THE FEDERAL LOW-INCOME HOUSING TAX CREDIT
AND
HISTORIC REHABILITATION TAX CREDIT
This outline provides an overview of the federal low-income housing tax credit and
historic rehabilitation tax credit.
I.
LOW-INCOME HOUSING TAX CREDIT
A.
Generally.
The federal low-income housing tax credit is an indirect federal
subsidy to support investment in the development and operation of affordable multi-family rental
housing for lower-income people. The credit is a dollar-for-dollar credit against federal income
tax due.
Initially established under the Tax Reform Act of 1986, it is now one of the longestrunning federal housing programs. The credit is provided for in Section 42 of the Internal
Revenue Code.1
B.
Amount of Credit. Generally, the amount of tax credit for a taxable year is equal
to the “applicable percentage” of the “qualified basis” of a “qualified low-income building.”
The low-income housing tax credit may generally be claimed annually over a ten-year
period (the “Credit Period”) beginning with the year that a building is placed in service or, at
the election of the taxpayer/owner of the building, the year thereafter. An averaging convention
applies to the first year of the Credit Period pursuant to which a certain portion of the tax credits
that would otherwise be allowable in that year are deferred until the first year following the end
of the Credit Period.
Unless otherwise indicated, all Section references are to the Internal Revenue Code of 1986,
amended, as in effect on the date hereof.
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The credit is designed so that, in the case of a new building that is not federally
subsidized and that is occupied solely by qualified low-income tenants, the owner of the building
will generally receive, in present value terms, tax credits equal to 70 percent of the costs of
construction. In the case of a building that is considered to be federally subsidized (generally,
building financed with tax-exempt bonds or with below-market loans financed with certain kinds
of federal funds), the credit is generally equal, in present value terms, to 30 percent of the cost
of construction.
The credit is in addition to the other tax benefits associated with the ownership of
residential rental property such as depreciation deductions.
C.
What Buildings Qualify. A “qualified low-income building” is a building in a
“qualified low-income project.” A “qualified low-income project” is generally defined as a
project for residential rental property that meet the (i) Minimum Set-Aside Test and (ii) the Rent
Restriction Test.
1.
The Minimum Set-Aside Test.
A project must set aside a minimum
number of residential units for qualified low-income tenants at restricted rents. A project owner
may elect either the “20-50 Test” or the “40-60 Test.”
The “20-50 Test” requires that 20 percent or more of the residential units in the project
must be both rent-restricted and occupied by individuals whose income is 50 percent or less of
area median gross income.
The “40-60 Test” requires that 40 percent or more of the residential units in the project
must be both rent-restricted and occupied by individuals whose income is 60 percent or less of
area median gross income.
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The election, which is made on IRS Form 8609, is irrevocable. The minimum set-aside
requirement must be met at all times from the close of the first year of the Credit Period through
the end of the 15-year “Compliance Period.”
2.
The Rent-Restriction Test. A residential unit is generally considered to be
“rent-restricted” if the “gross rent” with respect to such unit does not exceed 30 percent of the
“imputed income limitation” applicable to such unit. The imputed income limitation applicable
to a residential unit that is in a project that satisfies the 40-60 test is generally 60 percent of area
median income, adjusted for family size based the following assumptions: (i) in the case of a
studio apartment that does not have a separate bedroom, the unit is occupied by one individual,
and (ii) in the case of a unit that has one or more rooms, 1.5 individuals occupy the unit for each
bedroom. Detailed tenant income certification requirements apply.
“Gross rent” includes the applicable utility allowance, which is generally determined
using local public housing authority utility allowances. Thus, the maximum allowable rent must
take into account and be reduced by the applicable utility allowance.
D.
Qualified Basis. The “qualified basis” of a qualified low-income building for
any taxable year is an amount equal to the “applicable fraction” of the building’s “eligible
basis.” The “applicable fraction” is the smaller of the “unit fraction” or the “floor space
fraction” and is determined at the close of each taxable year. The “unit fraction” is a fraction,
the numerator of which is the number of “low-income units” in the building and the
denominator of which is the number of residential rental units in the building. The “floor space
fraction” is a fraction the numerator of which is the total floor space of “low-income units” in
the building and the denominator of which is the total floor space of the residential rental units in
the building.
