Demystifying LIHTC: An Interview with Mike Hollar
In this column, Mike Hollar, Senior Economist in PD&R’s Economic Development and Public Finance Division, talks about the Low-Income Housing Tax Credit program.
The Jackson is a part of POAH’s multiyear effort to transform a troubled 504-unit Section 8–assisted complex into a healthy, new, mixed-use, mixed-income community in Chicago’s Woodlawn neighborhood. Image courtesy of Preservation of Affordable Housing.
The Low-Income Housing Tax Credit (LIHTC) is a federal tax credit provided to developers of low-income housing. The program is structured such that state housing finance agencies allocate tax credits to developers. In return for the tax credits, the developers agree to maintain program rent and income restrictions. The program, as a federal tax credit, is a program of the Internal Revenue Service at the federal level, but is structured so that the most of the administration of the program is conducted by the state housing agencies.
The tax credit program was established in the Tax Reform Act of 1986. It was a replacement for accelerated depreciation provisions that had existed in the tax code that encouraged the provision of low-income housing. When Congress reformed the tax code in 1986, these provisions were removed from the code and in its place Congress established the tax credit program. Through this process, Congress replaced various tax provisions that were beneficial to the provision of low-income rental housing with a formal production program.
There haven’t been major changes, but there have been a number of small changes. For example, adding areas where the federal government encourages developers to locate low-income properties. Although Qualified Census Tracts (QCTs) were part of the original program, QCTs were originally defined as areas where at least 50 percent of the population earned less than 60 percent of the area median income, which is the program income limit. In 2000, Congress added the poverty rate criterion for QCTs, in which tracts with a poverty rate of at least 25 percent were eligible, and Difficult Development Areas, which are areas with high construction, land, and utility costs relative to the area mean income. While those were permanent changes to the statute, Congress has periodically made temporary changes, including targeting Gulf Opportunity Zones (GOZones) after Hurricanes Katrina, Rita and Wilma in 2005. The Housing and Economic Recovery Act (HERA) of 2008 also made a number of temporary changes to the program following the financial crisis in order to replace lost investor funding.
The tax credit program, since it is administered by state agencies, allows states to tailor the program to their specific housing needs. The way that states do this is through their Qualified Allocation Plans (QAPs). Each state is required to put together a QAP explaining how the state will administer the program, including how they are going to choose applications to award tax credits. In the QAP, the state will often identify areas where they want developers to focus.
The only areas that are encouraged by statute are Qualified Census Tracts (QCTs) and Difficult Development Areas (DDAs). A property that locates in one of these designated areas is eligible for an additional 30 percent tax credits above the amount they would otherwise be entitled. Those two provisions, as part of the federal statute, encourage the development of tax credit properties in either low-income, high poverty areas for Qualified Census Tracts, or in areas with higher development costs, which are Difficult Development Areas. States may have their own areas where they would like to have developments placed. Sometimes, they will reserve a certain amount of credits for rural versus urban areas and areas that may have a shortage of affordable rental housing.
Qualified census tracts have come under a lot of scrutiny for the provision’s incentive to locate low-income housing in low-income areas. It has become a real concern that this program, and this provision specifically, is encouraging the concentration of poor households in poor areas. Since race is highly correlated with income, this has served, in some respects, to concentrate minorities in high-minority tracts and, of more concern, in low-income tracts that are not areas of opportunity.
The tax credit program has really grown over the years, and it has become the primary production program for the federal government. Throughout most of the 2000’s (1999 through 2008), it was producing well over 100,000 units a year. It is still fairly close to that level, even after the financial crisis, when the program was hurt like every other area of the housing market. LIHTC production has rebounded from the crisis and has continued to perform very well placing properties in service. But not only does it place them in service, it keeps them in service. So, that is where you can really measure the efficiency of the program. One measure is the foreclosure rate, which is very low. Only about one to two percent of LIHTC properties enter foreclosure. That has become a real benefit of this program: properties remain in service and remain affordable to low-income families.
This comparison is difficult. The way this program works, tax credits are allocated for construction and rehabilitation and owners are then able to claim these credits over a period of 10 years. The affordability requirements require owners to maintain these restrictions for a minimum of 30 years. States, actually, often require affordability periods beyond the 30 years. This is different from some of HUD’s programs that provide monthly rental assistance directly to tenants, or provide operating subsidies over a longer period. So, the way that you would calculate the cost of the LIHTC program compared to HUD’s programs is not straightforward. There are not many cost studies that look at the whole life cycle of a cost to properties across programs.
The tax credit program allows developers and owners to opt out of the program after 15 years. We find that not many owners opt out. If they do, the state administering agency has the opportunity to find a buyer to maintain the rent and income restrictions. If the state agency is unable to find a buyer willing to maintain those restrictions and keep the property in the program, the owner of the property can opt out of the program and must maintain the restrictions for at least three years for the tenants that are currently in the property. Typically, once they opt out, they don’t remain affordable. There are not a lot of cases where the owners decide to opt out. The properties typically remain in the program for the full 30 years and sometimes longer due to agreements with the state.
Occasionally a property isn’t able to maintain the cash flow needed for maintenance and other types of expenses for which the owners have to pay. That appears to be the primary reason that they opt out. There could also be market conditions that prevent the owner from being able to rent out the apartments. Again, it would go back to the cash flow and not being able to have the money to maintain the property or avoid vacancy.
The program requires physical inspections to ensure that the units meet local building and safety codes. Properties that do not pass physical inspections may have their tax credits recaptured.
The future looks very bright for the program. There are no major changes being discussed. Over the last few years, there has been a lot of talk about tax reform. The current tax reform movement began with “let’s just clear the entire tax code.” So, the industry is a little bit worried that if Congress decides to enact major tax reform, they would eliminate all tax credits, including this program. That would obviously leave the affordable housing industry and the production of affordable housing units in a real bind and not provide enough funding to maintain today’s level. So, that would be the number one concern.
HUD doesn’t have much influence over this program, but by statute we are required to designate the Qualified Census Tracts and Difficult Development Areas. One change that HUD is making, and [has] announced over the past couple of years, is the change from designating difficult development areas at the metropolitan level, as metropolitan difficult development areas, so that entire metropolitan areas are either a DDA or they are not, to moving to designating [DDAs] by zip codes, which we call small DDAs (SDDAs). This change is intended to encourage the development in areas with potentially better opportunities regarding employment and education.
The primary change would distribute DDAs more broadly throughout the country. Rather than 35 to 40 entire metropolitan areas designated, small DDAs would designate several thousand ZIP codes across more than 200 metropolitan areas. This will encourage developers to locate affordable properties in areas of opportunity and, to some extent, offset the concern that the LIHTC program is encouraging development in low-income areas.