The low-income housing tax credit

The QAP may reflect additional, state-based affordable rental housing policy preferences, and each state can assign points to the federal selection criteria and its own preferences in its point scoring system. The scoring system typically is used to rank applicants requesting an allocation. Most allocators have two to three application cycles annually. Winning applicants receive a reservation of credit and move to the next stage of the allocating process.

Participation by Nonprofit Organizations

The IRS requires that each state set aside a minimum of 10 percent of its allocation to developments involving nonprofit organizations. The nonprofit must be an equity owner (typically a 1 percent general partner) that materially participates-that is, conducts more of the management of the asset and the ownership entity than any other owner participant-in the development and operation of the property. The nonprofit's ownership percentage is small since it cannot claim income tax liability and credits. The requirement for material participation is effective for at least 15 years, and if the nonprofit should fail and be replaced, it would have to be replaced by another nonprofit. For these and other reasons related to the technical and financial capacity of nonprofit housing providers, as well as the stringent definition of "materially participate," use of the 10 percent nonprofit set-aside pool has seen mixed success. Many developers do team up and work with nonprofits or municipalities but apply for the general set aside for tax credits, bypassing the material participation restrictions.

Mechanics of the Credit

The amount of credit allocated to each property is determined by a formula laid out in Section 42 of the IRS Code and simplified below:

[eligible development cost basis] x
[applicable fraction (percent of units meeting Section 42 rules)] x
[credit rate (either 4 percent or 9 percent)] =
annual tax credit

Developers selling equity ownership of a property use a variety of formulas to compute the amount of equity that can be raised, but one simplified calculation follows below:

[annual tax credit amount] x
[ten-year stream of credit] x
[present value pricing factor] =
equity investment

Costs allowed in establishing the eligible credit basis include costs of construction or rehabilitation and may include soft costs, such as architectural, engineering, and development fees. Soft costs related to permanent debt (origination fees, closing costs) and equity financing are not eligible. Since land costs are not depreciable, they are excluded from the eligible basis. The inclusion of landscaping costs, impact fees, and off-site improvement costs is determined by the particular facts, often after consulting with a tax attorney or accountant.

Credit Percentages by Type of Development

New construction or substantial rehabilitation expenses not financed by a federal source receive a 9 percent annual credit. For rehabilitation properties involving acquisition, a 4 percent annual credit is given on the eligible costs of acquisition. The actual credit percentages vary monthly and are indexed to ten-year U.S. Treasury bond yields. For example, the actual credit rate for the 9 percent credit in September was 8.50 percent and the 4 percent credit rate for the same period was 3.64 percent.

To include acquisition expenses in the eligible basis, the acquired property must have been under continuous ownership for at least ten years or otherwise have been "placed in service." This is an IRS rule to prevent churning of the depreciable basis for tax purposes. Furthermore, for acquisition/rehabilitation-type developments, eligible rehabilitation expenses must be the greater of $3,000 per unit or 10 percent of the acquisition basis.

For properties that use federally tax-exempt debt (such as mortgage revenue bonds) to finance 50 percent or more of their total cost, only the 4 percent credit is given. The tax code presumes this lower credit percentage will be offset by lower-than- conventional interest cost on the debt. For tax-exempt properties, the allocation rules are different. These properties must still meet the state's QAP rules, but their credit is not allocated from the state population component credit pool.

If the tax-exempt bonds financing the property are subject to the state's bond volume cap (the maximum amount of federally tax-exempt debt the state can issue each year), the credit can be allocated without a reduction in the population pool. Financing with tax-exempt debt thus can be advantageous because it sidesteps the competition for population pool credit. A recent survey showed that in 1995, 19 states allocated over $13 million in credit outside of their population pools to tax-exempt debt financed properties.

Grants or below-market-rate federal loans used to pay for development costs generally are subtracted from the eligible basis, thus lowering the credit amount. Loans funded through local or state awards of community development block grants do not reduce the eligible basis. Other low-interest loan programs, such as the federal Home Investment Partnership Program (HOME) or the Federal Home Loan Bank Board's Affordable Housing Program, have particular rules for classification when used with the credit.