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Allocation and Distribution of Tax Credit for the LIHTC Program

Written by

Anuj Pratap

Published

July 1, 2024

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    The Low-Income Housing Tax Credit (LIHTC) program provides federal tax credits as incentives to private investors to help increase the supply of low-income rental housing.   

    Investors earn tax credits in exchange for the equity they invest in funding these affordable housing projects. The tax credit they earn is a percentage of the eligible cost (i.e., the construction cost minus administrative and land acquisition cost) and the affordable housing units constructed.   

    This article gives an overview of how HFAs allocate these tax credits and the steps leading up to this. 

    The Background 

    Before we speak about how LIHTC is allocated and distributed to applicants, we must understand some elements that are part of the LIHTC application cycle.    

    Allocation Administration Agencies 

    Even though financing for LIHTC programs is disbursed by the federal government, individual states administer and allocate these funds according to their specific needs.   

    Often, the LIHTC allocated to individual developers and applicants each year combines federal and state funds. The individual states develop their requirements to use their federal fund allocation for the year. That is, different states will prioritize different kinds of housing and demographics of low-income households to target using affordable housing projects.   

    The federal government allocates funds from the central kitty to individual states based on the state’s population. Each state administers the LIHTC program through its low-income housing administration agency or the housing finance agency (HFA). For example, some LIHTC allocating agencies for California, Nebraska, and New York. 

    The Lifecycle of a LIHTC Application 

    Applicants submit their LIHTC application to the local state’s HFA. Once an online LIHTC application is approved by the state’s low-income housing administration agency or Housing Finance Agency (HFA), the applicants can move to start monetizing these tax credits.   

    These tax credits generate equity to fund the low-income housing development project.   

    Once the development is completed, investors can claim these tax credits over the next ten years. Investors hire asset managers who use the compliance tracking features of LIHTC software to ensure compliance with affordability requirements for the whole compliance period. 

    Federal Funds Cap 

    The federal government imposes a yearly cap on the funds disbursed to each state.   

    This cap is the state’s population times a multiplier. For 2024, the IRS has set this multiplier at $2.90 or $3,360,000, whichever is greater.  

    State Tax Credits 

    Each state has different application fees, application timelines for inviting applications, and unique application cycles for LIHTC. Plus, the deadline for accepting applications also varies. Therefore, applicants must know and follow their own state’s application process.  

    Every state housing agency also has different tax credit funds available for a specific year. Each state may also augment the federal funds for tax credits it received with a certain percentage of its budget to develop low-income housing.   

    States also enforce different credit periods or the period over which the tax credits will be ‘paid out’ to the investor.   

    In addition, the type of credits that each state entertains is also different. Some states cap the tax credit allocations by rural and metro areas. States also differ in the type of tax credits they disburse to developers, such as Certificated or Allocated. 

    A Note on Allocated vs. Certificated Tax Credits 

    While discussing tax credits generated from LIHTC investments, we need to briefly speak about the two types of tax credits: allocated and certificated tax credits.  

    Investors earn Allocated Tax Credits because of investments in low-income housing projects, which are claimed by the investors yearly.   

    Conversely, investors buy Certificated Tax Credits directly from the state or one of the project participants.   

    Allocated tax credits require a compliance period of 15 years (usually). They are subject to tax claw-backs or recapture by the IRS if the developed property does not meet affordability regulations. They are treated as long-term investments.  

    Certificated tax credits are usually free from these compliance requirements and are meant as short-term investments. However, the proceeds are taxable if an investor sells these tax credits further. 

    Applications for LIHTC 

    OK, now we have sufficient background information to understand the allocation of LIHTC. The HFA awards successful applications for LIHTC.  

    Once state HFA invites applications for LIHTC, applicants must address the specific points in the QAP that each state has set out.  

    Each state has a different threshold eligibility for awarding LIHTC and differs in its scoring framework of the LIHTC applications. Once the application is reviewed and scored, there can be no additional information that an applicant can provide.   

    The HFAs can notify applicants and seek clarification on their submitted information, but applicants must provide new details. Once the application is reviewed and the notification for clarification is addressed, the HFA scores each application and awards conditional letters of intent for awards of tax credits. 

    Conditional Reservation of Tax Credits 

    When the HFA approves the application for LIHTC, it issues a letter of reservation for tax credits. This reservation is conditional upon the applicant submitting the hard copy of all the documents submitted during the LIHTC application.   

    The developer or the applicant can use this conditional reservation to ask investors for equity to fund the development.   

    The HFA expects low-income housing development to be completed in the year the tax credit is awarded or in the next two years. This extension is permissible subject to approval by the HFA. 

    Carryover Allocation  

    The conditional reservation of tax credits does not mean the LIHTC has been allocated to the investor.   

    LIHTC only begins to be credited after the building is completed and put in service. If the applicant or developer cannot complete the development of the LIHTC project by the end of the year, the applicant can request a carryover allocation.   

    A Carryover Allocation extends the time allowed to complete the LIHTC development by two more years. The Carryover Allocation Agreement is a detailed form requiring an updated application, complete plans and specifications, and a statement of material change with filled-in carryover data sheets.   

    The applicant must also spend 10% of the expected basis within one year of issuing the Carryover Allocation. This 10% is called the 10% Test Certificate and must be submitted to the HFA in the year following the Carryover Allocation. 

    The 10% Test Certificate 

    The 10% test certificate submits that the developer has spent 10% of the development’s expected costs. These costs can include the acquisition of the land.   

    The 10% Test Certificate must be verified by an independent CPA or attorney and submitted by the applicant to the HFA within 12 months of an executed carryover allocation. In addition, the applicant will also need to prove that the development is up to code on the environment and energy regulations of the area. 

    Cost Certification  

    The final stage of allocating tax credits is the cost certification and issuing of the IRS Form 8609. New.  

    The cost certification is, in essence, the certificate of completion that the developer issues.   

    Each HFA provides clear guidelines for what the cost certificate must contain. The developer issues the cost certification to the HFA once the building is finished.   

    The developer documents the actual project costs. Each HFA provides specific guidelines for cost certifications.    

    Once the cost certificate is issued, the developer exits the development project and hands over the daily operation to the property owner or investor, who, often using LIHTC software, begins to claim the tax credits yearly. 

    The IRS Form 8609 

    The IRS Form 8609 is the tool by which investors can start claiming tax credits yearly on buildings that have been completed and are ready to be rented out.   

    After reviewing and accepting the cost certifications, the HFA approves the amount of tax credits initially stated in the LIHTC application.   

    The final tax credit amount usually remains unchanged. Once the HFA approves the cost certifications, the IRS issues Form 8609 to the investor or the building owner.   

    The investor now takes over the day-to-day running of the LIHTC project from the developer. The investor now begins to claim the federal tax credits using the issued 8609 forms to the tune of the amount the LIHTC application stated. Investors can claim these tax credits for the next ten years provided they ensure compliance in the affordable housing projects for the entire compliance period – usually 15 years.  

    LIHTC Compliance for Claiming Tax Credits 

    LIHTC applicants are allocated tax credits to monetize when their LIHTC applications are approved. However, these projects only earn tax credits once the developments are complete.  

    Tax credits must be applied for and claimed at the beginning of each year. They are not automatically credited to the investor. Therefore, this adds to the investor’s compliance burden since they must maintain compliance documentation and proactively monitor the tax credit application and allocation of tax credits yearly. 

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