The low-income housing credit--program expansion and investment opportunities: the low-income housing credit reduces developers' and investors' tax liabilities and raises the standard of living for low-income households. This article explains how the credit works and the investment opportunity it offers.

Author:Showers, Sean

For more than 60 years, the Federal government has provided assistance to improve the condition of low-income housing and to reduce its cost. (1) Initially, Federal housing policies focused mostly on production and development, but were refocused in the early 1980s when President Reagan began to implement voucher and tax credit programs. The Tax ReformAct of 1986 introduced the low income housing credit (LIHC), which revolutionized the Federal Low Income Housing (LIH) Program with the support of private investment. This program currently comprises 26% of the Federal government's funding for low-income housing and is primarily supported by large corporations and financial institutions motivated by tax savings and the Community Reinvestment Act (2) (CRA) credit. This article explains how to qualify for the LIHC, how it operates and the tax consequences to developers and investors.

LIHC Overview

The LIHC was introduced in Section 252 of the Tax Reform Act of 1986 as Sec. 42. At that time, President Reagan sought to encourage corporate involvement in the Federal government's dilapidated low-income housing program, to combat poor resource allocation and rising administrative costs. With the implementation of the LIHC, Congress took a business approach to the housing program, by stimulating business development in economically distressed areas.

The LIHC was specifically designed to promote the development of housing for low-income families, without requiring a lot of government involvement in day-to-day operations. Unlike other government housing programs administered by the Department of Housing and Urban Development (HUD), the LIHC program is governed by the Code and administered jointly by the IRS and state housing agencies. It was approved first on a year-to-year basis, but became permanent with the passage of the Omnibus Budget Reconciliation Act of 1993. (3)


State housing finance agencies are responsible for allocating LIHCs to developers in a competitive application and bid process for financially feasible proposals. (4) The Federal government initially allots each state housing agency an annual credit based on the state's population. The allotment is the same for each state and is currently set at the greater of $2 million or an inflation-indexed per-capita rate of $1.85 for 2005. (5) States can allocate LIHCs, which are currently valued at approximately $499 million a year (270 million citizens x $1.85). Each credit has a 10-year life before it reaches maturity. After 10 years, the total value of the credit is $4.99 billion. (6) The credits are distributed to developers for sale to investors (usually corporations). The funds raised from sales become equity in the project, which lowers the funding expenses and subsidizes rent; see Exhibit 1 on p. 558.


The LIHC gives the state agencies a certain degree of autonomy. They can set their own rules and project preferences within the broad Federal parameters outlined in Sec. 42. This allows them to use the credits for a multitude of diverse rental housing projects, such as new construction, substantial rehabilitation, or acquisition and rehabilitation. These projects have included garden apartments, townhouses, highrise buildings, scattered-site development, lease-purchase homes and single-room-occupancy facilities. Sec. 42 also allows project developments for use by a variety of residents, such as families, seniors and special-needs populations.


Qualified Basis

The LIHC is based on the qualified basis of a housing project; see Exhibit 2 on p. 559 for the basic LIHC computation.

There are three steps involved in calculating a project's qualified basis under Sec. 42(c)(1).The first involves determining the project's eligible basis under Sec. 42(d). According to Sec. 42(d)(1), a new building's eligible basis is generally its adjusted basis. An existing building's eligible basis hinges on the acquisition cost, based on various holding requirements under Sec. 42(d) (2).

The second step is the determination of the applicable fraction. According to Sec. 42(c)(1)(B), a low-income building's applicable fraction is the lesser of the project's unit fraction or floor-space fraction. Sec. 42(c)(1)(C) defines the unit fraction as the ratio of the occupied low-income units to all residential rental units in the building. The floor-space fraction, under Sec. 42(c)(1)(D), is the ratio of the occupied low-income floor space to the total residential rental floor space in the building.

Example: The eligible basis of a qualified low-income housing building is $1 million. The building consists of 100 units, 60 of which represent Sec. 42 rent-restricted units; the remaining 40 units are rented to market-rate tenants. The floor space of each low-income unit is 500 square feet; the market-rate units are slightly larger, at 600 square feet.

The project's unit fraction is 60% (60 low-income units/100 total units). The floor-space fraction is 56%, representing 30,000 low-income square feet ((60 x 500)/54,000 total square feet). The applicable fraction is 56%, the lower of the two. The qualified basis is $560,000 ($1 million x 56%).

Basis Boost

Once the eligible basis and the applicable fraction have been determined, the final step...

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