Until the middle of the last century, the federal government used to invest in affordable public housing. But by the 60s, federal investment in public housing declined.
The Low-Income Housing Tax Credit (LIHTC) program was initially envisioned to bridge this gap in affordable housing by incentivizing the private sector to develop and maintain affordable public housing.
Since then, the program has evolved into the mainstay of the affordable housing development market in the country. In recent years, critics have called for it to be revamped to meet modern challenges and changing market dynamics.
In this article, we explore what LIHTC is and its purpose, how it was created, and its recent history.
What is LIHTC?
LIHTC is a federal program for encouraging the development and preservation of affordable housing. Initiated by the Tax Reform Act of 1986 under President Ronald Reagan, LIHTC has been instrumental in financing millions of affordable housing units nationwide.
Bipartisan support helps its effectiveness in leveraging private investment toward creating affordable rental options for low-income Americans.
How Is It Different?
LIHTC is also referred to as Section 42 housing. It diverges from previous housing initiatives by focusing on attracting large corporate investments rather than individual wealthy investors. This shift followed a desire to introduce discipline and efficiency previously unseen in affordable housing programs.
By design, LIHTC operates under the administration of state agencies and is regulated by the Internal Revenue Service (IRS). This flexible oversight mechanism allows states to tailor the program to their housing needs. This decentralized approach also ensures that developers and investors adhere to the same standards to qualify for the tax credits.
The Purpose of LIHTC
The LIHTC program aims to incentivize private sector involvement in developing affordable housing. It offers tax credits for acquiring, rehabilitating, or constructing rental properties, with a section reserved for lower-income households.
In the past, this mechanism has facilitated the creation of housing for working families, veterans, seniors, and individuals with disabilities. It has also played a crucial role in rebuilding communities affected by natural disasters.
How Does LIHTC Work?
LIHTC encourages private investment in affordable housing and requires projects to meet specific affordability and quality criteria. It involves the allocation of tax credits to developers, project application and approval, investor participation, and utilizing different types of credits based on project specifics.
By enforcing systematic compliance requirements, the program ensures that the resulting housing developments serve the needs of low-income households and provide a return on investment for those who finance them.
Allocation of Tax Credits
State housing finance agencies (HFAs) allocate LIHTC to developers. The allocation is based on a per capita or minimum small population state allocation formula. This ensures that even states with smaller populations receive a significant allocation for LIHTC.
Project Application and Approval
Developers submit project applications to state HFAs, detailing how they meet the state’s Qualified Allocation Plan (QAP) criteria. The QAP sets forth the eligibility requirements for projects, including the number of affordable units, project cost thresholds, and housing quality. Projects that best meet these criteria are awarded tax credits.
Role of Investors and Tax Credit Syndicators
Once HFAs approve a project and allocate tax credits, developers often sell these credits to investors to generate funding for the project. Tax credit syndicators enter the ecosystem at this stage, aggregating and packaging tax credits into investment vehicles.
Investors provide capital in exchange for tax credits, which can offset their tax liabilities dollar-for-dollar over a ten-year period. This financing provides the upfront capital needed for housing development.
9% vs. 4% Credits
The LIHTC program offers two types of credits: 9% and 4%. Both credits are subject to the same affordability requirements but are designed for different projects.
The 9% credit, which a state’s HFA competitively allocates, is primarily used for new construction projects without additional federal subsidies. It covers a more significant portion of the project’s costs, providing a subsidy of approximately 70%.
The 4% credit is non-competitive and is typically used for projects involving tax-exempt bonds or other government subsidies. This tax credit subsidizes about 30% of the eligible costs.
Affordability and Compliance
To qualify for LIHTC, housing development projects must adhere to strict affordability requirements. Housing projects must set aside a certain percentage of units for tenants with incomes at or below specified levels relative to the Area Median Income (AMI).
Projects approved and awarded LIHTC tax credits must comply with the affordability commitment for at least 15 years. Compliance is monitored by state HFAs, with the IRS having the authority to reclaim tax credits if projects fail to meet these standards.
Legislative History of the LIHTC Program
LIHTC’s journey spans several decades. This journey reflects the shifts in policy from federally financed public housing to the public-private partnership model. It also spans changes in the economic philosophy of the times, notably the switch to the Regan-era trickle-down economics.
