%, developers arrive at the figure for Effective Gross Income. Using the same example above, your EGI for the property will be $28,500.
  3. Annual Operating Expenses (OPEX): Ofcourse, no financial analysis is complete without accurately predicting the OPEX of your property. The Annual Operating Expenses (OPEX) typically include management fees, insurance, landscaping, and more. However, it's crucial to note that OPEX excludes capital expenditures like major equipment replacements. Most experts recommend to separate property taxes from OPEX calculations, since they vary a lot across jurisdictions.
  4. Net Operating Income (NOI): Net Operating Income (NOI) represents the bottom line of a property's financial statement. It is the annual net cash flow generated after deducting operating expenses and property taxes. Notably, NOI excludes debt service or financing payments, serving as a fundamental metric for evaluating a property's financial health.
  5. Cash Flow After Financing (CFAF): Finally, you should consider Cash Flow After Financing (CFAF), which provides a comprehensive view of a project's financial viability. CFAF reflects the annual net cash flow remaining after accounting for debt service or financing payments. While CFAF is often regarded as the final metric in project feasibility analysis, developers also factor in considerations such as income tax obligations and replacement reserves for a thorough assessment.

Most organizations have a team working full-time to perform these complex financial analyses for the property. If you are lacking the resources to have a team in-house, you could consider hiring an external consultant to help you put the project financing together.

Step 4: Filling out the LIHTC application online

The LIHTC application process can look slightly different for you as a developer, based on which State HFA you are applying to. However, the typical online process has the following three stages:

  1. Pre-application - On most occasions, the State HFA will require developers to sign-up for the pre-application stage and demonstrate their interest and credibility in developing a project with affordable housing. Those considered eligible, will be invited to the following bidding stage of the LIHTC application process.
  2. Application - At this stage, you can submit a competitive bid for LIHTC on the online portal of the State HFA. The HFA will then review whether your application matches the QAP which the State agency has put together.
  3. Post-application - If you have been sucessful in your application, you will receive a conditional approval from the HFA. You have to make sure that all your documents are in order, including your environmental site assessments, proof of funding sources, proof of syndication, accessibility certificates, etc.  

Once you receive conditional approval, you need to raise equity from LIHTC investors or investment funds, to successfully monetize the tax credits that you will receive for the project. The exact dollar amount of the tax credit allocated to a single project is the result of multiplying the credit percentage (4% or 9%) by the project’s qualified basis. The qualified basis equals the combined construction cost of each LIHTC unit within the housing project. (less certain fees, etc that are not qualified). To maximize equity funding, developers often aim to set aside all the units as LIHTC units.

Section 5: When to ask for help?

If you are a developer and your head is already swimming with all the information you just read, don't worry, you are not alone. The process of applying for LIHTC is time-consuming, complicated and most large organizations have an entire in-house team working on the application. If you don't have the resources or the experience to apply on your own, it's okay to ask for help.

Bringing in an external consultant

Many smaller organizations, with no more than teams of 5-10 people working on developing affordable housing, choose to bring in external consultants. This is someone who is a financial consultant primarily, that can help you pencil in the numbers for your deal and help you get everything you need, to successfully apply for the tax credits.

Novogradac has a pretty good list of consultants that you can peruse through and look for consultants that help with LIHTC applications. Consulting services can be pricey so make sure to try and negotiate the deliverables and costs.

Having the right technology that can simplify the process

At Builders Patch, we have seen several customers use our software to shave off hundreds of work hours and simplify the LIHTC application process. If you are a developer that signs up on our platform, you will be able to access a checklist for the LIHTC requirements for your State. You will be able to easily compiled and store the documents you need for the application, corresponding to the checklist. Once you are done, you can download and send the package to the lending authority. For example, below is a sample for how the 4% LIHTC checklist for California looks like on our platform.

A snapshot of California State's 4% LIHTC checklist on Builders Patch

Developers also use our platform to have full visibility of their portfolio and pencil in the financials for their deal. Our intelligent data dashboards help developers have oversight on different aspects of their portfolio's financial health.

Sumedha Bose
Builders Patch Staff

Sumedha is a seasoned urban policy expert specializing in international housing policy. Armed with dual Master’s degrees from the prestigious Tata Institute of Social Sciences in Mumbai and Institut d’études politiques in Paris, she brings a wealth of knowledge and international perspective to her field.