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Low-Income Housing Tax Credits

Low-Income Housing Tax Credits. Lecture Notes National Trust for Historic Preservation November 4, 2010 Washington, DC John Linner National Development Council 1946 N. 13 th , #484, Toledo, OH 43604 ph: 419-242-5713 jlinner@nationaldevelopmentcouncil.org. Tax Credits.

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Low-Income Housing Tax Credits

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  1. Low-Income Housing Tax Credits Lecture Notes National Trust for Historic Preservation November 4, 2010 Washington, DC John Linner National Development Council 1946 N. 13th, #484, Toledo, OH 43604 ph: 419-242-5713 jlinner@nationaldevelopmentcouncil.org

  2. Tax Credits • A direct, dollar-for-dollar reduction of tax liability • Two kinds for rental housing • Historic Rehabilitation Tax Credits (HRTCs) • Low-Income Housing Tax Credits (LIHTCs) • Intended to give investors an incentive to make investments that have a public purpose

  3. Low-Income Housing Tax Credits (LIHTCs) • Introduced in Tax Reform Act of 1986 • Extended in Revenue Reconciliation Act of 1993 • Intended to encourage investment in low-income rental housing • Principal federal subsidy for low-income housing • Annual credit for 10 years

  4. For Permanent Rental Housing • Excludes nursing homes, health care facilities • Must be for “general use” • Normally, minimum six month initial lease term (exception for SRO’s, housing for the homeless)

  5. Three Threshold Criteria • Incomes of occupants • Rent restrictions • State agency approval

  6. Income/Occupancy • 20 percent of units must be occupied by tenants with incomes below 50 percent of area median income (AMI) OR • 40 percent of units must be occupied by tenants with incomes below 60 percent of AMI • Election must be made by time building is placed in service • Must be met in first year credits are claimed • Receive credits only on units occupied by qualified low-income tenants (applicable fraction) • Maximum credit award requires 100 percent low-income occupancy

  7. What Counts as Income? • Gross wages and salaries • Social Security, pension, retirement • Disability, worker’s compensation, unemployment • Welfare • Alimony, child support • Earned income tax credit > taxes • Interest, dividends or imputed income • Qualifying amount is “anticipated” total • Once qualified, a household’s income may rise above LIHTC limits without disqualifying unit • Annual recertifications may be waived for 100 percent low-income projects

  8. Rent Restrictions • All units receiving LIHTCs have rent restrictions • Restrictions based on number of bedrooms, imputed household size, and AMI • Imputed household size equals number of bedrooms x 1.5 persons per bedroom (one person for a 0-bedroom unit) • Rent cannot exceed 30 percent of income qualifier (either 50 or 60 percent of median) for the assumed household size • Maximum rent includes all utilities except telephone

  9. Computation for Two-Bedroom Unit • Imputed household size is2 x 1.5 persons/bedroom = three-person household • DC median income for three-person household is $92,400 • 60 percent of median is .60 x $92,400 = $55,440 or $4,620 per month • Maximum two-bedroom rent is 30 percent of $4,620 per month, or $1,386 per month • If utility allowance for two-bedroom unit is $125 per month maximum contract rent is $1,386 – 125 = $1,261 per month

  10. Computation for a One-Bedroom Unit • Imputed household size is 1 x 1.5 persons per bedroom = 1.5 persons • If DC median income for one person is $71,900 and median for two persons is $82,200, median for 1.5 persons is midpoint or $77,050 • 60 percent of median equals $46,230 or $3,852 per month • 30 percent of median is $1,155 per month • If utility allowance for one-bedroom unit is $100 per month, maximum contract rent is $1,155 - $100 = $1,055 per month

  11. Computation for a One-bedroom Unit (cont.) • Maximum rents do not include rental assistance (Section 8) or payments for supportive services from government agencies or non-profits • Maximum rents do include any tenant payments for services that are required as a condition of occupancy • In assisted living projects, services must be optional or funded by agencies

  12. Tenant Charges for On-site Facilities • If tenants must pay to use on-site facilities (garage spaces, storage spaces), then either • Payments count against maximum LIHTC rent, or • Costs of facilities are excluded from basis

