Low-Income Housing Tax Credit (LIHTC)

Key takeaways

• A tax credit is a dollar-for-dollar reduction in the amount of tax you owe.
• The Low-Income Housing Tax Credit (LIHTC) is a federal program for individuals who invest in low-income housing and is designed to encourage private investment in affordable housing for low-income people and families.
• To qualify for the LIHTC, developers must meet certain eligibility requirements and agree to meet an income test for tenants and a gross rent test.
• The LIHTC program offers significant federal benefits for investors, developers, and communities alike.
• IRS Form 8586 is used by investors and developers to claim the LIHTC on their federal income tax returns.

What is a tax credit?

Before we dive into the LIHTC, let's start with the basics. A tax credit is a dollar-for-dollar reduction in the amount of tax you owe to the government. Unlike tax deductions, which lower your taxable income, tax credits directly decrease the amount of tax you are required to pay. Essentially, tax credits serve as powerful incentives to promote specific behaviors or investments that are beneficial to communities.

For instance, if you owe $1,000 in taxes and qualify for a $500 tax credit, you will only need to pay $500 to the IRS. Tax credits can be refundable or non-refundable.

Refundable credits can result in a refund, even if the credit is greater than the amount of taxes you owe. On the other hand, non-refundable credits can only reduce the amount you owe to zero.

Now that we understand the concept of tax credits, let's look at one of the most impactful programs in affordable housing: the LIHTC program.

What is the Low-Income Housing Tax Credit?

The LIHTC is a federal program for individuals who invest in low-income housing and was designed to encourage private investment in affordable housing for low-income people and families. It was established in 1986 under Section 42 of the Internal Revenue Code and has become one of the most successful tools for increasing affordable rental housing across the United States.

Here's how it works:

• The government allocates tax credits to state housing agencies based on population size.
• These agencies, in turn, distribute the credits to developers that have made it through a competitive application process.
• Developers then use the credits to attract private investment for the construction or rehabilitation of affordable rental housing projects.

The amount of tax credit the government allocates to a project is calculated as a percentage of the eligible costs of the development and is spread over a 10-year period. The credit is available for 15 years at the same amount each year. In most cases, projects receiving the LIHTC must reserve a certain percentage of units for low-income tenants. This ensures affordability for people who need it most.

It's important to note that the LIHTC program operates as a dollar-for-dollar tax credit. This means that investors receive a credit equal to a portion of their investment in the affordable housing project. This gives private investors, such as banks and corporations, an incentive to participate in financing affordable housing developments.

By leveraging private capital, the LIHTC program helps to address the critical need for affordable housing while promoting economic growth and revitalization in communities across the country.

How to qualify for the LIHTC

To qualify for the LIHTC, developers must meet certain eligibility requirements.

Developer eligibility

• Developers must apply through their state housing agency for LIHTC allocation.
• Projects must meet specific affordability and rent restriction requirements set by the IRS.
• Developers must demonstrate financial feasibility and the ability to meet program guidelines throughout the development and compliance period.

Owners or developers of projects receiving LIHTCs must also agree to meet an income test for tenants and a gross rent test.

The income test can be met in three ways

• A minimum of 20% of the project's units must be leased to tenants who earn 50% or less of the area median income (AMI), adjusted for family size.
• At least 40% of the units must be rented by tenants with incomes at or below 60% of the AMI.
• At least 40% of the units must have tenants whose income averages no more than 60% of the AMI, while ensuring no units are occupied by tenants with income exceeding 80% of the AMI.

Through these income and rent tests, LIHTC projects provide affordable-housing opportunities to people who need them most.

How does the LIHTC impact federal income taxes?

The LIHTC program offers significant benefits for investors, developers, and communities alike, particularly where federal income taxes are concerned.

Here's how the LIHTC impacts federal income taxes

• Investors and developers who contribute equity to LIHTC projects receive tax credits equal to a percentage of their investment. These credits are allocated over a 10-year period, providing a steady stream of tax benefits.
• Investors and developers can use LIHTC credits to offset the amount of federal income tax they owe.
• LIHTC investments are typically structured as passive activities, allowing investors and developers to take advantage of passive activity loss rules. This allows investors to offset income from other passive investments with losses generated by LIHTC projects, reducing the amount of taxes they owe overall even more.
• Developers can attract private investment for affordable-housing projects by offering LIHTC benefits to investors. This encourages developers to pursue projects that may otherwise be financial losses, leading to an increase in affordable housing.
• By leveraging private capital to construct and rehabilitate affordable-housing projects, the LIHTC program creates jobs and stimulates local economies. This contributes to economic growth and helps to revitalize communities.

Overall, the LIHTC program serves as a powerful tool for promoting the development of affordable housing while providing significant tax benefits for investors and developers.

IRS Form 8609-A

Investors and developers can use IRS Form 8609-A, also known as the Annual Statement for Low Income Housing Credit, to claim the LIHTC on their federal income tax returns.

Once the credit amount is determined, investors and developers will need to enter the credit amount on Form 3800 - General Business Credits.

The LIHTC program has proven to be a vital tool in promoting affordable housing, stimulating economic growth, and fostering community development, while providing significant tax benefits for investors and developers.

Have questions or concerns about applying for the LIHTC or any other tax credit? Work with a Tax Pro who can help you get every credit, deduction, and dollar you deserve.

About the Author

Mark Steber is Senior Vice President and Chief Tax Information Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.

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