Low Income Housing Tax Credits (LIHTCs): Year 15 Exit StrategiesDecember 21, 2016
The Low Income Housing Tax Credit (LIHTC) program offers investors a break on federal income taxes. Learn how you can get involved and what happens after year 15.
Low Income Housing Tax Credits (LIHTCs) are the principal source of public funding for affordable rental housing development in the United States. In exchange for investment in affordable housing developments, investors can acquire a break on federal income taxes through the LIHTC program. To make certain these new units continue to be affordable, there are strict guidelines attached to the credits that keep projects affordable for a 15-year compliance period. What happens at the end of the compliance period, though?
The LIHTC program was established as part of the Tax Reform Act of 1986 and is commonly referred to as section 42, the applicable section of the Internal Revenue Code (IRC). LIHTCs are an indirect subsidy so rather than allocating government dollars straight to affordable housing developments, LIHTCs engage in the private market, ideally allowing affordable housing dollars to be more efficiently allocated.
- The credits are distributed to each state based on population and indexed to inflation.
- Developers receive the credits, based on a competitive application process; and then sell the credits to investors, usually in exchange for an ownership interest in the entity that owns the housing project.
- Investors in LIHTC, in exchange for the cash invested, claim tax credits on their federal income tax return for a ten year period.
- Since 1987, the LIHTC program has helped to create more than 1.6 million affordable units.
What is this ‘15 year compliance period’?
The project owners must agree to operate the property as affordable housing for fifteen years after the building is place in service.
The compliance period ends on December 31st of the 15th year of the tax credit period. How do you determine the tax credit period? Well, that is done on something called the “building-by-building basis”.
During this fifteen year span, owners of the LIHTC properties and their management agents must rent, at specified rent levels, to tenants meeting the eligibility requirements, including the income of the household. Each year the tenant remains in the low-income unit, a recertification must be performed to ensure the tenant continues to remain eligible. If the owners can’t support initial eligibility and annual recertification, this is noncompliance and puts the LIHTC owner at risk of losing its credit claim
What happens at the end of the 15 yr. compliance period?
Though the investor received the LIHTC credit for 10 years, during the 15-year compliance period, the investors also likely received tax benefits in the way of a pass-through of real estate losses, such as depreciation and interest expense where they were able to offset the losses against income taxes owed. Though some investors choose to exit the deal before the end of year 15, many will wait until after the 15-year compliance period. So how do investors exit a deal?
Possible Exit Strategies:
- The investor sells its interest to the remaining owner (General Partner or Managing Member) and the property continues to be operated as is (or converted to market rate rentals). The terms of the investor buy-out are generally outlined in the operating agreement.
- The entire property can be sold to an unrelated third party.
- The property can be sold to a nonprofit, typically an affiliate of the General Partner or Managing Member. The terms of this transaction, the Nonprofit Right of First Refusal, are generally outlined in the operating agreement.
- The property can be “recycled” as a new LIHTC property.
- The units can be converted to condos and sold to individuals
Questions on Low Income Housing Tax Credits or affordable housing? Contact us today.