Under current law, the biggest federal tax program designed to assist renters and promote affordable housing is on the supply side, but academics and policy experts say more is needed to match tenants with units in their budget.
This article, the second in a two-part series, explores both the existing tax regime for incentivizing the construction of affordable housing units as well as proposed policy options, including what a demand-side credit to assist low- and middle-income renters could look like. Previously, this series assessed the current housing and rental markets in a post-pandemic world and provided analysts’ perspectives on how to best address design flaws with the home mortgage interest deduction.
Low-Income Housing Tax Credit
Current Law. The Code Sec. 42 Low-Income Housing Tax Credit (LIHTC) is the federal government’s primary mechanism for incentivizing development of and investment in building new and rehabilitating existing affordable housing units. Generally, federal credits are allocated to state and local housing finance authorities, which award the credits to developers through a competitive application process.
In exchange for receiving credits that offset construction-related costs, the developers reserve some units with strict income limits to ensure low-cost rentals are available. The LIHTC can be claimed annually for 10 years after the units are placed in service, or sold to investors to receive equity for future projects. It is estimated that the yearly budget cost of the program is between $8 billion and $10 billion.
There are two LIHTCs: 1) a 9% credit that can be claimed when the LIHTC is the only applicable tax break or subsidy associated with the project; and 2) a 4% credit compatible with federal tax-exempt bond financing. Qualifying projects must satisfy one of several income-related tests and comply with it for 15 years. There is also a requirement for LIHTC units to remain affordable for a minimum 30 years.
The Department of Housing and Urban Development (HUD) designates certain locations as Difficult Development Areas (DDAs) or Qualified Census Tracts (QCTs) and determines area median income (AMI). Developments in DDAs or QCTs are eligible to receive additional LIHTCs.
According to the Tax Policy Center, “[f]rom 2000 through 2016, LIHTCs supported the construction or rehabilitation of an average of 115,000 affordable rental units each year. Since that point, annual production has dipped, averaging roughly two-thirds those levels.”
Challenges. A research paper by University of California, Irvine Assistant Clinical Professor Adam Cowing highlighted issues with what happens after the 15-year compliance window.
“Historically, because investors receive the credits in the ten years after a project is placed in service, and because the credits are no longer subject to recapture after the initial 15-year compliance period, investors have seen little need to oversee compliance after year fifteen,” wrote Cowing. “Therefore, investors have generally sought to exit the ownership of LIHTC projects at that point.”
Historically, the “vast majority” of LIHTC project ownership is transferred to developer partners after year 15, according to Cowing. These developer partners “generally have either a mission or business model that involves holding on to these properties and operating them, generating income from management fees, operating income, or refinancing,” he explained.
A recent trend, though, has been the emergence of so-called aggregators, disruptive investors who seek to “extract value from projects beyond the tax benefits the program is designed to provide.” This is achieved by “challenging the purchase rights held by nonprofits and other developers, in some instances to hold onto valuable property or perhaps to leverage a higher option price,” said Cowing. Further, aggregators can present a “qualified contract” to a state housing credit agency as an exception to the 30-year affordability requirement.
As explained by the National Council of State Housing Agencies, through the “qualified contract loophole” an owner can request a qualified contract, triggering a “one-year period during which the allocating agency seeks a qualified buyer to purchase the property and maintain it as affordable for the duration of the extended use period.” If a qualified buyer is not identified after that year, the property is released from the affordability requirement.
“This interruption of customary practice has increased uncertainty about the future of affordability at many LIHTC developments,” Cowing said. The expiration of the affordability guardrail “can jeopardize families’ ability to remain in their homes and afford the rent” when it is lifted, he continued. Aggregators tend to deploy this strategy “in appreciating markets where affordable housing is most needed.”
According to a 2018 research report by Corianne Payton Scally, Amanda Gold, and Nicole DuBois of the Urban Institute, the LIHTC by itself is not enough to “meet the needs of extremely low-income households, those earning 30 percent or less of AMI.” Moreso, because of the complexity and lengthy process with allocating and awarding the credits, “it frequently takes twice as long to put together a LIHTC-financed project than one that is market rate.”
Projects can also face other hurdles like “regulatory barriers” and pushback from communities, which can block or delay construction in areas where community approval is needed. Additionally, the Urban Institute researchers wrote that a “legacy of discrimination in public housing and in state and local regulations preventing affordable housing development continues in some places,” exacerbating racial segregation.
At the American Bar Association (ABA) annual meeting last August, the ABA House of Delegates adopted a resolution with its official position on the role of tax credits in addressing the “affordable housing crisis.” While the LIHTC has had success “by many measures,” the ABA noted the affordability levels are formula-based and not based on a renter’s income. “As a result, LIHTC units are often unaffordable to very low-income renters,” the resolution read.
