LIHTC 101: How Does it Work?
I recently wrote a post explaining what the low-income housing tax credit (LIHTC) is. But how does it actually work? Let’s start by saying you’re a developer, and you want to build a low-income housing project. What would the process of obtaining low-income housing tax credits and financing the associated project look like?
First, you need to develop a plan for the project and estimate how much it will cost. For simplicity, let’s assume you want to build a new apartment complex for low-income individuals, and it will cost an estimated $1.25 million. Of those costs, only $1.11 million are eligible for tax credits because land and several other expenses aren’t eligible. In this case, the project would be eligible for the new construction credit, which means that up to 90% of all projected costs could be covered. So if approved, you could receive nearly $1 million in state and federal credits over ten years.
To start the process, you have to get your project approved by the Missouri Housing Development Commission (MHDC), the state’s housing agency. This complex approval process includes filling out a slew of forms, completing audits of your finances, hosting inspections of the property, and paying a variety of fees.
Once you jump through the required hoops and get your project approved, you will likely need to sell the tax credits to begin development. (This is because many firms need the startup capital to fund construction; the credits are paid out over several years) To do this, most developers find a tax syndicator, which is simply a business that helps find investors willing to buy credits in exchange for financing the project. This process can be difficult because Missouri’s tax credits are non-transferrable, which means they cannot be transferred or sold to any investor that isn’t part of the development group. Thus, new legal partnerships are formed for most projects that include the developers and investors to allow them to buy and use the credits.
Once you have people willing to buy your credits, how much can you expect them to pay? The first hurdle is the federal tax implication for each investor. Paying less in state taxes (because they’re using credits) reduces the claimable portion of the federal tax deduction that comes from state taxes paid. In other words, using state tax credits can increase their federal tax liability. As a result, the value of the state credit to each investor drops by the federal tax rate they would have to pay on those funds—typically around 35% of the credit’s value.
In addition, getting money for tax credits today requires selling them at a discount, because the tax credits are issued over ten years. Selling all your credits today, adjusted for net present value, and including all fees for the syndicator’s efforts, you can expect to receive around 65% of the remaining value. After all is said and done, your $1 million in LIHTCs results in around $420,000 cash for project construction. These figures are in line with the analysis completed by Missouri’s State Auditor’s Office.
The rest of the project’s financing has to come from the developer, other investors, or mortgages. No matter the amount MDHC awards in tax credits, the end result is the same; there will typically only be around $0.42 of each dollar in tax credits available for actual construction. More than half the state’s investment in your project is lost by the time the construction can begin. This is a big reason why the program is such an inefficient use of taxpayer dollars.
For the next post in this series, I’ll look into the LIHTC program’s measurable impact (or lack thereof) on the supply of affordable housing in Missouri.