  13. LIHTC Rents (cont.) • Income qualification is based on the individual household’s income. Must be below threshold for that household. • Rent is based not on tenant’s household size or income but on threshold for imputed household size

  14. Maximum Rents May Decline • Maximum gross LIHTC rent may decline with decline in AMI, but cannot be less than initial maximum • Maximum contract rent may decline because of increase in utility allowance

  15. LIHTC Projects Must Remain Low-income on a Long-term Basis • Rent and income restrictions are in force for a minimum of 15 years (compliance period) • Additional 15-year “extended use obligation”

  16. State Agency Approval • LIHTCs are administered by states • Each state receives $2.15 LIHTCs per resident ($2.465 million minimum) for 2011 • State agency allocates credits • Creates own allocation plan • Underwrites projects • Monitors projects • At least 10 percent set aside for projects sponsored by non-profit organizations • States may require low-income occupancy for longer than 30 years

  17. Two Kinds of LIHTCs • 70 percent present value (9% credit) – presently fixed at 9.0% • 30 percent present value(4% credit) – floats and is adjusted monthly – 3.24% for November of 2010

  18. Two Kinds of LIHTCs (cont.) • Most projects are “9% deals” - receive 9% credit on all rehabilitation work or new construction • Others are “4% bond deals” - receive 4% credit on all rehabilitation work or new construction • Also sometimes receive 4% credit on the building portion of acquisition on a rehabilitation project

  19. Grants Excluded from Basis • No credits on costs funded with grants • Convert grants into loans

  20. New Construction/Substantial Rehabilitation • Annual credit for 10 years • Substantial rehabilitation requires spending the greater of • $6,000 per unit, or • 20 percent of remaining depreciable basis • “9 percent deal” - receive 9% credit on basis items (improvement costs) OR • “4 percent bond deal” - receive 4% credit on basis items

  21. ExampleNew Construction Project

  22. Example30% Basis Increase for Difficult Development Areas andQualified Census Tracts

  23. 30% Basis Increase contd. • A state may also provide the 30% basis increase for any project that the state believes needs additional credits in order to be feasible

  24. Improvement Basis (9% or 4% Credit) • Include • Construction and supervision • Architectural, engineering, design fees • Construction financing costs (fees, appraisals, interest) • Developer fees • Permits and inspection fees • Performance bonds • Furnishings • Environmental assessment • Development consulting fees • Property taxes and insurance • Community service space (qualified census tract, serve primarily low-income residents, limits on percentage of building basis)

  25. Not Considered Part of Construction or Rehabilitation Basis • Exclude • Permanent financing expenses • Syndication costs • Tax credit application fees • Reserves • Acquisition expense (land or building) • Off-site improvements (generally) • Organizational expense • All costs attributable to non-residential (exception for community service space) • All costs attributable to market-rate units

  26. Acquisition Credit • Can also receive 4% credit on portion of acquisition price attributable to building • Available with substantial rehabilitation only • Must spend greater of $6,000 per unit or 20% of building basis • Must meet “10 year placed in service rule” • Waivers for REO’s, preservation projects

  27. Acquisition/Rehabilitation In Difficult Development Area

  28. Historic Rehabilitation Tax Credits Reduce LIHTC Basis $4,000,000 Rehabilitation x .20 Credit Rate = $800,000 RTC $4,000,000 Rehabilitation - 800,000 RTC = $3,200,000 LIHTC Credit Basis x .09 $288,000 Maximum Annual LIHTC

  29. Historic Rehabilitation Tax Credits Reduce LIHTC Basis (cont.) • With 30% LIHTC basis increase $4,000,000 Rehabilitation - 800,000 RTC = $3,200,000 x 1.3 LIHTC credit basis increase = $4,160,000 x .09 = $374,000 Maximum annual LIHTC

  30. Issues in Combining LIHTCs and RTCs • Compliance with historic standards may increase costs • RTC’s reduce basis for LIHTCs – even greater impact if project is eligible for 30% basis increase