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1.
Eligible Basis. The “eligible basis” of a new building is generally its
adjusted basis for federal income tax purposes (including the adjusted basis of depreciable
property used in common areas or provided as comparable amenities to all residential rental units
in the building but excluding the adjusted basis of any portion of the property that is not
considered “residential rental property”) as of the close of the first taxable year for which lowincome housing credits are claimed with respect to the building.
The adjusted basis of
commercial space is not included in eligible basis.
a.
30 Percent Basis Step-Up for Projects in Qualified Census Tracts
and Difficult Development Areas. In the case of a new building located in a “qualified census
tract” or a “difficult development area,” the eligible basis of the building will be 130 percent
of what it would otherwise be. A “qualified census tract” is a census tract designated as such
by Secretary of Housing and Urban Development and is generally a census tract with a
concentration of low-income households. A “difficult development area” is generally any area
designated by the Secretary of Housing and Urban Development as an area which has high
construction, land or utility costs relative to area median gross income.
b.
Federal Grants Excluded from Eligible Basis. If, during any year
of the 15-year Compliance Period, a grant is made with respect to any building or the operation
thereof and any portion of the grant is funded with federal funds, the eligible basis of the
building for such taxable year and all succeeding taxable years shall be reduced by the portion of
the grant so funded.
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2.
Low-Income Unit. A “low-income unit” generally means a residential
rental unit that (a) meets the income and rent restrictions of the applicable minimum set-aside
test; (b) is “suitable for occupancy” (complies with local health, safety and building codes) and
(c) is used on other than a transient basis. Generally, a unit is considered to be leased on other
than a transient basis if the term of the initial lease is at least six months.
E.
Applicable Percentage. For property placed in service in 1988 and thereafter, the
applicable percentage is adjusted monthly by the Internal Revenue Service. The percentages are
to be adjusted to reflect the present values of 70 percent or 30 percent, respectively, determined
on a discounted after-tax basis based on the average of the annual applicable federal rates for
mid-term and long-term obligations for the month.
The applicable percentage varies depending on whether the building is a “new building”
and whether the building is “federally subsidized.” In the case of a new building which has
never been previously placed in service, the 70 percent rate applies unless the building is
“federally subsidized” for the taxable year. The 30 percent rate applies to existing buildings
that qualify for the credit and to new buildings that are considered to be “federally subsidized”
for the taxable year.
A new building is treated as “federally subsidized” for any taxable year if, at any time
during such taxable year or any prior taxable year, there is or was outstanding any obligation, the
interest on which is tax-exempt or any below-market federal loan, the proceeds of which are or
were used (directly or indirectly) with respect to such building or operation thereof.
A “below-market federal loan” generally means any loan funded, in whole or in part,
with federal funds if the interest rate payable on such loan is less than the applicable federal rate
in effect under Section 1274(d)(1) as of the date on which the loan was made.
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The “applicable percentage” is generally the percentage determined for the month in
which the building is placed in service. However, the taxpayer may elect to use the applicable
percentage as of the time the housing agency enters into a binding agreement to allocate credits
to the building rather than the applicable percentage that is in effect as of the time the building is
later placed in service.
The applicable percentage for July 2001 for new buildings receiving no federal subsidy
was 8.28 percent. The applicable percentage for July 2001 for buildings that are considered to be
“federally-subsidized” was 3.55 percent.
F.
Compliance Period. A project is generally required to be operating in compliance
with the requirements of Section 42 for a period of 15 years beginning with the first year of the
Credit Period. This 15-year period is referred to as the “Compliance Period.” Failure to
comply with the requirements of Section 42 throughout the Compliance Period may result in a
disallowance of credits, the ineligibility of the Project for tax credits in future years, or the
recapture of a portion of the credits claimed.
G.
Extended Low-Income Housing Commitment. Generally, no tax credits under
Section 42 are allowable with respect to a building for a taxable year unless an “extended lowincome housing commitment” is in effect with respect to that building as of the end of that
taxable year.
