Financing Focus

Incenting Development

Use the LIHTC program to help fund affordable housing.

Use of the Low-Income Housing Tax Credit program continues to encourage developers to provide quality affordable housing that targets the needs of the state.

Under the 1986 Tax Reform Act, the LIHTC program created federal tax credits issued by the IRS that are provided to state agencies and awarded to qualifying developers. The states award tax credits to developers based on affordable housing needs in local markets with every $1 of tax credit offsetting  $1 of taxes owed on the purchaser’s tax return.

Developers with awards then sell the tax credits to investors, who serve as 99.99 percent equity partners for tax purposes, to fund the project development. The developer, at 0.01 percent ownership, retains management control with the economic benefit resulting from the collection of the developer fee with no up-front equity. To ensure the tax credits serve populations in need, the program requires the development to remain in service for low-income populations for a minimum of 15 years (although each state can extend this in the Land Use Restriction Agreement).

The tax credit awarded to each project is based on the developer’s elected set-aside and the eligible basis calculation. The set-aside of low-income units requires that at least 20 percent of the units are reserved for residents making less than 50 percent of the area median income (AMI) or at least 40 percent of the units are reserved for residents making less than 60 percent AMI.

In many cases, developers opt for 100 percent set-asides to allow for the maximum tax credit awards. Eligible basis is determined as dollars spent on the affordable housing construction; items such as reserves and land are not included in eligible basis.

LIHTC Program Investments

LIHTC has two programs: 9 percent and 4 percent, which are based on the investment period.

The 9 percent awards: These provide nearly 70 percent of a project’s eligible basis cost. Plus, financing can be easier to obtain than the 4 percent award. However, a 9 percent award cannot be combined with federally funded debt. This program primarily is used for new construction.

The 4 percent awards: These provide nearly 30 percent of a project’s eligible basis cost, leaving a debt need of more than 70 percent of project costs. As a result, the developer needs to size the debt often to a 1.20 debt service coverage ratio despite constrained rents. Unlike the 9 percent awards, 4 percent awards are combined with federally funded debt  in the form of tax-exempt private activity bonds. The  4 percent program is often used for acquisition and rehab of existing properties.

Capital Stack Example: 9 Percent Program

For example, take a new LIHTC development of 75 units and a total project cost of about $14 million. See Table 1. Based on the example in Table 1, the LIHTC credit produces about $8.8 million in equity.

Using the LIHTC rents, the property will produce a net operating income of about $252,000, as seen in Table 2. Because of the AMI restrictions, the NOI of an LIHTC project will be reduced significantly from that of a market-rate project.

This $252,460 NOI will support a loan of approximately $3.2 million using a 5 percent interest rate, 35-year amortization, and a DSCR of 1.2. See Table 3.

The result is a $14 million project with an $8.8 million LIHTC equity infusion and a $3.2 million supported loan, leaving about $1.98 million of gap. This gap typically is covered by grants and soft loans to make the LIHTC project work. Additionally, the developer can defer 50 percent of the development fee (12 percent total) to help close this gap. See Table 4.

The LIHTC Process

Each state agency publishes a qualified allocation plan outlining application due dates as well as state needs, including locations of greatest need, minimum construction requirements, resident services, and other qualifying items.

The LIHTC award is a 15-year commitment; tax credits are earned over 15 years, but are paid over a 10-year period. To determine the annual amount earned each year, the annual tax credit award is multiplied by 10 and divided by 15. This is important when evaluating compliance and possible recapture. If the project were to fall out of compliance in year 11, the investor would be liable to repay the four years of tax credits already received in years one through 10.

Compliance is monitored by the state agency, and violations are reported to the IRS. States schedule site inspections and file audits to ensure compliance. As a result, it is crucial that developers have a strong compliance team to avoid recapture.

Influences on LIHTC Pricing

Buyers of tax credits are investors seeking a tax credit benefit. An investor could be any accredited or institutional investor; however, banks are the primary investor due to the Community Reinvestment Act, which requires banks to invest in the communities where they hold deposits. If a bank invests in an LIHTC project directly with the developer or through a fund, its CRA requirements can be achieved as a direct or indirect investment. If banks have significant deposits in a particular market, they have a greater need to satisfy CRA credit requirements. The demand to achieve CRA goals in these markets could drive up the price banks are willing to pay for tax credits, resulting in developers receiving more equity to fund their projects.

Strength in the Deal Team

Due to the complexities of the program, new developers are encouraged to arrange an experienced deal team to help create a strong LIHTC project that will be successful throughout the 15-year project period. Many failed projects have led states to cautiously award tax credits to less experienced teams. A strong deal team can include an experienced LIHTC tax accountant, legal counsel, co-developers (for-profit or non-profit), lender, tax credit equity partner (investor), architect, general contractor, and consultants.

Editor’s note: This article was adapted from the course “Low-Income Housing Tax Credit Financing.” For more information, visit

Jennifer Lampman

Jennifer Lampman is director of development at Greystone Affordable Development in Raleigh, N.C. She partners with developers to create affordable housing. Contact her at

Jeff Engelstad, Ph.D., CCIM, FRICS

Jeff Engelstad, Ph.D., CCIM, FRICS, is a professor of the practice at the University of Denver and is a senior CCIM Instructor. Contact him at

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