Trumbull Park Homes, a low-income housing development in Chicago, Illinois. Photo by Robert R. Gigliotti via Flickr.
In January, Smart Growth America released Federal Involvement in Real Estate, a survey of over 50 federal programs that influence real estate in some way. This post is the third in a series taking a closer look at some of the programs included in that survey.
Congress began the Low-Income Housing Tax Credit (Housing Credit) program in 1986 to incentivize the private sector to develop more affordable rental units for low-income households. Since its creation, the credit has created or preserved nearly two million affordable rental units across the country.
The program offsets investors’ federal income tax liabilities, but the responsibility for administering the program is delegated to the states. States designate housing credit agencies to distribute a pool of tax credits from the U.S. Department of Treasury based on their population. In 2010, the amount of credits agencies received was equal to the greater of $2.10 per capita or $2,430,000. For example, the population of Oklahoma in 2010 was about 3.6 million people, so the state received about $7.7 million in tax credits, or 3.6 million multiplied by $2.10.
Housing credit agencies allocate credits to projects that also meet certain criteria set forth in state qualified allocation plans and Section 42 of the Internal Revenue Service code. Both guidelines specify rules and scoring priorities for the competitive allocation process. Eligible projects must be a residential rental property and restrict rent to low-income tenants. A LIHTC property must also remain affordable for at least 30 years. Some states may require a longer affordability period for certain projects.
Developers are also required to choose between the 20-50 rule – which requires at least 20 percent of the units to be rent restricted and occupied by households with incomes at or below 50 percent of an area’s median income – or the 40-60 rule, which requires at least 40 percent of the units to be rent restricted and occupied by households with incomes at or below 60 percent of an area’s median income.
Developers may sell the credits they receive to investors or a syndicator, who assembles a group of investors and acts as their representative. Through a limited partnership, an investor acquires a 99.9% or 99.99% limited partner share, while the developer sponsor set up one or more general partners with a .1% or .01% share. Typically, a real estate developer can cover construction costs with investor equity. The sale of the credits further reduces the amount of debt a developer incurs when constructing a project. In return, the investor receives a dollar-for-dollar tax credit and other benefits for ten years. If the project were to stall or run into any difficulties, the most the limited partner can lose is the amount invested; however, the general partner can lose more than the amount invested.
However, partnerships are structured most often as limited liability companies (LLCs). A typical LLC consists of the developer managing the day-to-day operations of the project, and the credit purchaser as having a passive investor role. The developer still has a small percentage ownership interest (.1%), and the investor still has a large ownership interest (99.9%). All members of an LLC have liability that is limited to the amount invested. That is, if the project faces a setback, the most they can lose is the amount invested.
The housing credit provides many benefits for the federal government because the private sector takes most of the risk associated with building the projects. Investors may not reap the benefits from the credit unless the housing is built, maintained at a certain standard, and remains affordable throughout the compliance period. This model ensures that the program continues to fulfill its intended purpose of providing stable housing to low-income households, while developers and investors benefit from the return on their investments.
As members of Congress debate tax reform, they should consider protecting and preserving the housing credit.