Below is an overview of how LIHTC (low income housing tax credits) are calculated and applied to affordable housing projects. At the bottom of the post you will find downloadable excel files that correspond with the videos.
LIHTC – An Overview
LIHTC s are federal tax incentives given to the states who then award developers these credits for projects that meet certain criteria as outlined by both the state and federal government. Developers, once awarded, will then go and market these tax credits to investors who will then purchase them in exchange for offsetting taxes otherwise owed over a ten year period. The developer can then use the funding provided from the tax credit investors as equity. However, the disbursement of the tax credit funding is subject to negotiation between developer and investor and in most cases, the bulk is only distributed upon stabilization because the credits are not officially awarded until the project is up and running and has received a Form 8609.
Calculating the Amount of Tax Credits Awarded to a Project
The below video and corresponding text will walk you through how LIHTC s are calculated plus additional information that provides you with more context and information.
The amount of tax credits that can be allocated to a development project follows a formula that first starts with the project’s development budget. Once the budget has been created, some line items and their respective costs will be excluded to create what is called the Eligible Basis. Items that don’t qualify are non-depreciable. The Eligible Basis equals the budget less costs to acquire the property, finance it, reserves, syndication expenses, and marketing costs. The eligible basis can be thought of as construction related costs.
High Cost Adjustment Boost (130%)
If the project is determined to be in a Difficult to Develop Area or a Qualified Census Tract, the project may be qualified to increase the Eligible Basis by 30%. These areas can be found on the HUD User site here: https://www.huduser.gov/portal/datasets/qct.html.
After the Eligible Basis is determined, the developer needs to determine the Applicable Fraction, or the ratio of the building that qualifies as low-income housing. To do so, the developer needs to apply the lesser of the Unit Fraction or the Floor Space Fraction defined as follows:
- Unit Fraction – low income units/all residential units
- Floor Space Fraction – low income space/total residential space
Taking the Eligible Basis and multiplying it by the Applicable Fraction gives us our Qualified Basis.
Tax Credit Rate – 9% or 4%
There are two tax credit rates that projects quality for based on a percentage of the Qualified Basis, either 4% or 9%, and the requirements vary between both as do the rates.
These are the rate that we multiply the Qualified Basis with and then multiply by 10 (years) to get the total tax credits available to the project. However, the actual 4% and 9% ranges are rarely ever 4% and these rates change monthly dictated by the IRS. So the true rate that gets multiplied by the Qualified Basis can be found here. Select the latest PDF and scroll down to the bottom of the third page to see the current rates. To see a table of the historical and current rates, click here.
The rates are calculated by backing into the present value of the 10 years worth of tax credits so that the present value of the tax credits is equal to 30% of a project’s eligible basis for the 4% credits or 70% of the project’s eligible basis for the 9% credits. The video below shows you how it is done.
What’s the difference between 4% and 9%?
9% credits are competitive because there is limited availability for every state based on a state per capita formula. They also can’t be combined with tax exempt bonds. 9% bonds are available for new construction projects and existing projects with substantial rehabilitation needs.
4% credits are available without competing as long as they meet the states requirements and can be used for new construction as long as there are tax exempt bonds being utilized as well and are also available for acquisition of existing properties.
Tax Credit Factor
After the Qualified Basis is multiplied by the Tax Credit Rate and the Tax Credit Rate is multiplied by 10, we then multiply this by the Tax Credit Factor, which is the market price for every $1 of tax credits. This rate can fluctuate above or below the dollar mark depending on market factors and the total tax benefits to investors.
Tax Benefits to Investors
In addition to the tax credits awarded to the investor over the 10-year period as mentioned earlier, investors will also receive and report tax losses (depreciation, interest, etc.) because as the limited partner, they are actually the majority owner of the project with the sponsor acting as both development and in most cases property manager as well.
Download the LIHTC Calculator
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About the Author: Michael Belasco has over nine years of real estate and construction experience. He currently works for a global real estate investment, development, and asset management firm in San Francisco managing large scale development projects in the city. Michael has both an MBA and Master in Real Estate with a concentration in Real Estate Finance from Cornell University.