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For affordable housing developers, the Low-Income Housing Tax Credit is less a tax benefit than a financing mechanism. Created by the Tax Reform Act of 1986, the program gives state and local allocating agencies approximately $12 billion in annual budget authority to support affordable rental housing acquisition, rehabilitation and construction.
Understanding how credits are allocated, calculated and protected through compliance is central to determining whether a project can support the equity LIHTC investors provide.
The Low Income Housing Tax Credit (LIHTC) is a federal tax incentive under Internal Revenue Code Section 42 designed to encourage the development and rehabilitation of affordable rental housing. State and local housing credit agencies allocate the credits to qualifying projects under federal requirements. Rather than providing developers with a direct federal cash subsidy, the program helps attract private investment. LIHTC projects are commonly structured as partnerships in which investors contribute equity and receive allocations of tax credits and other tax benefits. This equity can reduce the amount of conventional debt the project needs to support. The LIHTC therefore helps address a financing gap that can arise when restricted affordable rents are not sufficient to cover the costs of developing, rehabilitating, and operating a rental housing project.
A LIHTC developer generally begins with the state or local housing credit agency that has jurisdiction over the property. Each allocating agency must operate under a Qualified Allocation Plan, or QAP, that establishes project priorities, selection criteria and compliance procedures. Developers submit applications addressing factors such as affordability, project feasibility, location and the state’s particular scoring requirements. Competitive 9% credits are generally awarded through the state’s allocation process and are subject to the state’s annual housing credit ceiling. The 4% credit generally applies to qualifying projects financed with tax-exempt bonds and is subject to Section 42 requirements. For qualifying tax-exempt bond projects, federal law may eliminate the need for a separate housing credit allocation, but the project owner must still obtain Form 8609 from the appropriate housing credit agency. The housing credit agency completes and signs Form 8609, Low-Income Housing Credit Allocation and Certification, for each qualifying building. The form documents the allocation and other information needed to claim the credit.
The annual Section 42 tax credit generally equals a building’s qualified basis multiplied by the applicable credit percentage. Qualified basis is generally eligible basis multiplied by the applicable fraction, reflecting the portion devoted to qualifying low-income housing. The 9% minimum rate generally applies to qualifying new or substantially rehabilitated buildings placed in service after July 30, 2008, that meet applicable requirements and are not federally subsidized. The 4% minimum rate generally applies to new federally subsidized buildings and qualifying existing buildings placed in service after December 31, 2020, including many projects financed with tax-exempt bonds. Credits are generally claimed annually over a 10-year credit period, beginning in the year the building is placed in service or, if elected, the following year.
LIHTC compliance continues well beyond construction and lease-up. Depending on the project’s election, at least 20% of units may need to serve households at or below 50% of area median gross income, at least 40% may serve households at or below 60%, or the project may use the average-income test. For rent-restricted units, gross rent, including applicable utility allowances, generally cannot exceed 30% of the unit’s imputed income limitation. The federal compliance period lasts 15 years, even though credits are claimed over 10 years. Extended-use agreements generally require affordability for at least another 15 years, creating a minimum 30-year affordability period, although state or project-specific requirements may extend it further.
Public Law 119-21, enacted July 4, 2025 and commonly called the One Big Beautiful Bill Act, expanded LIHTC opportunities in two significant ways beginning after 2025. First, State housing-credit ceilings increase 12%, creating greater capacity for allocated 9% credits, subject to state allocation plans and IRC §42 requirements. Second, certain bond-financed buildings can qualify for 4% credits without meeting the 50% bond-financing test when at least 25% of aggregate building-and-land basis is financed with qualifying tax-exempt bonds, including post-2025 obligations financing at least 5% of that basis. These changes may support preservation projects, capital stacks, and other Business Carve-Outs.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Nina Desai partner in charge of Bennett Thrasher’s Credits & Incentives Practice, or call us at 770.396.2200.
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