Low-Income Housing Tax Credits: A Financing Alternative in Difficult Times

Corporate & Finance Alert
(Rogelio J. Carrasquillo)
November 3, 2009

The economic uncertainty currently being experienced in the United States and throughout the world has particularly affected the construction industry. In addition to declining sales of new and existing homes in many jurisdictions, the US construction industry has seen many developers lose access to adequate construction financing. As a result, these developers find themselves looking for new alternatives to finance their construction projects and to ensure the projects’ viability.

One of these alternatives is to consider shifting from the construction of high income and middle income targeted housing to the construction and development of low-income rental housing. Even though this shift in a developer’s construction focus may be difficult at first, the alternative sources of funds available for these projects may make them viable during these uncertain times by reducing the amount of financing required to complete these projects. The main source of alternative funding for the construction of low-income rental housing projects is the allocation of low-income housing tax credits (“LIHTC”).

A. Low-Income Housing Tax Credits - A General Overview

The LIHTC is a federal subsidy used to finance the development costs of low-income housing which was enacted as part of the Tax Reform Act of 1986 and became effective on January 1, 1987. The LIHTC allows a taxpayer, typically the partners of the partnership which owns the project, to subsidize either 30% or 70% of eligible costs for the development of the low-income units in a rental housing project. There are two “pools” of credits: the 9 percent credit (which subsidizes approximately 70% of eligible project costs) and the 4 percent credit (which subsidizes approximately 30% of eligible project costs). The 4 percent credit refers to the credit percentage which is available for existing housing or for federally subsidized new construction or rehabilitation, while the 9 percent credit refers to the credit percentage available for new construction or rehabilitations, subject to the satisfaction of certain thresholds. The annual amount of 9 percent credits available to each state is based on population. Due to the limited availability of these credits there is a lot of competition and states create their own allocation process, as described below. The 4 percent credit is not subject to annual allocation caps.

The way the low-income tax credit works is that the credit is claimed by the taxpayer pro rata over a period of 10 years and can be used in connection with both new construction and renovation of residential rental units. Taxpayers claiming the LIHTC may use the tax credit to offset its regular tax liability, subject to certain limitations.

To avoid tax credit recapture, LIHTC taxpayers must comply with all applicable compliance rules and retain an ownership interest for at least a 15-year period. As a result, an investor in the project will typically retain its participation in the project for at least the compliance period. In addition, most state allocating agencies require an additional restriction on rents for a specified period beyond the initial 15-year compliance period, typically evidenced in an additional 15-year extended use agreement.

B. “Sale” or Syndication of the LIHTC: Source of Additional Equity

As mentioned above, the LIHTC provides an additional source of equity for the construction of rental low-income housing projects. Once a developer is allocated tax credits by a state allocating agency, as described below, such developer “sells” the tax credits to an investor or syndicator by entering into a limited partnership or limited liability company with such investor or syndicator. The investor’s or syndicator’s participation in the newly formed entity is typically 99.99% of the profits, losses, depreciation and tax credits, as a limited partner or member of the entity, and the developer typically serves as the general partner or managing member of the entity, holding the remaining 0.01% of the newly formed entity. The capital raised by such sale or syndication reduces the amount of equity that a developer would have to obtain from loans or the issuance of debt to cover the costs of the project.

Additional benefits to an investor acquiring the LIHTC include allocating the depreciation of the buildings owned by the entity, which is tax deductible, based on the investor’s equity participation in the entity.

C. Applying for a LIHTC Allocation

In order to take advantage of the 9 percent credits described above, taxpayers are required to participate in a competitive allocation of credits by presenting a project to the state’s LIHTC allocating agency (the “Allocating Agency”) and competing for the credits, as states are the ones responsible for the LIHTC allocation process. For example, in New York the allocating agency is the New York State Division of Housing and Community Renewal, in New Jersey the allocating agency is the New Jersey Housing and Mortgage Finance Authority and in Puerto Rico the allocating agency is the Puerto Rico Housing Finance Authority.

The state’s competitive processes and criteria to allocate these credits are generally outlined in their Qualified Allocation Plan (“QAP”). In general terms, the state’s QAP outlines a set of core eligibility requirements and a ranking system for projects to apply for tax credits. These criteria generally include evidence of site control, local approval such as preliminary site plan and firm commitments from other funding sources. States will generally accept applications one to three times a year, depending on the terms of their QAP. For example, the Allocating Agency in New Jersey accepts applications for 9 percent credits twice a year, around April and August.

The amount of the credits available to the developers will depend on various factors, including the actual cost of the project and the percentage of the project's units that are rented to low-income tenants.

D. Project Requirements: Set-Asides

A developer who wants to take advantage of the LIHTC must ensure that the proposed project complies with certain requirements. Most significantly, the project must comply with either of the following conditions, commonly referred to as “set asides”:

  • At least 20% of the residential units in the project must be both rent restricted and occupied by tenants whose income is 50% or less of the area median gross income; or
  • At least 40% of the residential units in the project must be both rent restricted and occupied by tenants whose income is 60% or less of the area median gross income.
  • In New York City, in lieu of applying the 40-60 test described above, the following condition must be satisfied: at least 25% of the residential units in the project must be both rent restricted and occupied by tenants whose income is 60% or less of the area median gross income.


It is not uncommon that the developer would agree to a higher percentage than those stated above. These “set asides” must be satisfied before the end of the first year of the credit period and must then be complied with throughout the compliance period.

In addition, rents charged for the rental units are limited to 30% of 50% or 60% of the area's median income, as adjusted for household size, as determined by HUD.

E. Other Benefits to the Developer

In addition to the profits that the developer may obtain from the construction or rehabilitation of the project, as well as the additional source of funds through the sale or syndication of the LIHTC, a developer in a LIHTC project can benefit from the following:

  • Developer Fees. A reasonable developer’s fee is allowed for LIHTC projects, which is generally around 15%, but depends on the jurisdiction. This fee is generally intended to compensate the developer for overhead costs associated with the LIHTC project.
  • Management Fees. A developer may be entitled to receive certain incentive management fees during the time the LIHTC project is operated as a low-income housing project.
  • Sale or Refinancing. After the end of the compliance period, the developer may receive a portion of the proceeds from any sale or refinancing of the project.

F. Conclusion

The use of the LIHTC for the development of low-income housing rental projects facilitates the construction and development of these projects, while providing an incentive for private developers to make affordable rental housing available. At a time when financing options for construction projects are limited, the source of funding available with the LIHTC could be the difference in making a project viable. Nonetheless, the application process can be long and complicated and the need of advisors with experience on these projects is essential. Experienced advisors and counsel become even more important when evaluating how to take advantage of additional funds available to developers of low-income housing rental units through the American Recovery and Reinvestment Act of 2009 (“ARRA”). Furthermore, due to the highly competitive nature of obtaining 9 percent credits under a state QAP it is essential to be well prepared and to start the application process early.

Rogelio J. Carrasquillo, author of this alert is Counsel to Gibbons Corporate Department, New York office and is admitted to practice in New York and Puerto Rico. If you have any questions regarding LIHTC and the tax credit application process, please contact Frank T. Cannone or Rogelio J. Carrasquillo.