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Tax Credit Apartments – What is a Tax Credit Property?

Tax Credit Apartments – What Is a Tax Credit Property?

Tax Credit ApartmentsTax credit apartments are housing projects or apartment complexes that let landlords or owners claim tax credits in exchange for offering units to low-income tenants with restricted rents. In general, tax credit apartments are complexes owned by a developer or landlord who participates in the Federal Low-income Housing Tax Credit (LIHTC) Program. These owners can claim tax credits for eligible buildings in return for renting some or all of the apartments to low-income tenants at a restricted rent.

The Low-Income Housing Tax Credit (LIHTC) Program encourages the development of affordable apartment communities.  Moreover, they offer rentals that are lower than market rates by providing tax breaks to property owners. The program does not provide tax breaks to the renter who rents the unit. LIHTC properties may include a percentage of market-rate units that are not financially subsidized.  Some offer reduced-rent LIHTC units with a tiered rent structure. A tiered rent system means that tenants with various incomes may pay varying rent rates for similar units. These low-income housing apartment developments are managed by private management companies and individual proprietors. LIHTC units may also be associated with a rental subsidy scheme, such as the Project-Based Section 8 program.

Tax Credit Apartments and Properties – A Closer Look

The low-income housing tax credit (LIHTC) is intended to reduce rents for low-income tenants. The government provides financial assistance to property owners that acquire, build, or renovate affordable rental homes. The LIHTC was included in the 1986 Tax Reform Act. According to The Tax Policy Center, around 110,000 affordable rental apartments have been built under the LIHTC each year since the mid-1990s, for a total of 2 million units since its introduction.

State governments receive tax breaks from the federal government. The credits are subsequently distributed to private developers of affordable rental housing. Developers typically sell the credits to private investors in exchange for financing. Once the housing is rented, investors or developers can collect the tax credits over a 10-year period.

The Low-Income Housing Tax Credit (LIHTC) subsidizes the acquisition, construction, and rehabilitation of affordable rental housing for low- and moderate-income tenants. The LIHTC was enacted as part of the 1986 Tax Reform Act and has been modified numerous times. Since the mid-1990s, the LIHTC program has supported the construction or rehabilitation of about 110,000 affordable rental units each year (though there was a steep drop-off after the Great Recession of 2008–09)—over 2 million units in all since its inception. The federal government issues tax credits to state and territorial governments. State housing agencies then award the credits to private developers of affordable rental housing projects through a competitive process. Developers generally sell the credits to private investors to obtain funding. Once the housing project is placed in service (essentially, made available to tenants), investors can claim the LIHTC over a 10-year period. (Source: taxpolicycenter.org)

Tax Credit Apartments & Properties – How Property Owners Qualify for the Credit

The credit is available to apartment complexes, single-family homes, townhouses, and duplexes. However, owners and developers must meet revenue and gross rent requirements.

  • 20/50 Rule – At least 20% of units must be occupied by tenants whose income is 50% or less of the area’s median income (AMI) adjusted for family size.
  • 40/60 Rule – At least 40% of the units are occupied by tenants with an income of 60% or less of AMI.
  • 40/60/80 Rule – At least 40% of the units must be occupied by tenants with an average income of no more than 60 percent of AMI.  No units can be occupied by tenants with income greater than 80% of AMI.

Qualification and Compliance Period

Rents must not exceed 30 percent of either 50 or 60 percent of AMI.   It depends on the proportion of tax credit rental units in the project, according to the gross rent test. All LIHTC projects must meet the income and rent requirements for 15 years or the credits will be revoked. Furthermore, a thirty-year compliance period is typically required. Investors in LIHTC projects are often corporations with enough income tax liabilities to benefit from non-refundable tax credits. For example, financial firms have significant income tax responsibilities, a long planning horizon, and frequently earn a Community Reinvestment Act credit for LIHTC investments.

The gross rent test requires that rents do not exceed 30 percent of either 50 or 60 percent of AMI, depending upon the share of tax credit rental units in the project. All LIHTC projects must comply with the income and rent tests for 15 years or credits are recaptured. In addition, an extended compliance period (30 years in total) is generally imposed. Most investors in LIHTC projects are corporations that have sufficient income tax liability to fully use nonrefundable tax credits. Financial institutions traditionally have been major investors, because they have substantial income tax liabilities, have a long planning horizon, and often receive Community Reinvestment Act credit from their regulators for such investments. Taxpaying investors cannot claim credits until the project is placed into service.(Source: taxpolicycenter.org)

Costs and Benefits of Tax Credit Apartments & Properties

According to the Tax Policy Center, the LIHTC is anticipated to cost roughly $9.5 billion per year. It is intended to provide low-income households with cheap rental housing.

Pros

Supporters consider it a successful initiative.  In their view, it has significantly expanded the supply of affordable housing for more than 30 years. LIHTC tackles a major market failure which is the scarcity of high-quality affordable housing in low-income neighborhoods. Using private-sector economic incentives to create, manage, and maintain affordable housing for lower-income tenants results in greater efficiency.

Cons

According to critics, the federal subsidy per unit of new construction is excessively expensive. As a result, critics claim that a large percentage of the federal tax subsidies do not go directly toward the construction of new rental homes.

  • Too many layers –  The subsidy compensates and finances too many players.  For example, organizers, syndicators, general partners, managers, and investors.
  • Concentrated in underprivileged areas – LIHTC developments are sometimes concentrated in low-income neighborhoods with limited economic prospects. The incentives should promote development in more prosperous places where residents have access to better-paying jobs and schools. As the program exists, it has the potential to deepen society’s inequality issue.
  • Overly complex – Laws and regulations, according to critics, are unnecessarily complex.
  • No incentives for landlords when the compliance period expires – Once the minimum compliance periods have passed, landlords may find it difficult to keep homes affordable.

Final Words

The LIHTC program can be advantageous to landlords, developers, and those in need of affordable housing. It grants a tax credit to individuals who rent, create, or remodel affordable housing units.  Moreover, it incentivizes them to offer more units. This makes low-income households more able to obtain cheaper, affordable housing.  The LIHTC was included in the Tax Reform Act of 1986.  Its sole purpose is to make more affordable housing units available to individuals in need. It provides federal funds for building or refurbishing rental units of this sort. Most developers would not invest in low-income housing without the tax credit since they would not make a profit.

Up Next: What Is Stepwise Regression?

Stepwise RegressionStepwise regression is a statistical technique for regressing several variables while concurrently deleting those that aren’t significant. The process uses a  step-by-step iterative construction of a regression model.  Independent variables are selected for use in a final model through a series of automated steps. At every step, the candidate variables are evaluated, adding or removing potential explanatory variables in succession. The stepwise process adds the most significant variable or subtracts the least significant variable. It does not consider all alternative models, and after the procedure is finished, it returns a single regression model.

The selection process typically uses the t statistics for the coefficients of the variables being considered at each iteration. The availability of statistical software packages makes stepwise regression possible, even in models with hundreds of variables. The t statistic is a computation used during a t-test to evaluate whether your null hypothesis should be rejected. A t-test can be used to evaluate whether your population differs from some value of interest or whether two samples come from separate populations.

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