Investing in affordable housing or developing an affordable housing property can be daunting. There are many types of tax credits that you may be able to benefit from, depending on the type of property, its location, and several other factors. We have compiled a guide to introduce each type of tax credit that might apply to your project, including how they overlap and what restrictions they have.
The New Markets Tax Credit (NMTC)
What it is: The New Markets Tax Credit was introduced and authorized in the Community Renewal Tax Relief Act of 2000 as a way to stimulate investment and growth in low-income urban neighborhoods and rural communities that lacked access to capital needed to support and grow businesses.
The NMTC attracts capital to these communities by providing private investors with a federal tax credit for qualified investments made in projects in underserved and rural areas. This credit is currently set to expire on December 31, 2020, but there are talks to extend the NMTC indefinitely. It was also set to expire in 2019, but it was extended for one year at that time.
Investors receive a 39% tax credit of the equity they invest, and the tax credit is taken over a seven-year period.
Situations it applies to: The New Markets Tax Credit is largely used in situations where there is a gap in available financing. It allows investment to flow to areas that aren’t heavily served by conventional lenders and investors.
Restrictions: The NMTC structure is complicated. The process begins with the Community Development Financial Institutions Fund (CDFI) within the Department of Treasury.
A tax credit investor needs to invest in a Community Development Entity (CDE). A CDE must be a domestic corporation that has demonstrated a mission of serving or providing capital to low-income communities or people. The CDE applies to the CDFI fund for NMTC allocation. In turn, the CDE must use “substantially all” of the equity investment from the tax credit investor to finance community and business projects.
Another restriction is that NMTCs cannot be used 100% on multifamily properties; there must be at least a 20% commercial property component, which is based on revenue and not square footage. In addition, ownership changes or transferring of the property can result in recapture of the credits (which means the credits must be repaid to the government) if these events occur within the seven-year period.
NMTC in action: The Boys and Girls Clubs of Manatee County was operating out of a building that was more than 50 years old. The facility was no longer meeting the needs of the kids in the community, who depended on it for after-school care, tutoring, and mentoring services, so the organization started a campaign for donor support. They raised $6 million, but it became clear that the project was likely to cost closer to $11 million. Learn how the NMTC helped them bridge that funding gap and break ground on a new facility.
To learn more about New Markets Tax Credits, click here.
The Low-Income Housing Tax Credit (LIHTC)
What it is: The Low-Income Housing Tax Credit program was introduced and authorized in the 1986 Tax Reform Act and is the largest source of funding for new affordable housing in the United States.
The LIHTC program has been modified numerous times throughout the years and was made a permanent part of the Internal Revenue Code in 1993. The Low-Income Housing Tax Credit has two components: A 9% credit that subsidizes 70% of new construction and cannot be combined with additional federal subsidies, and a 4% credit that subsidizes 30% of unit costs in a project acquisition and can be used with other federal subsidies. The Low-Income Housing Tax Credit provides investors a dollar-for-dollar tax credit to use against their federal tax liability over a 10-year period.
Situations it applies to: It applies to acquisition, construction, and rehabilitation of affordable housing for low- and moderate-income tenants. Many types of rental properties are eligible, such as apartment buildings, single family homes, townhouses, and duplexes.
Restrictions: To receive the credit, the project needs to help tenants of a certain income level, while meeting requirements that pertain to the gross rental rate. The credit awarded is based on how well the property qualifies. Properties must comply with investment regulations for 15 years and meet affordable rent requirements for at least 30 years. Also, property owners must continuously monitor compliance with these tests, and if a property fails to comply, the investors can lose the tax credits and thus their tax benefit.
How does it apply to mixed-use developments? A mixed-use development combines the housing needs and commercial needs of a community into one project. This becomes difficult in terms of the LIHTC since this type of credit cannot be claimed based on commercial property. In these deals, a multiple ownership structure needs to be established in order for the residential portion of the project to be able to claim the LIHTC.
LIHTC in action: Tampa-based affordable housing developer Blue Sky Communities broke ground in September 2020 on a new 65-unit affordable housing community in St. Petersburg’s Skyway Marina District. Read more about Skyway Lofts.
To learn more about LIHTC, click here.
Historic Tax Credits
What it is: The Federal Historic Rehabilitation Tax Credit was first introduced in the form of a tax deduction in 1976. The tax deduction was then converted into a federal tax credit within the Revenue Act of 1978. The intent of the credit was to promote financing for rehabilitation of historic buildings. The program is one of the nation’s most successful and cost-effective community revitalization programs.
The National Trust for Historic Preservation says: “In addition to preserving historic buildings, the HTC revitalizes communities and spurs economic growth—all while returning more to the Treasury than it costs, $1.20 in tax revenue for every dollar invested. It is a critical ingredient for historic preservation building stronger communities.”
