Federal Low Income Housing Tax Credit

The federal low income housing tax credit is the principal federal source of subsidy for affordable housing production nationwide. From a tax accounting perspective, the federal low income housing tax credit is complicated. However, from a practical perspective, it is simple: By allowing the state’s leading housing agency to allocate credits to developers, the federal government effectively gives states a pot of funds that they can allocate along with other available funds to subside the construction or deep rehabilitation of affordable housing:

Developers that receive tax credits through [Executive Office of Housing and Livable Communities (HLC)] make them available to private investors that acquire equity interests in the projects.  These investors can claim the total amount of the credit each year over a 10-year period. Due to a strong market for federal tax credits, each dollar of credit available in each year translates into one dollar (or more) of investment in development projects. In other words, a $20M allocation of federal tax credits in a given year translates into at least $200M of investment. The total combined amount of federal LIHTC used by EOHLC-funded projects over the past few years is approximately $456M annually.

EOHLC, The Affordable Homes Act – Research and Analysis as of September 17, 2024.

That is all one really needs to know from the highest level policy perspective, but it is helpful to understand the basic legal mechanism of the credit. Federal law defines the vocabulary used to describe the credit and sets the maximums on how much a credit housing agency can award for each project and in total annually for all projects. This post is a collection of notes and resources on the following housing credit topics.

• Basic credit computations
• Projects that qualify for the credit
• Enforcement and reporting
• State flexibility in allocating credits
• Limits on total credit awards
• Massachusetts approach

Basic credit computations

Section 42 of the Internal Revenue Code creates the low-income housing credit as follows:

In general . . . , the amount of the low-income housing credit determined under this section for any taxable year in the credit period shall be an amount equal to . . . the applicable percentage of . . . the qualified basis of each qualified low-income building

42 U.S.C. §26(a). Note that

Credit period

The credit period is 10 taxable years, subject to various rules and elections as to when the period should start, what occurs if the property is disposed of, etc. 42 U.S.C. §26(f). So a credit of $X is really an award of $10X used over time.

Applicable percentage

The applicable percentage is defined in general as the percentage which will

yield over a 10-year period amounts of credit . . . . which have a present value equal to—
(i) 70 percent of the qualified basis of a new building which is not federally subsidized for the taxable year, and
(ii) 30 percent of the qualified basis of a building not described in clause (i).

42 U.S.C. §26(b).

“Present value” is a way reflecting of the time value of money — money today is worth more than money later. Since the credit is used over a 10 year period, it is not as valuable as if it were all up front. Under the specific present value methodology and additional applicable rules in 42 U.S.C. §26(b), the 70 percent level works out to an annual credit of 9% of qualified basis (or more) and the 30% level works out to an annual credit of 4% of qualified basis or more.

While the 42 U.S.C. §26(b) refers to a “new building” as receiving the credit yielding 70 percent over 10 years, known as “the 9% credit,” another section of the law (42 U.S.C. §26(e)) allows rehabilitation expenditures to be considered a separate “new building.” Thus “the 9% credit” is available to most affordable housing projects, except those that are receiving another federal subsidy (defined in 26 U.S.C. 42(i)(2) as tax exempt financing ) — projects that have another federal subsidy receive the “the 4% credit”.

Qualified basis

Qualified basis is basically the portion of the project cost that is attributable to low income units. That portion is computed as the lesser of the low-income floor area share or the low-income unit count share. 42 U.S.C. §26(c)(1). There can be gray areas as to what project costs can be included in basis (e.g., relocation costs in a rehab project). Additionally, special rules may alter the qualified basis:

• 42 U.S.C. §26(d)(3) diminishes the basis if the project uses higher quality standards for the non-low-income units in the building.
• 42 U.S.C. §26(d)(4) excludes non-residential components of the project (e.g., commercial), but allows shared common areas, and in high-poverty tracts also allows community service facilities.
• 42 U.S.C. §26(d)(5) boosts the basis by 30% if the project is in a high poverty census tract or a “difficult development area,” an area in which development costs are very high relative to income.
• 42 U.S.C. §26(d)(5)(B)(v) allows the state housing credit agency to award a 30% boost in basis if necessary for a project to be financially feasible.

