The Low Income Housing Tax Credit program, LIHTC, pronounced “lie-tech” in the industry, is the federal government’s primary tool for financing the construction of affordable rental housing. Since its creation in the Tax Reform Act of 1986, the program has financed the development of more than three million affordable housing units across the United States. For developers entering the affordable housing space, understanding how LIHTC works is the starting point for understanding a financing structure that is substantially more complex than conventional market-rate multifamily development.
How the Tax Credit Program Works
LIHTC operates by allocating federal tax credits to state housing finance agencies, which in turn award the credits to affordable housing developers through a competitive application process. The developer then sells those tax credits to investors, typically large banks and corporations with federal tax liability, in exchange for equity capital that funds the project’s construction. The investors receive the tax credits over a 10-year period and use them to reduce their federal tax liability dollar for dollar.
The amount of tax credit a project receives depends on its eligible basis, essentially the construction cost of the affordable units, and whether it is a 4% credit project or a 9% credit project. Nine percent credits are more valuable and more competitive; they are awarded through the state housing finance agency’s qualified allocation plan (QAP) and are subject to scoring criteria that vary by state. Four percent credits are paired with private activity bonds and are generally less competitive but available to a broader range of projects.
The equity raised from selling the tax credits, typically $0.80 to $1.10 per dollar of credit depending on market conditions, is combined with a construction loan, soft loans from public sources (CDBG, HOME funds, state housing trust funds, local housing authority funds), and sometimes a developer equity contribution to fund the total project cost.
What Makes LIHTC Development Different
LIHTC development is more complex than market-rate multifamily in several specific ways that developers entering the program need to understand before they commit to a project.
Income restrictions and rent limits. LIHTC projects are required to rent a specified percentage of their units to households earning below a specified percentage of the area median income (AMI), at rents that do not exceed a percentage of that income level. The specific income and rent restrictions depend on the type of credit and the commitments made in the tax credit application. These restrictions must be maintained for the compliance period, at minimum 30 years, and violations can result in recapture of the tax credits by the IRS.
The compliance monitoring obligation. The state housing finance agency monitors LIHTC projects for compliance with the income and rent restrictions throughout the compliance period. Annual reports, tenant income certifications, and periodic physical inspections are all part of the compliance monitoring framework. Developers who do not establish adequate management systems for compliance documentation before they lease up will create problems that are expensive and difficult to resolve after the fact.
Layered financing complexity. The combination of tax credit equity, construction loan, public soft loans, and sometimes permanent financing from the bond market creates a closing process of considerable complexity. Each funding source has its own closing requirements, documentation standards, and draw procedures. A development team that has not navigated a layered LIHTC closing before will benefit substantially from advisory support.
Construction management requirements. LIHTC projects often have construction management requirements that conventional market-rate projects do not. HUD-insured construction loans for LIHTC projects require the contractor to be certified and to follow HUD’s specific procurement and documentation standards. Projects with HOME or CDBG funding have Davis-Bacon prevailing wage requirements that affect contractor selection and payroll documentation throughout construction. The construction manager or owner’s representative on a LIHTC project needs to understand these requirements and enforce them, failures in compliance documentation during construction create audit risk that can affect the project’s credits years after construction is complete.
The State Application Process
LIHTC credits are allocated through state housing finance agencies according to a qualified allocation plan that each state develops and updates periodically. The QAP specifies the scoring criteria by which applications are evaluated, and those criteria vary significantly by state. Washington State’s QAP emphasizes projects serving the lowest income households and projects in high opportunity areas. Texas has different criteria that reflect the state’s geographic diversity and housing policy priorities. The competitive landscape for 9% credits is intense in most states, and applications that do not score near the top of the QAP’s criteria will not receive credits.
Developers entering a new state’s LIHTC program benefit from working with advisors who have navigated that state’s specific QAP, who know what criteria the state’s housing finance agency weighs most heavily and what application elements distinguish competitive from marginal applications.
Cost Certification at Completion
After a LIHTC project is completed, the developer must submit a cost certification to the state housing finance agency, a detailed accounting of the project’s actual costs, certified by an independent CPA, that establishes the final eligible basis and the final tax credit allocation. The cost certification process requires documentation of every cost element that went into the project, construction costs, architectural and engineering fees, financing costs, and developer fee, in a format that the housing finance agency and the tax credit investors can verify.
Construction managers and owner’s representatives who maintain meticulous cost documentation throughout the construction process, who can produce the line-item cost records needed to support the cost certification at completion, provide value that extends well beyond the construction period.
Innergy Integral has managed LIHTC affordable housing projects directly, including the Sun Plaza renovation in El Paso under a combined CMAR and HUD contract. That direct experience informs our development advisory and construction management practice for affordable housing projects across the Pacific Northwest and the Southwest.
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