An extended low-income housing commitment is an agreement between the
taxpayer/owner of the project and the applicable state agency that meets the requirements of
Section 42(h)(6)(B). The commitment must be recorded pursuant to state law as a restrictive
covenant on the property by no later than the end of the first year of the Project’s Credit Period.
The amount of credit allowed in any taxable year may not exceed the amount necessary
to support the applicable fraction specified in the low-income housing commitment for such
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building. However, in the case of a building financed with volume cap bonds, the low-income
housing commitment may be amended to increase the applicable fraction.
H.
Tax Credit Allocations.
1.
Projects That Are Not More Than 50 Percent Financed With Tax-Exempt
Bonds Require a Tax Credit Allocation. Generally, in order for a building to be eligible for
low-income housing tax credit, the building must receive an allocation of the housing credit
dollar amount from the state or local agency in whose jurisdiction the project is located. In
Oregon, the allocating agency is the Oregon Housing and Community Services Department.
The amount of low-income housing tax credit that may be claimed with respect to any
building in any taxable year may not exceed the housing credit dollar amount allocated to the
building.
The aggregate amount of credits that may be allocated within any state is limited by the
state's annual low-income housing credit authority limitation. The credit allocations which may
be made by the applicable agency for each state are generally limited to $1.75 ($1.50 for 2001)
for each resident of the state, as determined by the most recent estimate of the state's population
released by the Census Bureau before the beginning of the year to which the limitation applies.
For years after 2002, the state tax credit ceiling will be increased by a cost-of-living adjustment
factor.
2.
Nonprofit Set-Aside. Ten percent of a state's housing credit ceiling for
any calendar year is reserved for projects involving “qualified nonprofit organizations.” A
“qualified nonprofit organization” generally means an organization exempt from federal
income taxation under Section 501(c)(3) or (4) of the Internal Revenue Code, one of the exempt
purposes of which includes fostering low-income housing and which is determined by the state
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housing credit agency not to be affiliated with or controlled by a for-profit organization.
Furthermore, in order for a project to qualify for the set-aside, the nonprofit organization must
materially participate in the development and operation of the project throughout the fifteen-year
compliance period.
3.
Timing of Tax Credit Allocation.
Credits may be allocated only during
the calendar year in which the building is placed in service except where:
a.
credits are claimed on additions to qualified basis;
b.
credits are allocated in a later year pursuant to an earlier binding
commitment made no later than the year in which the building was placed in service; or
c.
an allocation made with respect to a “qualified building” which is
placed in service not later than the close of the second calendar year following the calendar year
in which the allocation is made is timely (a “carryover allocation”).
The term “qualified building” means a building which is part of a project in which the
taxpayer's basis, as of the later of (i) the date which is six months after the date on which the
allocation is made or (ii) the close of the calendar year in which the allocation is made, is more
than 10 percent of the taxpayer's reasonably expected basis in the project (as of the close of the
second calendar year after the year in which the allocation is made). This requirement is referred
to as the “10 percent test.”
For purposes of the 10 percent test, the taxpayer's basis in the project includes the
adjusted basis of land and depreciable property, whether or not such amounts are includible in
eligible basis. The cost of construction services is included in the basis of an accrual method
taxpayer when the services are performed.
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I.
Tax Credit Allocation Must be Made Pursuant to State Qualified Allocation Plan.
Under Section 42(m), the housing credit dollar amount allocated with respect to any building
shall be zero unless (i) such amount was allocated pursuant to a “qualified allocation plan” of
the housing credit agency which is approved by the governmental unit of which the agency is a
part, (ii) the agency notifies the chief executive officer of the local jurisdiction within which the
building is located of the project and provides that individual a reasonable opportunity to
comment on the project, (iii) a comprehensive market study of the housing needs of low-income
individuals in the area to be served by the project is conducted by a disinterested individual at the
developer’s expense, and (iv) a written explanation is made available to the public for any
allocation that is made by the agency that is not in accordance with the established priorities and
selection criteria of the agency.