The Tax Cuts and Jobs Act (TCJA) passed in December 2017 modified the HTC program. In September 2020, the IRS issued final regulations on the changes made to the HTC program under the TCJA. This guidance describes the HTC as a dollar-for-dollar credit to use against the investor’s federal tax liability over a five-year period for qualified rehabilitation expenses. This tax credit is equivalent to 20% of qualified rehabilitation expenses.
Situations it applies to: The historic tax credit applies when a historic structure will be used for a business or other-income producing purpose, such as a residential rental property, and a substantial amount is spent to rehabilitate the historic structure.
The rehabilitation of historic properties has become a driving force of community revitalization across the country. There may also be state and local historic tax credits and grant programs available in your area, so it’s important to work with a CPA who is an expert in such tax credits and can advise about specific incentives in your area.
Restrictions: The building must be a certified historic structure, and the credit is based on a percentage of the qualified rehabilitation expenditures. Also, during the rehabilitation process, the historic structure must be preserved according to specific rules, such as replacing adobe windows with adobe windows. In addition, ownership changes or transferring of the property can result in recapture of the credits (the credits needing to be paid back to the government) if such events happen with the five-year recapture period.
HTC in action: An early 20th Century office building in Kansas City became 134 affordable apartments, thanks in part to an HTC. See more examples of HTC renovations here.
To learn more about HTCs, click here.
The Renewable Energy Tax Credit
What it is: The goal of the Renewable Energy Tax Credit program is to encourage the development of renewable energy. This program created favorable tax credits and depreciation provisions within the Internal Revenue Code. The program consists of two business credits: The Investment Tax Credit (ITC) and the Production Tax Credit (PTC).
Situations it applies to: The ITC relates to expenses invested in renewable energy, such as solar property. The PTC is used mostly for investments in energy producing facilities, such as wind developments.
Restrictions: The ITC credit reduces the federal income taxes owed by the owner of a project where there has been a substantial investment in renewable energy equipment. This might include solar panels added to the roof of a building or geothermal heat pumps installed for cooling and heating.
The credit is equal to 26% of the renewable energy property costs if placed in service by December 31, 2020. The credit then begins to phase down through 2021, then remains at 10% starting in 2022. The credit is earned the date the project is placed in service. The investor is subject to a five-year credit recapture period if the energy property is taken out of service.
The PTC credit reduces the federal income taxes owed by the owners of a renewable energy facility, and the credit is based on the total amount of electricity produced. PTCs begin when a project is placed in service and are earned annually over 10 years.
RETCs in action: In Bradenton, Florida, a senior living facility called Grand Palms was designed as an energy-efficient building. The project comprises 72 residences and features many “green” upgrades. Completed in 2018, the complex was built by the NDC Construction Company and, on average, is 30 percent more efficient than what is required by the Florida Code.
For more on RETCs, click here.
Can you stack NMTC, LIHTC, HTC, RETC?
With all these tax credits available, it can be a puzzle to figure out whether and how they all fit together. Your CPA will be able to take a broad view of the entire tax credit landscape and advise you on which tax credits might be the most beneficial and how they may work together.
- If the ownership structure is set up correctly, the New Market Tax Credit can be stacked with the historic tax credit. The NMTC cannot be directly mixed with the Low-Income Housing Tax Credit, since NMTC financing cannot be used for residential rental properties.
- To stack the NMTC with the Low-Income Housing Tax Credit in the same project, a condominium structure must be created that legally separates the commercial and multifamily parts of the building into two different ownership entities.
- LIHTCs and HTCs can be stacked, but since the calculation of the eligible basis for the LIHTC differs significantly from the calculation of the qualified rehabilitation expenses for the HTC, extra attention should be taken to differentiate the two.
- On the surface, Renewable Energy Tax Credits, specifically Investment Tax Credits, and HTCs have similar criteria and thus are easy to stack together, but due to HTCs requiring that the historic character of the building to be maintained, it may be challenging to install the equipment required by the ITC.
- HTCs and LIHTCs are regularly stacked, as well as NMTCs and HTCs. Stacking each of these credits with historic credits helps communities take old, abandoned buildings and reinvent them into businesses and housing that benefit the community. Also, adding a LIHTC to an HTC project will usually increase the amount of investor equity available for the project.
With any of these credits, it is best to consult your tax advisor to make sure that the federal tax credit you’re looking into will benefit your project, your finances, and your community in the long run.
Each tax credit program has its own complex set of rules and guidance on exactly how it can be used and stacked. Accountants who specialize in helping developers, owners, and investors with affordable housing properties can help with every step of the process. If you have more questions about tax credits for affordable housing, reach out to Spoor Bunch Franz at info@sbfcpa.com.