Qualified low income building

A qualified low-income building is one that is part of a qualified low-income housing project. 42 U.S.C. §26(d)(2)

Projects that qualify for the credit

A qualified low-income housing project is a housing project that meets one of three tests:

• . . . 20 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income [“AMI”].
• . . . 40 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 60 percent or less of area median gross income.
• . . . 40 percent or more . . . of the residential units in such project are both rent-restricted and occupied by individuals whose income does not exceed the imputed income limitation designated by the taxpayer with respect to the respective unit. [In this test, the project could have a 40% of its units comprised of a mix of higher limits for units (up to 80% of AMI) and lower limits for units (down to 20% of AMI), but the average of the mix has to be 60% of AMI. More detail in 26 CFR 1.42-19.]

42 U.S.C. §26(g)

These three alternative qualification standards each incorporate two distinct quantities: (a) the restricted rent specified for the unit and (b) the income of the actual occupants of the unit. Both of these are tied back to the area median income, but they are separate quantities — in other words, there is a rent limit for each apartment and an income limit for the household in each apartment. A “rent-restricted” apartment has a gross rent that does not exceed 30 percent of the applicable income limitation for the unit — for example, 50% of AMI in the first test above. But the applicable AMI for the rent computation for the unit is defined with reference to the area median income for a household size consistent with the number of bedrooms in the unit (not the actual size of the household occupying the unit). In addition to the rent-restriction for the unit, the income of the actual household in the unit must meet the AMI restriction.

The effect of the two level restriction is to assure that subsidized projects are not cramming larger families into small units and charging them based on family size. If the rules imposed only an income restriction and then defined rent directly as a percentage of the occupants income, a landlord could get a relatively high rent based on the higher AMI for larger families, but place them in an undersized unit, so overcharging for the undersized unit. Over the life of a project, both the statistically determined AMI and the actual income of the occupying households will fluctuate, creating the need for various hold-harmless and transition rules.

Note that the tax credit statute (at 42 U.S.C. §26(g)(4)) incorporates rules and definitions pertaining to individual income and area median income from the tax exempt bond financing statute, 42 U.S.C. 142(d), which in turn incorporates income definitions from the Section 8 program.

Enforcement and reporting

The tax code, 26 U.S.C. 42(h)(6) explicitly requires that projects benefiting from the credit have a binding agreement as to the affordability terms with the state housing agency. That agreement must be enforceable under state law and recorded in the deed to the property and must extend for at least 15 years (longer as required by the state agency). 26 U.S.C. 42(m) requires that the state housing credit agency have a monitoring program that assures compliance with both income limits and habitability standards.

Additionally, enforcement is derived from the threat that the tax credit could be lost. Project operators are required to certify compliance annually to the IRS under 26 U.S.C 42(i). IRS regulations under this section (26 CFR 1.42-5) require very complete annual record keeping and annual certifications pertaining to the the occupants of low-income units and their income, including documents such as tenants’ tax returns. This record-keeping requirement is sometimes perceived as burdensome by tenants.

State flexibility in allocating credits

States have considerable flexibility in allocating credits provided the above rules are met. First, since states choose the projects to which credits may be allocated, they may choose to impose stricter affordability requirements and additional requirements on the projects they choose to fund. Second, they are explicitly permitted choose to reduce the applicable percentage or qualified basis with the result that the credit is less than the amount determined by the rules above for a given project:

In allocating a housing credit dollar amount to any building, the housing credit agency shall specify the applicable percentage and the maximum qualified basis which may be taken into account under this section with respect to such building. The applicable percentage and maximum qualified basis so specified shall not exceed the applicable percentage and qualified basis determined under this section without regard to this subsection.

26 U.S.C. 42(h)(7)(D)

A state might choose to lower the credit either to spread available resources further or because a project does not need the full credit to be viable.

A State or local housing credit agency may adopt rules or regulations governing conditions for specification of less than the maximum credit percentage and qualified basis amount allowable under section 42 (b) and (c), respectively. For example, an agency may specify a credit percentage and a qualified basis amount of less than the maximum credit percentage and qualified basis amount allowable under section 42 (b) and (c), respectively, when the financing and rental assistance from all sources for the project of which the building is a part is sufficient to provide the continuing operation of the building without the maximum credit amount allowable under section 42.

