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More DetailsEditor's Note: This article, in a slightly different form, was originally prepared for the Quarter Notes newsletter of Neighborhood Reinvestment Corporation. We appreciate their permission to reprint it. What are Low Income Housing Tax Credits (LIHTC)? If you do your own taxes, maybe you know a tax deduction is a reduction in the income that is taxed by the federal government, for example, a charitable contribution. A tax credit is a direct reduction in the actual amount of taxes that you owe, like child care credit. Therefore, a tax credit is more valuable than a tax deduction, since a $1.00 tax deduction is worth only what your tax rate is, for example, 28%, but a $1.00 tax credit is worth that whole dollar. A Low Income Housing Tax Credit is a tax credit for taxpayers who invest in low income housing. Who gets them? Mostly they are sold to corporate taxpayers like banks, insurance companies, and oil companies. They will pay cash to receive the low income housing tax credit, which they use to reduce the amount of taxes they owe the federal government. Pools of individual investors exist as well and they buy tax credits to lower their tax bills. How does the LIHTC help build affordable housing? Most taxpayers who would take the credit don’t know anything about building affordable housing, much less how to invest in viable projects. Many organizations that know a lot about affordable housing don’t pay taxes — they are nonprofit corporations. The federal government set up a system to notify each state of a budgeted amount of federal tax credits through state housing agencies (the government has to budget for tax credits like it budgets for guaranteed student loans — its an expense, revenue that it will not be getting). The state agencies take that allocation and divide it among affordable housing developers through a competitive process, usually called tax credit allocation rounds. Once a nonprofit has been awarded an allocation to build its low income project, it takes that tax credit and sells it to investors for some amount of money. For example, a non-profit receives $500,000 of tax credits which it can’t use because it doesn’t pay taxes, but it was awarded because it plans to build a beautiful affordable housing development that complies with federal rules and regulations (and there are lots). The non-profit takes that award and sells it to Anystate Insurance, who can use those tax credits against their tax bills. Two notes: 1) the total tax credits are taken over ten years, not one; and 2) the investor will usually pay about 50 - 60% of the total tax credit. Anyway, the non-profit takes the cash that it received from the insurance company, in this case $300,000, and uses it towards building the affordable housing project. Who owns the project? Good question. I’m glad I asked. These parties go into business together as a limited partnership. A partnership is a legal relationship between the nonprofit sponsor (the "general" partner) and the nonprofit investor (the "limited" partner). If two such different partners own the property, how do things get done? A partnership agreement is a document that governs the functions of the partnership, including property oversight (if you’ve used tax credits, your office should have a copy available). The nonprofit is motivated by its mission to provide neighborhood-based, resident-managed housing to the community. In the partnership agreement, the nonprofit is given management responsibilities, in light of their mission, but primarily to act in accordance with LIHTC rules and regulations (namely that residents are low income). The nonprofit designs and builds the project, and makes the day-to-day decisions without input from the investor (that's why the investor is a "limited" partner). The nonprofit does agree to provide periodic reports to the investors. The private investor is motivated financially. In the partnership agreement, the investor agrees to be responsible for filing appropriate tax documents evidencing compliance with the IRS in order to receive the credit. Because their risk is greatest (including repayment of the credits and massive penalties), the private investors reserve the right to intervene in the management of the property if the tax credit obligations are not upheld. This includes the right to pick a different nonprofit sponsor. Partnerships rarely dissolve — usually parties work it all out (it creates quite an effective system of checks and balances, though). The LIHTC legislation only allows investors to take tax credits for ten years. The legislation, enacted in 1986, isn’t even that old yet, so no tax credit project has actually closed out. So what happens after ten years? Although the tax credits are only good to the investors for ten years, IRS requires that the project remain affordable for fifteen years. Therefore, the investor will want to stay in the partnership to ensure compliance with affordability regulations through year 15 to avoid penalties. At the end of this fifteen-year period, the nonprofit is most interested in owning the property outright. The investors want to find investment options elsewhere. Most often, at the end of the compliance period, the property is sold to the nonprofit. The nonprofit either borrows money to pay for the property or assumes the outstanding debt from the partnership. This process begins around years 12 or 13. Is the nonprofit buying something it already owns? It’s like buying out the other half of a business from your partner, debt and all. When the tax credits expire, the property becomes a straight rental project owned by a limited partnership. How are the terms of a sale set fifteen years in advance? To put themselves in the best position, most nonprofits require an option to buy the property at the end of the tax credit period up front as part of the investment deal. Investors agree to this in the very beginning when they purchase the tax credits. The sale terms are included in the partnership agreement. In Massachusetts, the sale price is often arranged to make it as easy as possible for the non-profit to purchase the development. The partnership uses sales proceeds to pay off outstanding debt, if any, and dissolves the partnership. Although the terms are outlined in the beginning, there remains a bit of haggling at the end. Will the price be affordable to the nonprofit? It is impossible to predict with certainty fifteen years into the future. Even with very favorable pricing, the nonprofit may still have to borrow more money with which to purchase the property. There are things that the nonfprofit can do in advance to protect itself at the end, including long- term affordability restrictions, below-market loans and land leases. Experience with these strategies are all hypothetical so far. The tax credits expire in year ten, yet the legislation is only nine years old. We will have to wait to find out! Editor's Note: Tax credits limit resident control and make it more difficult, but the 2 can be combined. For resident-controlled projects, there are two ways the co-op or other resident-organization can participate in operating a tax-credit development. In some cases, the resident organization is one of the partners in the partnership. Typically, after the development is up and running, the resident organization takes over the role of "Managing Partner" from the non-profit sponsor. See the accompanying articles in this issue for opinions on whether this option is consistent with the Internal Revenue Code. In other cases, the resident organization leases the entire development from the partnership. In both cases, but especially the second, the resident organization has less autonomy than it would if it owned the development without the benefit of a partnership. |
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