  31. Master Tenant Leases • Tax code allows RTCs to be passed through to a tenant • Create separate partnership (master tenant) to lease building and take RTCs • No basis reduction on LIHTCs • Used most often on large bond deals

  32. Example • Project with $10 Million of Historic Rehabilitation in Qualified Census Tract

  33. Typical Credit “Prices” • RTCs - $.80-.90 per dollar • LIHTCs - $.65-.80 per dollar • Prices are negotiated between developers and investors • Prices have declined sharply since peak in 2006-2007

  34. Competition Problem • Most states have two or three times as many proposed projects as they can fund • Makes the application process increasingly uncertain • Incur substantial predevelopment costs with no assurance of feasible project

  35. Solution – Bond Deal • Qualify for “4%” credit outside state’s normal allocation process • Requires allocation of “private activity” bond cap • State gets $95 per resident in bond cap (compared to $2.15 per resident in LIHTC’s)

  36. Tax-Exempt Financing and LIHTCs • Projects with 50 percent of costs funded with tax-exempt financing automatically receive 4% credit without state approval outside state’s LIHTC Allocation process • Financing must be from state’s volume cap for private activity bonds • Often mixed-income projects

  37. Must Fund Half of Development Costs With Tax-exempt Debt • Must pay for 50 percent of cost (land plus depreciable basis) with bond proceeds • Rent restrictions may limit the amount of permanent debt • Can meet the 50 percent test with tax-exempt interim financing and pay down with investor equity and soft permanent debt

  38. Problem – 4% Credit Yields Fewer Credits and Less Equity

  39. Need More Debt to Do Bond Deals • Higher “must pay” debt > higher NOI > higher rents • Without higher rents > large amounts of deferred payment loans (HOME, CDBG, AHP, State or local subsidies)

  40. Two General Types of Bond Deals • Relatively high rents, NOI sufficient to support Enough permanent debt to meet 50 percent test • Often mixed income with significant portion of units at market rate • 100 percent of units at tax credit rents, meet 50 percent test with interim financing

  41. Bond Deals Are Often Riskier • Higher rents, more market risk • More debt service than “9%” tax credit projects • Frequently done with FHA insurance - lower debt coverage requirements, less margin for error

  42. Bond Deals (cont.) • Advantages of 4% bond deals • Less competition for bond cap than for tax credits • May be faster – do not have to wait for LIHTC round • Disadvantages of bond deals • Less equity, more debt • More players • Higher transaction costs • Lower investor interest today

  43. Who Are the Limited Partners in Tax Credit Deals? • Corporate equity funds • Large corporate direct investors • Private placements • Equity funds for individuals

  44. Methods of Organizing the Ownership of an LIHTC Project • Limited Partnership • Limited Liability Company Objectives • Limited liability for investors • Direct pass-through of credits, losses and gains

  45. Limited Partnership • At least one General Partner (GP) • At least one Limited Partner (LP) • GP owns 0.01 percent • LP owns 99.99 percent • GP manages partnership • LP is passive investor • LP has limited liability • GP has unlimited liability

  46. Limited Liability Corporation (LLC) • A corporation taxed like a partnership • At least one manager (like a GP) • At least one member (like an LP) • Advantages over Limited Partnership • Limited liability for all owners • Investors can have role in management

  47. Investors Invest ForTax Benefits - Credits, Losses • LP invests solely for tax benefits - gets 99.99% of the tax credits and the losses • Developer/GP tries to capture as many of the cash benefits as possible (developer’s fees, cash flow, residuals)

  48. Ways Of DivertingCash Flow To GP • Deferred developer fees • Payments on GP loans • Partnership management fees • Incentive management fees – limited to lesser of 80-90 percent of cash flow or some percentage (10-15 percent) of effective gross

  49. Investors Also Value Losses Principal Payments + Reserve Deposits - Depreciation - Amortization - Accrued Interest = Taxable Income (Losses) x Tax Rate = Taxes (Tax Savings)

  50. Doing a LIHTC Project – Step One • Applying for credits • Site identification and control • Preliminary design concept and budget • Information about the development team • Market/feasibility analysis • Financial projections • Operating pro forma • Estimate of credits • Sources and uses • Letters of interest from financing sources

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