26 CFR 1.42-1T(d)(2)

In fact, 26 U.S.C. 42(h)(6)(C) requires the state credit awarding agency to limit credits to the amounts necessary to support the affordability commitment for the building. This principle is restated in 26 U.S.C. 42(m)(2):

The housing credit dollar amount allocated to a project shall not exceed the amount the housing credit agency determines is necessary for the financial feasibility of the project and its viability as a qualified low-income housing project throughout the credit period.

State flexibility is structured through the development of a “qualified application plan” setting forth “selection criteria to be used to determine housing priorities of the housing credit agency which are appropriate to local conditions.” The qualified application plan must give preference to:

• projects serving the lowest income tenants,
• projects obligated to serve qualified tenants for the longest periods, and
• projects which are located in [disadvantaged areas] and the development of which contributes to a concerted community revitalization plan,

26 U.S.C. 42(m)(1)(B)

The qualified application plan must also specify the monitoring procedures as to compliance with project affordability requirements and unit habitability, which shall include regular site visits.

Limits on total credit awards

The aggregate housing credit ceiling for each state is defined by 26 U.S.C. 42(h)(3)(C) as state population multiplied by $1.75 (or $2,000,000 if that is greater). However, these amounts are adjusted for inflation and have been boosted by subsequent legislation — see 26 U.S.C. 42(h)(3)(H) and (I). The IRS details the ceiling computations by regulation. In addition to the main population based component of the ceiling, there are three other components:

• carry-over credits not allocated in the previous calendar year (unused credits cannot be carried beyond one year)
• credits allocated to projects in any prior calendar year but returned due to project changes
• allocations from a national pool of credits unused by other states — only states that have fully allocated their credits in the previous year are eligible for this pool

Population is determined according to the most recent official census estimate available before the beginning of the calendar year. (26 U.S.C. 42(h)(3)(D)(iii) incorporates 26 U.S.C. 146(j), the section defining the population for volume cap purposes.) The IRS details the ceiling computations by regulation and publishes applicable population limits and multipliers in revenue bulletins as shown in the table below. Columns (1) through (5) in the table below compute the total 9% credits allocated to Massachusetts. Column (7) shows the actual amount of credits allocated to projects

Massachusetts federal low income housing credit ceiling for 9% credit

Calendar Year	(1) MA Population	(2) National ceiling per capita	(1) x (2) = (3) MA Ceiling, Population Component	(4) National Unused Pool Allocation to MA	(3)+(4) = (5) Total allocation ex. carry-over, return	10 x (5) = (6) Approximate equity value** (allocation x10)	(7) Actual amounts allocated to MA to projects***
2020	6,892,503	$2.81250	$19,385,165	$82,289	$19,467,454	$194,000,000	$19,876,866
2021	6,893,574	$2.81250	$19,388,177	$237,751	$19,625,928	$196,000,000	$19,713,884
2022	6,984,723	$2.60000	$18,160,280	$174,903	$18,335,183	$183,000,000	$18,335,183
2023	6,981,974	$2.75000	$19,200,429	$368,067*	$19,568,496	$196,000,000	$20,309,730
2024	7,001,399	$2.90000	$20,304,057	not yet known	$20,304,057	$203,000,000	not yet known
FY20-24 avg.****						$199,000,000	$19,936,948

This statewide ceiling only applies to the “9% credit.” For projects receiving tax-exempt bond financing and so receiving the “4% credit”, the portion of the credit for project costs so financed does not count towards the tax credit ceiling. If more than 50% of the costs for the project are so financed, the entire 4% credit for the project does not count towards the tax credit ceiling. 26 U.S.C. 42(h)(4). However, only credits for projects using a type of tax-exempt financing that is subject to the tax-exempt volume cap do not count towards the credit ceiling. While the overall volume cap has grown steadily, the amounts of 4% tax credit in the table below bounce around. The amounts in column (4) are the amounts for projects actually beginning their credit period (receiving their form 8609) in the calendar year and so reflect variations in project timing.