A “qualified allocation plan” is a plan which (i) sets forth selection criteria to be used to
determine housing priorities of the housing credit agency which are appropriate to local
conditions, (ii) gives preference in allocating housing credit dollar amounts among selected
projects to projects serving the lowest income tenants and projects obligated to serve qualified
tenants for the longest periods, (iii) projects located in qualified census tracts , the development
of which contributes to a concerted community revitalization plan; and (iv) which provides a
procedure that the agency will follow in notifying the Internal Revenue Service of
noncompliance with the provisions of Section 42 of which the Agency becomes aware. In
addition, certain selection criteria are required to be included in a “qualified allocation plan.”
J.
Tax Credit Allocation May Not Exceed the Amount Needed for the Project to be
Financially Feasible. The housing credit dollar amount allocated to a project may not exceed the
amount the housing credit agency determines is necessary for the financial feasibility of the
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project and its viability as a qualified low-income project throughout the credit period. The
housing credit agency is required to make this determination as of each of the following times:
(i) the application for the housing credit dollar amount, (ii) the allocation of the housing credit
dollar amount, and (iii) the date on which the building is placed in service. Thus, the housing tax
credit dollar amount ultimately allocated to a building on a Form 8609 may be less than the
housing credit dollar amount allocated to such building in a carryover allocation.
K.
Bond-Financed Projects. A tax credit allocation from the state’s credit allocating
agency is not required for any portion of a building financed by volume cap bonds. If at least
50 percent of the aggregate basis of a building and land is financed with volume cap bonds, the
building is entirely exempt from the allocation requirement.
Bond-financed projects are required to satisfy the requirements of the state credit
allocating agency’s credit allocation plan.
Furthermore, the agency issuing the bonds must make a determination that the Tax
Credits for the Project do not exceed the amount necessary to assure Project feasibility. In
making this determination, the agency must take into account various criteria, such as the
reasonableness of the development and operating costs of the project. Furthermore, the agency
may use an applicable percentage that is less, but not greater than, the applicable percentage
applicable for projects requiring a tax-credit allocation.
L.
Tax Credit Recapture. Generally, any disposition of a taxpayer’s interest in a
building or any reduction in a building’s “qualified basis” during the building’s “Compliance
Period” may result in tax credit recapture.
The recapture amount generally equals the
“accelerated” portion of the credit plus an interest penalty.
During the ten-year “Credit
Period,” the accelerated potion of the credit is generally one-third of the credits claimed in each
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year so that if a building is disposed of during the “Credit Period,” that is the portion of the
credit that is subject to recapture.
A taxpayer may avoid tax credit recapture upon the disposition of a building or an
interest therein during the Compliance Period by posting a bond with the U.S. Treasury that
meets certain requirements specified by the Internal Revenue Service.
M.
Tax Credit Investors. The use of low-income housing tax credits by individuals is
strictly limited under the Internal Revenue Code. As a result, in nearly all cases, the tax credits
are “sold” to syndicators of tax credit funds. The syndicators in turn “sell” the tax credits to
large institutional investors.
For federal tax purposes, the tax credits follow the ownership of the project. Therefore,
projects are typically owned by a limited partnership or limited liability company in which the
investor holds a 99.9 or 99.99 percent interest. Typically, investors make staged investments
over the course of a few years. Although last year, investors were often paying over $0.80/tax
credit dollar, the price has since dropped due to increased product availability.
The yields to tax credit investors are currently between 7 and 9 percent.
N.
Development Fees.
Low-income housing tax credit projects can generate
substantial development fees. Typically, a portion of the development fee is deferred for at least
a few years with the deferred portion often paid from the later staged investor payments.
II.
HISTORIC REHABILITATION TAX CREDIT
A.
Generally.
The federal rehabilitation tax credit provides an indirect federal
subsidy for the rehabilitation of certain older structures.
B.
Amount of Credit.
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1.
10 Percent Credit. The credit is equal to 10 percent of the “qualified
rehabilitation expenditures” incurred with respect to any “qualified rehabilitated building”
other than a certified historic structure.
2.
