What it means
Building affordable housing is expensive, and rents from lower-income tenants often cannot cover the cost. The tax credit fills the gap.
Developers receive an allocation of credits, sell them to investors, and use the cash raised as equity to reduce the amount they need to borrow. State housing finance agencies distribute the credits through competitive applications.
Each agency publishes a plan setting out its priorities, and developers compete to win an allocation. Some developments qualify for a larger credit, usually described as the 9% credit, and others for a smaller one, the 4% credit, but these labels are shorthand, and the actual rates are set under federal rules.
The annual credit equals the qualified basis (the eligible building cost for the affordable units) multiplied by the credit rate. It is claimed each year over ten years, and the property must stay affordable for a compliance period that is longer, commonly at least fifteen years.
If the property stops meeting the rules, past credits can be recaptured. Investors, often banks and large companies with big tax bills, buy the credits through partnerships and pay a price for each dollar of credit, usually below one dollar.
The gap between the price and the face value is their return, together with other tax benefits. This is why the credit is in effect an equity-raising tool.
The programme has been a major source of affordable housing finance, but it is complex. Rules on income limits, rents, set-asides and compliance require specialist advice, and developers must manage lengthy approval processes.
The programme was created by the Tax Reform Act of 1986 and is written into the tax code as Section 42. It has been extended and adjusted by later legislation, so the detailed rules, caps and rates are best checked with the relevant agency or a specialist adviser.
Developers typically hire consultants to handle applications and compliance.
In practice
Real-world examples.
Example
A non-profit developer wins an allocation of credits from a state agency to build a 60-unit apartment building. It sells the credits to a corporate investor and uses the proceeds to cover a third of the construction cost. The rest is financed with a mortgage that the building's restricted rents can support.
Example
A regional bank buys a share in a partnership holding credits, lowering its tax bill for ten years while also meeting its goals for community investment. The bank's tax team models the timing of the credits to make sure it will have enough tax liability to use them each year.
Example
A property manager is hired to run an affordable development and must check tenants' incomes every year to keep the property in compliance and protect investors from recapture. Errors in income certification can be costly, so the manager uses a checklist and an annual audit.
Formula
Calculation
Annual credit = Qualified basis x Applicable credit rate
Total credits = Annual credit x 10 years
Equity raised = Total credits x Price paid per dollar of credit
Suppose a project has a qualified basis of $10,000,000 and an applicable credit rate of 9%.
Annual credit = $10,000,000 x 0.09 = $900,000.
Total credits over ten years = $900,000 x 10 = $9,000,000.
If an investor pays $0.90 for each $1.00 of credit, equity raised = $9,000,000 x 0.90 = $8,100,000.
The investor receives $9,000,000 of tax savings for an $8,100,000 investment, a gain of $900,000 before other effects and time value.Case study
Seen in the real world.
Riverbend Homes is an illustrative, fictional developer planning a 100-unit apartment complex for lower-income families. The total cost was $25,000,000, but the rents tenants could afford supported only $15,000,000 of debt.
The developer obtained a credit allocation and sold the credits to a corporate investor at $0.88 per dollar, raising roughly $9,000,000 from about $10,200,000 of credits. Together with a small subsidy from the city, this closed the funding gap and the project went ahead.
Over the following years the manager kept careful tenant records and met every compliance test. In the fictional story the investor received its tax savings on schedule, and the example shows how the credit connects tax incentives, private investment and public goals.
Watch out
Common mistakes.
- Thinking the credit is a grant paid to the developer, when it is a tax benefit sold to investors.
- Treating the 9% and 4% labels as exact fixed rates, when the actual rates are set under federal rules and can differ.
- Ignoring compliance, since failing the income or rent tests can lead to the loss of credits already claimed.
Questions
People also ask.
Who can claim the credit?
The investors who own the property, often through partnerships, claim the credits against their tax bills, and developers usually sell them to raise equity.
How long does the credit last?
It is generally claimed over ten years, while the affordability requirements continue for a longer compliance period.
Who allocates the credits?
State housing finance agencies do so under federal rules, through competitive processes that favour projects meeting local priorities.
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