- Understanding the basics
- How the amount of tax credits is computed
- Know your state’s priorities
- Simple steps to follow
- One developer’s success story
The low-income housing tax credit is a credit against regular federal income tax liability for investments in acquisition and rehabilitation or construction of qualified low-income rental housing. The credit was authorized by the Tax Reform Act of 1986. Many states, including New York and California, also have a state tax credit program.
Credits for eligible properties generally are taken annually over a 10-year period beginning with the tax year in which the project is placed in service or, at the owner’s election, the next tax year. The amount of credit is based on the qualified basis of the low-income buildings. Where a building is not fully rented by the end of the first tax credit year, full credit may not be available.
Eligible buildings must comply with a number of requirements regarding tenant income levels, gross rents and occupancy. Projects must be held for low-income use for a minimum of 30 years under federal law. Some states require low-income use for longer periods. The credit is allocated to states, which review applications and select projects to receive allocations according to considerations in the state’s tax credit allocation plan.
Understanding the basics
Federal law requires that:
- States provide the minimum amount of tax credit authority to make projects feasible and give priority to projects that serve the lowest-income households for the longest period of time.
- Projects claiming the tax credit must be rented to low-income tenants for a minimum of 30 years and longer in some states. The projects must meet either of the following requirements for low-income use:
- At least 20% of the residential rental units must be rent-restricted and occupied by individuals whose income is 50% or less of area median gross income, adjusted for family size; or
- At least 40% of the residential rental units must be rent-restricted and occupied by individuals whose income is 60% or less of area median gross income, adjusted for family size.
How the amount of tax credits is computed
The maximum amount of credits that may be taken for a project equals the applicable percentage multiplied by the qualified basis of each qualified low-income building. The amount is also limited to the amount allocated to the project by the credit allocating agency.
The applicable percentage is a percentage that will yield over the 10-year credit period a credit with a present value equal to:
- 30% of the qualified basis of a building for acquisitions of existing buildings and for new construction or rehabilitation projects that utilize federally subsidized financing (including tax-exempt bonds) on or certain other forms of federal assistance. This is the equivalent of 4% (approximately) annual credit over 10 years.
- 70% of the qualified basis of a building for newly constructed buildings and rehabilitation that does not use certain forms of federal aid. This is the equivalent of 9% (approximately) annual credit taken over 10 years.
Know your state’s priorities
Tax credit allocation priorities vary from state to state, so there is no formula for winning credits that will work in every state. The single most important way to improve your project’s chances of winning credits is to know the allocation priorities in your state thoroughly and do all you can to meet every single one of them.
However, there are certain common elements that are required by federal law to be in every state’s Qualified Allocation Plan. At a minimum, states must give priority to projects that serve the lowest income tenants for the longest period of time. Each state must also set aside at least 10% of available credits for projects sponsored by qualified nonprofit organizations. As of 2001, under a new requirement, they must also give priority to projects that contribute to a local community revitalization plan.
Allocation plans are tailored to each state’s needs, and many states create larger set-asides for nonprofit sponsors. Some give most or all of their credits to nonprofit groups.
Many states also set aside credits for rural, urban or distressed areas. Other popular set-asides are for specific project types, like small projects and housing for special needs populations such as elderly and handicapped tenants.
Within each set-aside category, projects are selected according to criteria or preferences set forth in each state’s allocation plan. States often use a point system to rank projects based on each item. Projects must earn a minimum number of points to qualify for a credit allocation. Projects with the highest ranking are selected to receive allocations.
But even if you adhere to every priority in a state’s allocation plan, you could still come up empty if you are not careful to follow the application requirements in your state to the letter. If you’re building in one of the many states that is taking a hard-line approach to the application process, an incomplete or undocumented application could bring fast rejection of your application with no chance to correct it.
Simple steps to follow
The good news is that there are a number of simple steps you can take to a better application. The following suggestions were culled from Affordable Housing Finance magazine’s comprehensive survey for state allocating agencies’ tax credit programs.
- Start early. By getting a head start on your application, you’ll not only reduce the risk of making careless errors in the eleventh hour but also be able to submit a project that is ready to proceed with construction, which many states, including Alabama, Arizona, Michigan and Vermont, are weighing heavily in their scoring criteria.
- Read carefully. Since most states revise their allocation plan every year, and changes from year to year can be quite substantial, reading the current QAP should be your first step. As simple as it seems, many tax credit administrators complain that applicants do not seem to read the current qualified allocation plan before applying.
- Obtain community support. More and more state HFAs are seriously considering community backing in their allocation decisions. Letters of community support are becoming as indispensable as financial comparables in the application package. In many states, local official notification is a threshold requirement.
- Hire an application consultant. While developers can get by without calling on a third party to help with the application process, a consultant’s advice can be invaluable, particularly to a newcomer. Application consultants may deal with hundreds of applications a year, giving them a broad perspective on the competition that even a seasoned developer can benefit from.
- Be realistic. The “check the boxes” mentality-–developing an application around maximum scoring alone–-is strongly discouraged by tax credit staff. This applies to financial as well as market feasibility. States are not fooled by applications where the numbers work on paper but long-term financial viability is questionable, and you are only hurting yourself by scraping by on a thin financial margin in order to maximize scoring.
- Take advantage of free training, workshops and other services. Virtually every state HFA now holds application workshops throughout the year. Even tax credit pros are encouraged to attend such seminars, since they need to keep up on the latest changes in the tax credit allocation plan and application.
- Streamline the process. Use online resources and computerized applications and scoring to streamline the application process. HFAs have entered the electronic age with easy-to-use applications on disk that will even estimate your ranking before you submit your application, which can save time and eliminate errors. Most states HFA Web sites allow developers to download program guidelines, lists of deadlines and more.
- Submit a complete application with needed documentation. While this seems self-evident, in a survey of 21 tax credit administrators, 18 said that “incomplete applications” was the number one error that applicants made. Develop a checklist of documents required by the HFA and go over it several times before mailing your application. Many states will dock points from a tax credit application for failing to provide sufficient documentation.
- Triple-check calculations. “Math errors” were sited by tax credit administrators as the second most common application pitfall. Application reviewers may not recognize a simple mathematical mistake or misplaced number and your project’s score may suffer as a result.
- Make a review appointment. Sign up with the state tax credit staff to review your application. Staff can provide suggestions on improving your application before submission. Florida, Illinois and many other state allocation agencies encourage one-on-one conferences with the staff; others offer technical support via phone, fax and e-mail.
One developer’s success story
For one developer who has been extremely successful at winning tax credit allocations year after year, self-scoring an application before it has been submitted to the state allocating agency isn’t a mere formality. It’s a key part of the developer's strategy for maintaining its competitiveness as credits become harder to get.
Rating an application against a state’s selection criteria and modifying the project as needed helps to ensure that the project matches the state’s priorities in the allocation plan, said Jeff Voorhees, president of Voorhees Development Group in Des Moines, Iowa.
Making modifications doesn’t mean applications are submitted just for points. His firm targets applications to states where the allocating agencies’ priorities match well with his plans.
In addition, states generally leave room in their selection criteria to enable a developer to focus on some criteria while downplaying others.
In states that tightly adhere to their point-based scoring system, accurately self-scoring an application will give the applicant a good idea before awards are announced how well the project will score, he said. That’s the case in Arizona.
Coming into the application process with strong local support is also key. His firm won’t develop where the local government doesn’t’ back the plan. “We have no interest to go where we have to fight a battle,” he said.
Where the support is strong, his firm in some cases will help the local government and even local businesses write letters of support for the project, which are included in the application package.