Blogs| The Difference between 4 Percent Credit and 9 Percent Credit

The Difference between 4 Percent Credit and 9 Percent Credit

Written by

author

Anuj Pratap

Published

Aug 29, 2024

Topics

LIHTC

Article Contents

    Low-Income Housing Tax Credits, or LIHTC for short, is a program in the United States that gives tax breaks to encourage the building of affordable homes. LIHTC program helps developers who want to build houses for low-income tenants. It is a big reason we have so many affordable rental homes in the U.S. today.  

    How LIHTC Program Works?   

    Low-Income Housing Tax Credits (LIHTC) work like this: when a company or person wants to build affordable housing, they can earn tax credits. These credits are like coupons that lower the amount of taxes they have to pay. But here’s the twist: they can sell these tax credits to investors, who give them money to build the homes. This process is called “syndication.”  

    Once the homes are built, they must stay affordable for 30 years, which means the rent can’t be too high. The houses have to be affordable for low or moderate-income tenants.  

    For the first ten years after the affordable homes are built, the investor who bought the tax credits gets to use a part of those credits each year to reduce how much tax they owe.  

    So, LIHTC helps developers build affordable homes by giving them tax credits, and then they can sell those credits to investors to get the money they need to build affordable houses. However, the homes must stay affordable for a long time, and the investors use the tax credits to lower their taxes for the first ten years after they are built.  

      

    Understanding Housing Credit Rates  

    Housing Credit rates play a crucial role in financing affordable housing projects by covering a portion of development costs. These rates determine the maximum amount of Housing Credit authority a project can receive. Investors purchase these credits at market-based prices, providing the necessary equity for building affordable housing.  

    It’s important to note that a lower Credit rate translates to less equity available for financing rental housing, influencing the overall affordability and feasibility of housing projects.  

    When the Housing Credit was first established in 1986, Congress set the 9% and 4% Credit rates to reflect the economic conditions of the time. Initially, these rates were not fixed; they fluctuated monthly according to a formula related to federal borrowing rates. This floating nature meant that the actual applicable credit rates often differed from the nominal 4% and 9%. 

    There are two primary Housing Credit rates, each suited to different types of construction projects –  

    The 4 Percent Credit  

    The 4% credit subsidizes approximately 30% of eligible low-income unit costs. This credit is mainly used for the acquisition of existing properties and for new development or rehabilitation projects financed with tax-exempt private-activity bonds.  

    By leveraging this credit, developers can secure a significant portion of the necessary funding, though navigating the specific criteria and regulations associated with its use is vital.  

    The 9 Percent Credit  

    In contrast, the 9% credit provides a more substantial subsidy, covering around 70% of eligible low-income unit costs. This credit primarily aims at new construction projects and substantial rehabilitation efforts not involving tax-exempt bond financing.  

    The higher subsidy percentage makes the 9% credit particularly attractive for larger and more ambitious affordable housing projects, enabling developers to achieve financial support and feasibility.  

    Note: Tax-exempt bonds are issued by a government entity, typically a state or local government. When investors buy these bonds, they lend money to the government. The government, in turn, uses this money to fund projects that serve a public purpose, such as building roads, schools, hospitals, or affordable housing.   

     

    How Do 4% and 9% Credits Get Their Names  

    The names 4% and 9% for Housing Credits come from the percentage of project costs they help cover. These costs include things like building materials and design fees. A project must allocate at least 20% of its units to affordable housing to qualify for tax credits. 

    The “9%” credit helps cover 70% of the project costs over ten years, which is really good for new buildings or big renovations that don’t use special tax-exempt bonds. 

    On the other hand, the “4%” credit covers 30% of the costs over ten years. It’s usually used for buying existing buildings or new projects using tax-exempt bonds. 

    These percentages were decided when the program started to ensure projects get enough money. The 9% credit gives more help, but the 4% credit still provides a good amount. 

    In simple terms, the 4% and 9% credits are named based on how much of the project costs they help with. Understanding these percentages helps builders and planners use these credits well to make and keep housing affordable.  

    How to Choose the Appropriate Tax Credit 

    This comprehensive guide is designed to help stakeholders determine the appropriate tax credit for affordable housing projects—either 4% or 9%. It systematically categorizes projects based on their nature and funding characteristics, providing a clear pathway to tax credit eligibility.  

    Project Type Classification:  

    The process is initiated by identifying whether the project is a new construction or a rehabilitation (rehab) effort. This fundamental classification sets the direction for further evaluation, ensuring that projects are assessed according to their specific characteristics and needs.  

    For New Construction:  

    For new construction projects, the project may qualify for the 9% credit if tax-exempt bonds are not used. This credit is allocated through a competitive process, where projects must demonstrate their merits, such as access to amenities and adherence to green building standards. Approximately half of the applicants typically receive this credit, emphasizing the importance of a strong application.  

    For Rehabilitation Projects:  

    Rehabilitation projects are directed towards the acquisition, requiring at least 20% of the adjusted basis to be spent on the project. These projects qualify for the 4% credit, which is allocated through a non-competitive process. Despite being non-competitive, projects must still comply with various rules and criteria specific to their type to ensure eligibility.  

    4% Credit Specifics:  

    The 4% credit is commonly associated with projects involving significant rehabilitation costs or those utilizing tax-exempt bonds. This is less competitive, making it more accessible while enforcing strict eligibility criteria to maintain project quality and integrity.  

    Securing Additional Financing: 

    Once a project is awarded tax credits, the next step involves securing additional funds to proceed. Several options are available, such as second mortgages, federal or private grants, and traditional mortgages. This crucial step ensures that projects have the necessary financial backing to move forward.  

    Final Project Phases:  

    After confirming funding, the project advances through syndication, which involves leveraging tax credits to attract investment. This is followed by the construction phase, where the actual building or renovation takes place, and finally, the project transitions into service, becoming fully operational.

    This is a clear and systematic approach to navigating the complexities of tax credits in affordable housing. Breaking down the decision-making process into manageable steps helps stakeholders make informed and confident decisions, ultimately supporting the successful development of affordable housing projects.  

    Related Blogs

    Get to Know More About Fusion

    Fill in your email address for a free demo, expert opinions, and the latest LIHTC news and trends. We will never spam you. That’s a promise.

    Doubts? Contact us nowblack_chevron