Proposed changes. Part of President Biden’s fiscal year 2025 budget proposals include several revisions to the LIHTC. First, the annual housing credit dollar amount (HCDA) received by states would be increased to $4.37 per capita (up from $2.75 per capita in 2023) with a minimum $5,039,154 for “smaller” states. For 2023, the minimum for smaller states is $3,185,000. In 2026, these levels would again rise to $4.99 and $5,754,271, respectively. Subsequent years would be indexed for inflation.
Next, buildings would be eligible to earn the 4% rate if 25%, instead of 50%, of the building and land are financed by a private activity bond. Lastly, the qualified contract provision would be repealed.
The National Low Income Housing Coalition (NLIHC) put forth its own wish list of LIHTC enhancements in April 2023. Any expansion to the credit should include the following reforms, according to the NLIHC:
- Increase the LIHTC “basis boost” for developments with at least 20% of units for those with “extremely low incomes or those experiencing homelessness” from 30% to 50%
- Allow tribal and rural communities to qualify as DDAs.
“Indigenous people living on Tribal lands have some of the worst housing needs in the United States,” the NLIHC said. “They face high poverty rates and low incomes, overcrowding, lack of plumbing and heat, and unique development issues. Likewise, rural communities face unique barriers to developing affordable rental homes, including lower incomes, higher poverty rates, and lack of access to private capital.”
Synergy With Housing Vouchers
On March 7, 2023, the Senate Finance Committee held a hearing on the role of tax policy in upping the supply of affordable housing. One of the hearing’s expert witnesses, Cato Institute Senior Advisor Mark A. Calabria, testified there “is far too much complexity today in affordable housing development” and wished for any changes to the LIHTC to better coincide with non-tax subsidies.
Calabria said there is often overlap between LIHTC properties and other subsidies, such as housing vouchers, subsidized mortgage rates, and HUD’s HOME program, a federal block grant targeting low-income households. Streamlining subsidies, Calabria continued, “could reduce development costs somewhere between 2 and 10 percent, depending upon locality.” He expressed concern that non-LIHTC developments are not as subsidized because of “double-dipping” in LIHTC projects.
Because the median income of renters is about 60% of all median income in many places, “full income averaging would result in almost no actual targeting.” Calabria recommended the committee set a sub goal; for example, designating a specified percent of units for households with less than 30% of their area’s income. “The Committee may also want to consider capping the percent of units that can be occupied by households over 120 percent of area median income,” said Calabria.
Another witness at the hearing, Tax Foundation Senior Policy Analyst and Modeling Manager Garrett Watson, told the committee LIHTC projects are usually developed in “higher-poverty neighborhoods” where tenants cannot enjoy the “benefits of living in places with more opportunities and amenities. He said that as few as one-third of LIHTC subsidies “go to low-income households” while developers and investors get the rest.
Watson also cited a report from the Government Accountability Office (GAO) highlighting oversight issues with the credit’s administration. “Notably, GAO recommends that policymakers designate an agency to collect data to better understand project development costs,” he explained. “Such data would help inform future reform efforts, ensuring agencies impose limits on costs, root out fraud, and reform opaque and discretionary credit allocation processes.” Helpful data would include information related to developer and syndicator fees, and “outcomes for properties and tenants over time.”
Since there is so much overlap between the LIHTC and other federal assistance programs, it is “harder to evaluate the effectiveness of the credit compared to alternatives” like housing vouchers, Watson said.
Center on Budget and Policy Priorities (CBPP) Senior Director of Housing Policy Will Fischer also favors non-tax subsidies. Fischer told Checkpoint in an interview that the “most direct and straightforward way” to allocate federal resources to those with the lowest incomes “would be to extend” existing federal assistance programs.
Housing vouchers, he said, are “highly effective at reducing homelessness, overcrowding, [and] housing instability,” but “only reach about one-in-four eligible people because of funding limitations.” While there are myriad ideas on how to go about lowering costs on both the supply and demand sides, “the top priority should be to help people who have very low incomes and are on the margin between being able to afford housing at all,” Fischer said.
An attractive aspect of housing vouchers is they allow families to “start paying rent immediately,” he continued. With tax subsidies, “there’s questions of timing of delivery,” and while the Code has “become more flexible in doing that in different ways,” it is “still a big design question.”
Fischer clarified it is “important to have programs” like the LIHTC to address housing shortages and the credit has its role to play, but “itself alone … doesn’t generally make housing affordable to people with incomes around or below the poverty line.” Supplemental assistance like housing vouchers that “accompany” the LIHTC are important for those with the most urgent needs.
