How does the low-income housing tax credit work?

The Low Income Housing Tax Credit is a tax credit for real estate developers and investors who make their properties available to low-income Americans as affordable housing. It is paid for by the federal government and administered by the states, based on their own affordable housing needs. Since the program’s inception, nearly 3 million units of affordable housing have been built with the help of the tax credit.

Why a tax credit?

Tax credits and deductions reduce taxes for businesses and investors. Tax credits are used as incentives for companies to do something. Most tax credits are for individual business owners. For example, a business can get a job opportunity tax credit for hiring new employees who live in certain areas or have specific “employment barriers.”

What is the Low Income Housing Tax Credit?

The LIHTC provides real estate investors and developers with an incentive to construct or renovate buildings to increase the amount of affordable housing for low-income Americans. The program was created by federal law in 1986 (Tax Reform Act of 1986) and is administered by the IRS. You may see a LIHTC credit called a “Section 42” tax credit because it is based on Section 42 of the federal tax law. According to the Urban Institute, the process for competitively allocating tax credits is guided by federal regulation , uses federal dollars and is controlled by the states.

What is affordable housing? What is Official Protection Housing?

The simple answer is that affordable housing costs no more than 30% of median income in a specifically designated area (called AMI). The LIHTC focuses on rental properties such as affordable housing. The Consolidated Appropriations Act of 2018 updated this requirement: households earning up to 80% of AMI are now allowed in LIHTC-assisted units, as long as the median income of all households in the assisted units is at or below 60% of the AMI. Affordable housing is sometimes called subsidized housing, because low-income people may qualify for subsidies to help them pay for a house. Section 8 housing is a type of subsidized housing.

How does the low-income housing tax credit work?

The federal government gives money to all states for low-income housing tax credits, based on population. Each state has a housing agency that awards tax credit money to groups of developers according to a plan developed by the state. Developers agree to build buildings that are available to low-income people, and in return, the state gives developers tax credits. The developers then sell the credits to investors to raise the money needed to build. Loans can represent up to 70% of project financing.

State housing agencies are responsible for granting tax credits and managing the process. They receive a specific amount of tax credit money each year. California explains a common way to allocate; the credits go to developers of affordable housing projects. Corporations are established to obtain investors and capital to create qualified buildings in exchange for tax credits.

Each state handles the requirements for these tax credits differently. Many states have a developer experience requirement, for example; some, like Ohio, may allow newer developers to work with more experienced partners.

The US Department of Housing and Urban Development (HUD) provides a list of state housing agencies to help you find the right agency for your state.

How Real Estate Developers Receive the Tax Credit

Typically, a group of investors creates a business entity (usually a corporation) to build or renovate structures to create qualifying affordable housing. To qualify, the housing project must go through a qualification process, based on the availability of units in the project for use by low-income individuals.

To receive low-income housing tax credits, properties (buildings) must be “qualified.” To qualify, a building must:

  • Include a specified minimum percentage of affordable units.
  • Stay affordable for a minimum of 30 years.

Tax credits come in two types:

  • A 4% credit for new construction involving other government assistance or the purchase of an existing project.
  • A 9% credit for new construction (or significant rehabilitation) without government assistance.

The IRS has LIHTC forms to fill out

  • Form 8586 is used to claim the credit on the business tax return.
  • Form 8609 is used to obtain a home credit allowance for a building.
  • Form 8609-A is an annual report showing compliance with the requirements.

You may see these forms described on a search page, but they are not for people who want to apply for a low-income housing tax credit. Tax professionals from the real estate development company must complete these forms.

Be eligible for low-income housing tax credits

Like any other tax situation, the Low Income Housing Tax Credits are complicated and eligibility is limited. If you are interested in applying for an LIHTC, contact your state housing agency.

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