Massachusetts 4% tax credits

Calendar Year	4% credits allocated in MA
2013	$17,151,653
2014	$12,520,005
2015	$5,655,349
2016	$19,758,549
2017	$18,601,515
2018	$18,540,864
2019	$28,675,504
2020	$31,101,819
2021	$27,210,447
2022	$18,712,604
2023	$34,635,423
2024	not available yet
Average 2019 through 2023	$28,067,159
FY20-24 average estimate*	$28,599,609

Combining the last lines of the two previous tables, we estimate total average annual credit volume over the FY20-24 period as $48.5 million. Multiplying the total of $48.5 million by 10 to reflect the 10 year period of awarded credits, one gets $485 million in tax average annual federal credit equity over the FY20-24 period, which is not far above HLC’s $456 million estimate for the same quantity “over the past few years.”

Another correspondence worth noting is that the $25 million average annual volume of 4% credit is consistent with approximately $625 million in annual 4% tax credit basis — $625 million is in the same ball park as the annual amount of tax-exempt financing devoted to housing. While it is lawful to use tax exempt bonding to finance entire projects in which only a share of units are affordable, the total tax credit basis and the financing volume can be close to each other only if most of the units financed are tax credit eligible; this appears, in fact, to be the case — according to Mass Housing’s recently filed 2024 Annual Report, 92% of the units they financed in 2023 were affordable. See more on tax-exempt financing here.

Projection of average federal LIHTC equity volume in Massachusetts, FY25-29

Both the volume cap, which drives the 4% credit, and the population-based 9% credit ceiling are subject to cost-of-living adjustment according to the C-CPI-U, which was growing at a rate of 2.4% annually as of October 2024. (There could be federal action to award growth beyond inflation in one or both credits, but recent legislation to to do so failed.) Additionally, in 2024, the Healy administration raised the share of volume cap allocated to housing by approximately $100 million which translates into an additional roughly $40 million in 4% tax credit equity in calendar 2024. The attached spreadsheet compiles a projection of average annual federal low income credit equity over the coming five fiscal years FY2025-2029 reflecting these factors: $583 million. This projection is used in later posts.

Massachusetts approach

The Massachusetts Executive Office of Housing and Livable Communities publishes full information on its housing tax credit program. As detailed in Massachusetts Qualified Allocation Program and noted in this previous post about the state LIHTC, Massachusetts imposes additional limits on tax credit availability. Among these limits, Massachusetts:

• adds a deep affordability requirement — 10% to 15% (depending on project type) of units must be reserved for extremely low income persons (under 30% AMI). See Qualified Allocation Program, Section IV and Threshold #11. 
• requires a 30-year affordability period for federal credits and 45-year affordability period for state credits. Qualified Allocation Program, Section IV and Threshold #9.
• narrows the definition of the third of the three federal affordability models, the model in which income levels are averaged across units. The QAP notes that this model is complex and that few developers are using it.
• reserves the 9% credit for new production projects and, with some exceptions for seniors and other populations, “at least 65% of the units in a proposed production project must have two or more bedrooms, and at least 10% of the units must have three bedrooms.”
• prefers projects meeting sustainable development principles

The QAP is an important document that details all dimensions of the project prioritization process, including detailed design requirements. It defines a “competitive scoring system” that considers many project quality factors and implements many other prescriptions. This scoring system is used in a “one-stop shopping” model that allocates not only tax credits, but most other subsidy programs available from HLC — see for example, the Winter 2024 Notice of Funding Availability. See detailed discussion of the QAP here.

Resources

• Federal LIHTC
  • HLC’s LIHTC overview page
  • Federal Code Section on Low Income Housing Credit, 26 U.S.C. 42
  • Federal Regulations on Low Income Housing Credit
  • Tax Policy Center Briefing on LIHTC
  • Congressional Research Office (2023) — introduction
  • Congressional Research Office Report (2015) — formula
  • Demystifying LIHTC (HUD economist Q&A)
  • Understanding State LIHTC Allocations
  • LIHTC, how it works and who it serves, Urban Institute (2018)
  • GAO Report on oversight weaknesses and data gaps (2018)
  • 2024 Credit Ceiling and Volume Cap — Tax Notes
  • Form 8609 — allocation and certification of tax credit by agency
  • Form 8610 — transmittal of 8609 forms for calendar year, reconciliation to annual ceiling
  • Computing the basis for LIHTC (IRS 2015)
  • Comparing LIHTC and Rehabilitation Credit
• Tax Exempt Bonds for Qualified Residential Rental Projects
  • Tax Exempt Bond Volume Cap, 42 U.S.C. 146
  • Joint Committee on Taxation Report on Tax Incentives (JCX-36-242024)

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