Even so, housing vouchers come with their own challenges. In a CBPP blog post in April, Fischer wrote that “too many people aren’t able to use their vouchers” since they expire after 60 days.
“One reason vouchers can be difficult to use is that many landlords refuse to participate in the program,” read the post. “Sometimes this is because of bias against people with low incomes or people of color (who make up more than two-thirds of voucher holders), and sometimes landlords don’t wish to comply with program requirements (for example, to hold a unit vacant until the housing agency conducts an inspection that is required before subsidies can begin).”
The Congressional Research Service (CRS) in a 2019 report said housing vouchers could possibly help alleviate cost effectiveness issues with the LIHTC by subsidizing renters’ incomes directly. “Individuals, in turn, are able to secure housing from currently available properties or ones that become available in response to the demand for housing at higher rents, which is a cheaper way to provide shelter than constructing new buildings,” according to the CRS.
Renter Tax Credit
Beyond the LIHTC and housing vouchers, an alternative route for assisting renters that has gained traction is the idea of a renter tax credit (RTC). No such benefit currently exists at the federal level, but several states have their own tax relief programs for tenants of varying scope, income thresholds, and eligibility requirements. The NLIHC developed an interactive database of all active state RTCs as well as other assistance programs, such as those that are project based. Some state RTCs are limited to certain groups, and others are based on property tax rates.
Connecticut’s Renters’ Rebate Program provides a credit worth up to $700 for single persons ($900 for married couples) but is restricted to the elderly, those with disabilities, and those making less than $43,800 ($53,400 for married couples). It is calculated using a percentage of rent paid, plus utilities.
California’s nonrefundable RTC, by comparison, is more broadly accessible but with a much lower, flat amount. California residents who paid rent in the state for at least half of the year and earn $50,746 or less ($101,492 or less for married couples) can claim the credit on their state income tax returns. However, the amount has been set at $60 ($120 for joint filers) since 1979.
Federal RTC proposals also vary in approach and mechanical function. RESULTS, which self-identifies as a non-partisan advocacy group, released a policy brief outlining its RTC proposal. At its core, the RTC should be fully refundable, RESULTS emphasized, like the Earned Income Tax Credit (EITC) and RTCs in states like Minnesota, New York, and Vermont.
RESULTS Associate Director of US Poverty Policy Michael Santos and primary author of the policy brief told Checkpoint in an interview that the RTC could be distributed in direct monthly installments similar to the advance Child Tax Credit (CTC) during the second-half of 2021. Santos is also the chair of the ABA Commission on Homelessness and Poverty and recently moderated an ABA webinar exploring federal RTC potential frameworks and issues.
While there is pushback against fully refundable credits in general, either because of costs or the belief that such a benefit would disincentivize work, the advance CTC showed that the IRS is capable of administering a monthly credit. A federal RTC would assist those already working, and advance payments would act as a “safe harbor” against sudden changes in their income, Santos said.
“One day you might lose a job or one day you might get paid well, so how do you actually address that?” he said. “At the end of the day, even gainfully employed people are unable to afford their rents. A full-time minimum wage worker cannot afford a two-bedroom apartment in any state in the US. That is a sad reality.”
The RESULTS brief offers that the credit could be based on rent and utility expenses paid. Those considered “rent-burdened,” meaning they pay more than 30% of their incomes on living expenses, would be entitled to an RTC equal amounts paid over that threshold. It uses the example of someone who earns $1,000 per month. To not be rent-burdened, they would need to not pay more than $300 in rent and utilities. If they pay $500, their monthly CTC would be $200.
Alternatively, the credit could be based on the Fair Market Rate or the Small Area Fair Market Rent. Either way, that 30% principle would mean the RTC would not only just capture taxpayers who receive other forms of housing assistance or other credits like the EITC, Santos explained. It would also reach middle-income households whose wages have not kept up with rising rents.
“I think it’s a common myth that a household might get evicted because of a job loss or inability to pay rent, but the reverse holds just as if not equally true, like [if] someone gets evicted despite them working,” he said. “They just don’t have enough money or funds to actually afford the rent that they currently pay.”
Santos cautioned that there is a balance in designing a tax policy like an RTC because its administrability “could get easily complicated” the “more equitable” it aims to be. He said $1,000 in San Francisco “is a lot different” than $1,000 in Montana. A flat amount or percentage based on income alone is “very simple” and “clear cut” but does not account for “geographical housing conditions,” said Santos. However, incorporating location-specific rent rates into the rules for a federal-level RTC could prove cumbersome.
“That’s an area that is definitely ripe for more research.”
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