LIHTC 101 – A Comprehensive Guide to Affordable Housing Investments
Affordable housing remains a pressing issue in many parts of the country, and the Low-Income Housing Tax Credit (LIHTC) program stands out as one of the most effective tools to address this challenge. In this blog post, we’ll delve into the basics of LIHTC, how it works, and why it might be an attractive option for investors seeking both financial returns and social impact.
What is LIHTC?
The Low-Income Housing Tax Credit (LIHTC) program was created under the Tax Reform Act of 1986 and has since become the most significant funding source for affordable rental housing in the United States. The program provides tax credits to private developers and investors who build or rehabilitate affordable housing for low-income residents.
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How Does LIHTC Work?
LIHTC works by providing developers with tax credits that can be sold to investors. These credits reduce the federal tax liability of the investors who purchase them, making it easier for developers to finance affordable housing projects. The credits are allocated over 10 years, and projects must comply with specific affordability requirements for at least 15 years.
Types of LIHTC:
- 9% Credit: Provides a higher subsidy and is typically used for new construction projects.
- 4% Credit: A lower subsidy is often combined with tax-exempt bonds for rehabilitation projects.
Benefits of LIHTC for Investors:
- Tax Incentives: LIHTC provides a dollar-for-dollar reduction in federal income taxes, offering significant tax benefits over a decade.
- Stable Returns: LIHTC investments are often backed by government or nonprofit entities, providing a lower-risk profile with stable returns.
- Social Impact: By investing in LIHTC projects, investors contribute to developing affordable housing, helping to address housing shortages, and supporting low-income communities.
An Example
A simplified example may help in understanding how the LIHTC program is intended to support affordable housing development.
Consider a new apartment complex with a qualified basis of $1 million that is utilizing the 9% credit. Assuming for the purposes of this example that the credit rate is exactly 9%, the development will generate a stream of tax credits equal to $90,000 (9% × $1 million) per year for 10 years, or $900,000 in total. Under the appropriate interest rate, the present value of the $900,000 stream of tax credits should be equal to $700,000, resulting in a 70% subsidy.
Because the subsidy reduces the debt needed to construct the property, the rent levels required to make the property financially viable are lower than they otherwise would be. Thus, the subsidy is intended to incentivize the development of housing at lower rent levels—and therefore affordable to lower-income families—that otherwise may not be financially feasible or attractive relative to alternative investments.
The situation would be similar if the project involved 4% credits, except the developer would be entitled to a stream of tax credits equal to $40,000 (4% × $1 million) per year for 10 years, or $400,000 in total. The present value of the $400,000 stream of tax credits should be equal to $300,000, resulting in a 30% subsidy.
The Impact of LIHTC:
Since its inception, the LIHTC program has been instrumental in creating over 3 million affordable housing units across the country. This program not only helps bridge the housing gap but also stimulates local economies by creating jobs and revitalizing communities.
Lastly,
LIHTC is more than just a tax credit; it’s a powerful investment tool that combines financial returns with meaningful social impact. For investors looking to diversify their portfolio with socially responsible investments, LIHTC offers a unique and rewarding opportunity.
Are you interested in exploring how LIHTC investments can fit into your strategy? Contact us today to learn more about the opportunities available through the LIHTC program