Low-Income Housing Tax Credit

Program Overview

The Low-Income Housing Tax Credit (LIHTC) is a federal tax credit administered by the Internal Revenue Service under Section 42 of the Internal Revenue Code. The program incentivizes private investment in affordable rental housing by allowing investors to claim a credit against federal income tax liability in exchange for equity contributions to qualifying projects.

LIHTC is the engine behind nearly every affordable housing transaction in the United States. The vast majority of new affordable rental construction in the country uses LIHTC in some form. The program operates through state housing finance agencies (HFAs), which allocate credits annually under federal per-capita formulas and award them to specific projects through a competitive process governed by each state's Qualified Allocation Plan (QAP).

Program History

LIHTC was created by the Tax Reform Act of 1986 as a replacement for prior accelerated depreciation deductions for low-income housing. It was originally enacted as a temporary program but has been reauthorized and modified continuously since 1986 and was made permanent in 1993.

How LIHTC Works

LIHTC provides a dollar-for-dollar reduction in federal tax liability spread over 10 years. The credit amount is calculated by applying the credit rate (9% or 4%) to the project's eligible basis — broadly, the depreciable basis of the building — adjusted for the qualified portion of low-income units. The annual credit equals the rate times eligible basis times the applicable fraction (low-income units as a percentage of total units).

9% vs 4% Credits

The most important structural distinction in LIHTC is between the 9% credit (competitive, larger, no bond requirement) and the 4% credit (non-competitive, smaller, requires tax-exempt bond financing). The two credits serve different deal profiles and capital stack strategies.

QAP & Allocation Process

Every state housing finance agency publishes a Qualified Allocation Plan (QAP) annually. The QAP is the rulebook for how 9% credits will be awarded that year. It establishes scoring criteria, threshold requirements, set-asides for specific populations or geographies, cost containment limits, and the application schedule.

Reading a QAP carefully is the single most important pre-application task in a 9% deal. The QAP determines which projects score competitively, which set-asides apply, and what cost and basis limitations the project must satisfy.

Common QAP Scoring Categories

• Cost containment — per-unit cost limits, total development cost caps, efficiency benchmarks
• Location — opportunity area scoring, transit access, school quality, environmental factors
• Income targeting — deeper affordability (50%, 30%, 20% AMI units) scores higher than 60% AMI baseline
• Special populations — veterans, seniors, persons with disabilities, supportive housing set-asides
• Readiness — site control, zoning, environmental clearance, construction documents
• Sustainability — green building certifications, energy efficiency, renewable energy
• Preservation — expiring use restrictions, existing affordable stock
• Developer experience — track record, capacity, financial strength
• Nonprofit set-aside — minimum 10% federal requirement, some states use higher set-asides

Minimum Set-Aside Election

Every LIHTC project must elect one of three minimum set-aside options at the time of allocation:

• 20/50 election — at least 20% of units at or below 50% AMI
• 40/60 election — at least 40% of units at or below 60% AMI (most common)
• Income averaging — units average 60% AMI or below, with individual units between 20% and 80% AMI (added 2018)

The election is irrevocable. Most projects elect 40/60, but income averaging has become increasingly popular for mixed-income projects.

Syndication & Equity Pricing

Developers rarely have sufficient tax liability to claim LIHTC credits themselves. Instead, credits are sold to a tax credit investor — typically a corporation with significant federal tax liability — in exchange for equity. The transaction is structured as a partnership in which the developer (general partner) holds 0.01% of the partnership and the investor (limited partner) holds 99.99%.

The price paid for each $1 of credit is the equity pricing. Pricing varies based on market conditions, project quality, geography, and investor demand. Strong markets historically see pricing of $0.85 to $0.95 per credit dollar. Weaker periods see $0.70 to $0.85. Higher pricing means more equity proceeds to the project.

Compliance & Recapture

LIHTC compliance is rigorous and ongoing. The initial compliance period is 15 years, during which all low-income units must remain rent-restricted and income-qualified. State-level extended use agreements typically push total affordability to 30 years or longer.

