Though Congress retained the Low-Income Housing Tax Credit (LIHTC) as part of its tax policy overhaul, the decision to also lower the corporate tax rate from 35 percent to 21 percent could lead to a decline in overall investment in affordable housing, according to Chicago-based law firm Ginsberg Jacobs LLC, an expert in LIHTCs and other forms of tax credit financing used for real estate developments.
“When it comes to lining up funds for the development and preservation of affordable housing, I know of no better tool than Low-Income Housing Tax Credits,” said Darryl Jacobs, co-founder of Ginsberg Jacobs. “Now that we have a clearer picture of the tax landscape, it’s important to note even experienced real estate developers don’t always understand how LIHTCs work, due in part to the extensive application process and numerous compliance requirements. The fact that just about all of the affordable communities built over the last 30 years had help via federal subsidies speaks to the importance of this program, especially with a shortage of affordable housing options in cities across the country.”
How it started
The LIHTC program was created as part of the Tax Reform Act of 1986 — made permanent in 1993 — as a way to give private owners the incentive to build affordable housing. Without this incentive, affordable rental projects in today’s market simply don’t generate enough profit to justify construction. With the equivalent of nearly $8 billion in annual budget authority to issue tax credits, it’s the largest program of its kind in the U.S. According to the U.S. Department of Housing and Urban Development, between 1987 and 2015, the LIHTC program resulted in the creation of 45,905 projects and 2.97 million affordable housing units.
How it works
The LIHTC works through subsidies, requiring the Internal Revenue Service to allocate funds to the states based on population. Each state, in turn, looks to its own housing finance agency to allocate the tax credits. A state’s criteria are contained in its Qualified Allocation Plan (QAP). For example, California, with a population of 39.35 million, was eligible in 2016 for an allocation of $92.74 million in credits. To protect states with smaller populations, there is a minimum credit allocation of $2.69 million.
“A real estate developer looking to bridge the financing gap for a new multifamily project or the rehab of an old one might consider including affordable units,” said Jacobs. “Obtaining credits can be competitive, however, requiring the developer to bid against other projects in the state. Preference goes to projects that serve the lowest-income tenants for the longest periods of time, and projects located in qualified census tracts that are part of a community revitalization plan. Projects also have to be timed just right, as credits are only allocated at specific times per year.”
Developers must agree to set aside a certain number of units for tenants below a certain income threshold and cap rents on those units based on the area’s median income. Rent restrictions must remain in place for at least 30 years after a project’s completion, possibly lower depending on the state. Since housing needs are different across the country, a state’s QAP contains the minimum federal requirements and may issue more specific — and sometimes stricter — rules. For example, a state may prefer new construction projects over rehabs, or require a higher number of affordable units in one project.
What really makes affordable rents possible in a LIHTC project are the outside investors who typically purchase credits from the developer in exchange for equity. This dollar-for-dollar reduction of their federal tax liability infuses the project with much-needed cash and, in doing so, reduces debt and lowers long-term financing costs — all making it easier for the project to move forward. Investors generally receive tax credits in allotments over a 10-year period.
The LIHTC offers two types of credits. The first, known as the 4 percent credit, is applied automatically to a project receiving tax-exempt, private activity bonds. It is equivalent to 30 percent of the “qualified basis,” calculated using the percentage of low-income units and the cost of construction or acquisition/renovation minus land and other nonqualifying costs. Unlike the 4 percent credit, a 9 percent credit is available via a competitive application process, but only for projects not financed by tax-exempt bonds.
Tax plan’s potential impact
Though the tax plan signed into law by President Donald Trump in December preserves the tax-exempt bonds utilized in conjunction with the 4 percent credit, LITHCs will likely be impacted primarily through cutting the corporate tax rate from 35 percent to 21 percent. This would, in effect, reduce the value and incentives for developers because tax benefits would shrink. Prior to the final bill’s passage, accounting firm Novogradac & Company estimated that lowering the corporate tax rate to 20 percent (Congress ultimately settled on 21 percent) would result in an equity loss of nearly $1.2 billion annually — the equivalent of 85,600 to 93,900 rental homes over 10 years.
Opponents of LIHTCs say the program is a tax loophole that benefits developers and should be eliminated from U.S. tax policy. They cite numerous studies including one from the University of Oklahoma in 2010 that estimates the value of tenants’ rent savings was only 35 percent of the value of the tax benefits going to investors, and a 2010 study for the Journal of Public Economics that found as much as 100 percent of development subsidized by LIHTCs is offset by declines in private development.
Meanwhile, affordable housing advocates are calling for keeping LIHTCs, and even expanding the program. Last year, U.S. senators Maria Cantwell and Orrin Hatch introduced a bill that would increase the annual LIHTC allocation by 50 percent, allowing for the creation or preservation of up to 1.3 million affordable homes over the next decade. That’s 400,000 more than is possible under current law.
“The debate over Low-Income Housing Tax Credits will go on in Washington,” said Jacobs. “At this moment, it’s as important as ever to be informed about how affordable housing is paid for in the U.S., and how building it or not affects people’s lives within the evolution of cities.”
About Ginsberg Jacobs:
Ginsberg Jacobs LLC is a Chicago-based law firm that provides comprehensive legal solutions in the areas of real estate, finance, taxation, tax credits, litigation, corporate, and trusts and estates planning. Informed by the team’s experience working at larger law firms, Ginsberg Jacobs’ small-by-design approach delivers highly personalized service across multiple disciplines and geographies, including Alaska and Hawaii, using alternative-fee arrangements to eliminate unnecessary overhead. The firm represents both public and private entities, including some of the country’s most prolific lenders, developers, investors and businesses ranging from Fortune 500 companies to high-growth startups.