LIHTC: Low-Income Housing Tax Credits in Relation to HUD 221(d)(4) Loans
The Low-Income Housing Tax Credit (LIHTC) program, sometimes referred to as section 42, is a government initiative that encourages private investors to finance housing for low-income families and individuals. To do this, the LIHTC program provides an indirect federal subsidy in the form of a tax credit that a developer or investor can claim on their income tax return.
- How Developers Use LIHTC to Reduce Their Tax Expenses
- How Developers Save Money With LIHTC
- What Kinds of Projects Qualify for LIHTC Credits
- To learn more about LIHTC and how it may be able to help you save money on an FHA 221(d)(4) loan , fill out the form below and a HUD/LIHTC financing specialist will get in touch.
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How Developers Use LIHTC to Reduce Their Tax Expenses
The Low-Income Housing Tax Credit (LIHTC) program, sometimes referred to as section 42, is a government initiative that encourages private investors to finance housing for low-income families and individuals. To do this, the LIHTC program provides an indirect federal subsidy in the form of a tax credit that a developer or investor can claim on their income tax return. This program can be used with FHA multifamily construction loans, like the HUD 221(d)(4) loan. In addition, loans involving LIHTC can also often qualify for streamlined processing, which can cut significant time off the loan application process.
How Developers Save Money With LIHTC
Typically, LIHTC is calculated as a percentage of the cost of developing a project. And, it allows the beneficiary to claim it annually over a 10-year period. LIHTC amounts can be calculated with two different credits:
The 4% credit (which takes the value 30% of the eligible costs of the project)
The 9% credit (which takes the value of 70% of the eligible costs of the project.)
What are the benefits of Low-Income Housing Tax Credits (LIHTC)?
The Low-Income Housing Tax Credit (LIHTC) program is a federal government tax credit that helps facilitate the construction and rehabilitation of affordable housing units throughout the U.S. Unlike tax deductions, which create a reduction in taxable income, tax credits provide a dollar-for-dollar reduction in an investor’s tax liability, which can be incredibly attractive.
The LIHTC program helps fund the new construction and rehabilitation of a variety of different property types, including traditional apartments, single-family homes, and two- to four-unit multifamily properties. In addition, LIHTCs can fund the conversion of structures like schools, warehouses, and motels into multifamily properties. Properties using these credits must generally cap rents for some or all of the units at a certain percentage of a location’s area median income, or AMI.
The LIHTC program also offers a 10-year credit on federal income tax, which incentivizes developers to create low-income housing. Without the incentive, affordable rental housing projects would not be as appealing to multifamily investors, since they otherwise might not generate sufficient profit to justify investment.
How do LIHTCs work in relation to HUD 221(d)(4) loans?
HUD 221(d)(4) properties with a large number of affordable units can sometimes qualify for the Low-Income Housing Tax Credits (LIHTCs). These are typically issued by state and local government agencies. For FHA multifamily properties, developers need to set aside at least 40% of the project’s units for residents earning 60% or less of the area median income (AMI). Alternatively, developers can choose to set aside 20% of the building's units for residents earning 50% or less of the AMI.
LIHTCs are available in two major varieties, the 4% tax credit and the 9% tax credit. The 4% credit factors in 30% of the eligible project costs, while 9% tax credit factors in 70% of the eligible project costs. In practice, this functions as a credit that a developer or investor can write off of their taxes over a 10-year period. The type of tax credit a project can use usually depends on the specific government agency that is funding the credits.
What are the eligibility requirements for LIHTCs?
In order for a property to be considered eligible for the LIHTC program, it must pass at least one of these three affordability tests:
- 20% or more of the units are occupied by (or reserved for) tenants with an income of 50% or less of the area median income (AMI).
- 40% or more of the units are occupied by (or reserved for) tenants with an income of 60% or less of the AMI.
- 40% or more of the units are occupied by (or reserved for) tenants with an income of no more than 60% of the AMI, and the property has no units occupied by tenants with an income greater than 80% of the AMI.
In addition to the above, a gross rent test must also be passed. This test requires that rents for the property do not exceed 30% of either 50% or 60% of AMI (the exact percentage depends on the number of rental units set aside for the credit). LIHTC properties are required to pass these income and rent tests for a period of no less than 15 years — or risk having the tax credits recaptured by the local housing authority.
For more information, please see Low-Income Housing Tax Credit and LIHTC: Low Income Housing Tax Credits in Commercial Real Estate.
What are the advantages of using LIHTCs for HUD 221(d)(4) loans?
The advantages of using Low Income Housing Tax Credits (LIHTCs) for HUD 221(d)(4) loans include:
- A 10-year tax deduction (provided the property qualifies) which can save developers and investors significant amounts of money.
- Builder Sponsor Profit Risk Allowance (BSPRA) which can reduce the amount of cash needed at closing.
- No income limits for the FHA's multifamily financing program.
- Ultra-low 0.25% green MIP is available for Energy Star approved energy-efficient development projects.
For more information, please visit Apartment Loans and Multifamily Loans.
What are the disadvantages of using LIHTCs for HUD 221(d)(4) loans?
The main disadvantage of using LIHTCs for HUD 221(d)(4) loans is that there are strict limits on cash distributions to owners. This can make it difficult for developers and investors to access the equity they need to fund their projects. Additionally, LIHTCs require a significant amount of documentation, including third party reports such as environmental assessments, architectural and engineering reports, and market studies. This can add to the time and cost of the loan process.
How can I apply for LIHTCs in relation to HUD 221(d)(4) loans?
You can apply for Low Income Housing Tax Credits (LIHTCs) in relation to HUD 221(d)(4) loans if the property financed with the loan has a minimum of 40% of the building's units set aside for tenants earning less than or equal to 60% of the area median income (AMI) as defined by HUD. Alternatively, you can choose to allot 20% of the project's units to tenants earning less than or equal to 50% of the area median income. More information about HUD 221(d)(4) loans and more information about LIHTCs can be found on these websites.
The specific kind of credit that works for a project usually depends on whether government bonds are used to finance it.
What Kinds of Projects Qualify for LIHTC Credits
For a HUD multifamily project to qualify for the LIHTC program, developers must allocate a minimum of 40% of the building's units for tenants who earn 60% or less of the area median income. Or, vice versa, developers must allocate 20% of the building's units for tenants who earn no more than 50% of the area median income. However, since competition of LIHTC credits can sometimes be fierce, some developers choose to designate 80%, 90%, or even 100% of the units in the project for low-income residents.