20 Percent Credit. The credit is equal to 10 percent of the “qualified
rehabilitation expenditures” incurred with respect to a “certified historic structure.”
C.
Eligibility. A “qualified rehabilitated building” is any building that:
1.
has been “substantially rehabilitated;”
2.
was placed in service before the beginning of the rehabilitation;
3.
is a structure with respect to which depreciation (or amortization in lieu of
depreciation) is allowable; and
4.
in the case of a building other than an historic structure, complies with
certain requirements regarding the percentage of walls and internal structural framework retained
AND the building was placed in service before 1936.
D.
Certified Historic Structure. A “certified historic structure” is any building that
is listed in the National Register or that is located in a registered historic district and certified by
the Secretary of the Interior (National Park Service) as being of historic significance to the
district
E.
Substantial Rehabilitation.
A building is generally considered to be
“substantially rehabilitated” only if the “qualified rehabilitation expenditures” during the
24-month period selected by the taxpayer in accordance with the applicable Treasury
Regulations and ending with or within the taxable year exceed the greater of (i) the adjusted
basis of the building (including structural components) or (ii) $5,000. The adjusted basis of the
building (including structural components) is determined as of the beginning of the first day of
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the 24-month period or the holding period of the building, whichever is later. The determination
of the beginning of the holding period is made without regard to any reconstruction by the
taxpayer in connection with rehabilitation.
F.
Qualified Rehabilitation Expenditure.
The term “qualified rehabilitation
expenditure” generally means any amount properly chargeable to capital account:
(i) for
property which is depreciable for federal income tax purposes and which is (a) nonresidential
real property, (b) real property with a class life of more than 12.5 years, or (c) an addition or
improvement to property in one of the above-described classes, and (ii) in connection with the
rehabilitation of the qualified rehabilitated building.
The term “qualified rehabilitation
expenditure” does not include the cost of acquiring the building, the cost of any enlargements to
the building or, in the case of a certified historic structure, any expense unless the rehabilitation
is certified by the Secretary of the Interior (National Park Service) as being consistent with the
historic structure of the property. The term “qualified rehabilitation expenditure” also does
not include any expenditure in connection with the rehabilitation of a building that is allocable to
the portion of the property which is, or may be reasonably expected to be, “tax-exempt use
property” as defined in Section 168(h) of the Internal Revenue Code.
Generally, real property may be classified as “tax-exempt use property,” in whole or in
part, either if it is leased to a tax-exempt entity pursuant to a “disqualified lease” or if it is
owned by a partnership composed of both taxable and one or more tax-exempt entities and the
partnership’s tax allocations are not qualified allocations.
G.
Timing of Credit. The rehabilitation tax credit can be claimed only in the year in
which the rehabilitated property is “placed in service.”
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H.
Depreciable and Low-Income Housing Tax Credit Eligible Basis Reduced by
Amount of Rehabilitation Tax Credit Claimed. If a taxpayer claims a rehabilitation tax credit
with respect to a building, the depreciable basis of the qualified rehabilitation expenditures
incurred with respect to the building is reduced by the amount of the rehabilitation tax credit
claimed. The eligible basis of the rehabilitation expenditures is also reduced for purposes of
determining the low-income housing tax credit based on those expenditures.
I.
Recapture. The rehabilitation tax credit is subject to recapture in the event of
early disposition (including destruction from casualty or condemnation) of an historic credit
property. If, within five years after the date the building is placed in service, the building is
disposed of, the owner’s tax for the year will be increased by an amount equal to the amount of
the rehabilitation tax credit originally allowed, multiplied by a “recapture percentage”
determined on the basis of the holding period of the building.
The “recapture percentage” is 100 percent for a disposition within the first year after
the building is placed in service and decreased by 20 percent for each full year that elapses
thereafter such that no recapture occurs in the event of a sale occurring more than five years after
the building is placed in service. For purposes of determining recapture of the rehabilitation tax
credit, a disposition is deemed to occur in any sale exchange, transfer, distribution, involuntary
conversion or gift of the building, or the occurrence of any other event which causes the building
to cease to qualify for the rehabilitation tax credit.
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