Key Compliance Requirements

• Income certification — tenant household income must be certified at move-in and recertified annually (with some exceptions under the 2008 Housing Act)
• Rent restriction — rents capped at 30% of the applicable AMI level for the unit's set-aside
• Annual reporting — state HFA reporting on occupancy, rents, income certifications
• Available unit rule — complex rules governing when over-income tenants can remain in qualifying units
• Vacant unit rule — vacant units must be filled with income-qualified households
• Next available unit rule — specific rules for backfilling units in mixed-income properties

Recapture

If a project fails compliance during the 15-year period, the IRS can recapture previously claimed credits plus interest. Recapture is the single biggest risk that disciplines compliance behavior. Year 1-10 noncompliance triggers full recapture of all credits claimed; years 11-15 trigger pro-rata recapture.

Bonds — surety bonds or letters of credit — can be posted in some circumstances to mitigate recapture risk, though this is uncommon in modern deals.

2026 Landscape

The 2025 OBBBA changes have fundamentally reshaped LIHTC deal flow heading into 2026. Several trends are visible:

• 4% deal surge — The reduction of the bond threshold from 50% to 25% has accelerated 4% deal activity dramatically. Projects that were previously uneconomic at the 50% threshold now pencil at 25%.
• State QAP updates — All 50 states are updating QAPs to reflect the new 4% rules, the 12% per-capita increase, and related allocation mechanics. QAP timing has shifted in several states.
• Equity pricing strength — The permanent enhancements have improved investor confidence and supported pricing in most markets. Bank investors are deploying capital aggressively in 2026.
• Bond cap pressure — The expanded 4% eligibility has increased pressure on state private activity bond caps. Some states are running low on volume cap in their first half of the year.
• Preservation activity — The 4% changes have triggered a wave of LIHTC preservation deals, particularly for expiring 1990s-era 9% deals approaching year 30.
• Supply chain stability — Construction cost inflation has moderated compared to 2022-2024 highs, supporting better deal economics across the board.

4% vs 9% Bond Compliance Mechanics

One often-overlooked structural difference between 4% and 9% deals is the tax-exempt bond compliance regime that 4% deals must navigate but 9% deals do not. Because 4% deals require PAB financing to qualify for credits, they inherit a separate set of bond-specific compliance requirements that operate alongside the LIHTC compliance regime.

Bond-Specific Requirements in 4% Deals

• Arbitrage and rebate — IRS rules limit how much earnings bond proceeds can generate above the bond yield. Excess earnings must be rebated to the federal government. Tracked and reported on Form 8038-T.
• Bond covenants — Bond documents typically include affirmative and negative covenants governing project operations, reporting, and reserves that go beyond LIHTC compliance.
• Use of proceeds restrictions — At least 95% of bond proceeds must be spent on qualified residential rental project costs, with strict tracking and certifications.
• Set-aside elections at the bond level — PAB-financed projects must elect either the 20/50 or 40/60 minimum set-aside at bond issuance, which may differ from the LIHTC set-aside election.
• Final allocation timing — 4% credits are calculated based on actual placed-in-service basis and bond proceeds, requiring final allocation paperwork from the HFA that closes the bond compliance loop.
• Refunding bonds — Reissuing or refunding bonds during the 15-year compliance period triggers complex bond and LIHTC analysis, particularly under the new 25% test where post-2025 PAB issuance dates matter.

9% deals avoid all of this because they do not use tax-exempt bond financing. The 9% deal compliance burden is significant but confined to the LIHTC regime — income certification, rent restriction, available unit rule, and the standard annual reporting cycle. The 4% deal has all of that plus a parallel bond compliance regime.

LIHTC Deal Structures

LIHTC deals can be structured in numerous ways depending on whether 9% or 4% credits apply, what other subsidies are layered, what the developer's tax position requires, and how the syndicator structures the partnership. A dedicated guide covers every common LIHTC deal structure used in practice.

Related Programs

LIHTC is rarely the only subsidy in a deal. Below are the programs most commonly layered with LIHTC in affordable housing transactions — each has its own dedicated guide.