Before the LIHTC program, the federal government financed most public housing. LIHTC marked a shift from government-financed to government-subsidized low-income housing.
The Tax Reform Act of 1969
The Tax Reform Act introduced specific tax breaks for affordable housing to address affordable housing issues. However, it was also marked by challenges, including susceptibility to fraud, highlighting the complexities of incentivizing private investment in affordable housing.
The Section 8 Program in the 1970s
As a response to the declining quality of public housing and the need for more direct subsidies, the Section 8 program was introduced in the seventies. It represented a significant federal effort to subsidize the rent of low-income Americans, emphasizing direct federal assistance for housing.
The Reagan Administration and Decline of New Constructions
The 1980s brought a significant change in federal housing policy under President Reagan. Emphasizing trickle-down economics, the administration cut federal spending on affordable housing programs, including Section 8 construction subsidies.
This period saw a decline in new construction of affordable housing, as tax rule changes aimed at encouraging private investment in rental properties had the opposite result.
Tax Reform Act of 1986
The Tax Reform Act of 1986 was a watershed moment marking the birth of the modern LIHTC legislation. In response to the challenges of the early 1980s, the Tax Reform Act of 1986 created the LIHTC program.
It was designed to encourage private investment in affordable housing through tax incentives, marking a pivotal shift in the approach to housing policy. The program was first met with skepticism but became a cornerstone of affordable housing finance in the country.
Congressional Renewal and Permanency
After its initial success, LIHTC faced the need for renewal in 1989. Initially, the program was renewed annually by Congress. By the beginning of the nineties, it had many supporters from the affordable housing community and corporate investors.
The Omnibus Budget Reconciliation Act of 1993 eventually made LIHTC permanent. As other affordable housing funding declined, LIHTC became increasingly central to the delivery of affordable housing.
Evolution of the LIHTC Program
Since its inception in 1986, the LIHTC program has become the primary mechanism for financing affordable rental housing in the United States.
However, challenges exist. The program’s complexities and performance during significant financial crises (when affordable housing is often needed most) feed the ongoing debates surrounding its effectiveness and efficiency.
Immediate Criticism
LIHTC faced scrutiny over its complexity and the indirect route through which it channels support for affordable housing. Since it relied heavily on tax incentives for corporations, critics argued that it introduced inefficiencies and depended too much on the fluctuating profitability of corporate investors.
The 2008 Sub-Prime Lending Crisis
The Great Financial Crisis profoundly impacted LIHTC. The financial conditions suppressed demand for tax credits as corporate profits plummeted.
This downturn halted many new developments and rehabilitation projects, prompting Congress to intervene with the American Recovery and Reinvestment Act of 2009. This Act introduced financing programs to revive stalled LIHTC projects.
Lowering of Corporate Tax Rate in 2017
The demand for LIHTC fell even further in the run-up to the 2016 Presidential Elections. The subsequent reduction of the corporate tax rate depressed the need for LIHTC from Corporations who felt that offsetting their tax liability was unnecessary.
As lower tax liabilities reduced corporations’ incentive to invest in tax credits, there was lower demand, and thus, fresh investments in affordable housing programs decreased.
The program’s sensitivity to tax policy shifts was challenging, and developers had to adapt to a new financial landscape.
The 2018 Consolidated Appropriations Act
In response to the fresh challenges facing LIHTC, the 2018 Act increased the amount of tax credits available by 12.5 percent through 2021. It also introduced new affordability guidelines.
By this legislative adjustment, Congress aimed to counteract the dampened investment climate and support financing more affordable housing units.
The Tax Relief for American Families and Workers Act of 2024
The Act of 2024 extended the 12.5% allocation increase, which expired in 2021. It also reduced the tax-exempt bond financing requirement for LIHTC projects. These provisions are meant to make the LIHTC program more accessible and practical.
Successful Despite Challenges
LIHTC has adapted to the changing landscape of affordable housing. It has successfully weathered economic downturns, policy shifts, and the evolving needs of low-income Americans.
Despite its criticisms and challenges, it has produced millions of affordable housing units. Plus, it has demonstrated the potential of public-private partnerships in addressing complex social issues. The program’s bipartisan support, resilience, and adaptability illustrate its critical role in the affordable housing ecosystem.
