Managing Sites Financed by Both Tax-Exempt Bonds and Tax Credits
The owner of a tax credit site you manage may tell you that the site also participates in the tax-exempt bond program. But you might not be entirely sure as to what this means and what compliance issues to be mindful of when management participates in the bond program.
There are two federal tools or federal financing incentives associated with the tax code that enable owners or developers to produce affordable rental housing for low-income people. One tool uses a tax-exempt bond. States and local governments often finance public projects such as roads and schools through the issuance of a tax-exempt bond. It’s considered tax-exempt because the purchasers of these bonds don’t have to pay federal taxes on interest payments received. Because of the tax savings, the interest paid by the owner will be less for tax-exempt bonds than for non-tax-exempt bonds or conventional loans.
Under Section 142(d) of the Internal Revenue Code, to promote certain private activities that are deemed to benefit the public, each state is authorized to issue a set amount of private activity “volume cap” tax-exempt bonds. These volume cap bonds can be allocated to finance affordable housing projects. For 2015, the amount of the volume cap for each state is the greater of $100 per capita or $301,515,000.
The Housing Tax Credit is a credit or reduction in tax liability each year for 10 years for owners and investors in affordable-income rental housing that’s based on the costs of development and the number of qualified affordable-income units. By providing a credit against federal tax liability or a dollar-for-dollar reduction in the amount of liability, the housing tax credit is an incentive for individuals and corporations to invest in the construction or rehabilitation of affordable housing for low-income families. The tax credit is used as a cash down payment (or equity) for the development, and as long as there are no significant compliance violations, the tax credits don’t have a repayment.
The tax credit and bond programs were created under the Tax Reform Act of 1986 to provide incentives for private investment and development of affordable/work force housing for low- to moderate-income individuals and families to help relieve the financial burden of public housing on the federal budget. The tax credit and bond programs provide financial assistance for a wide range of development including new construction, substantial rehabilitation, and the acquisition and rehabilitation of properties. The tax credit program is much like a cash down payment, and the bond program provides a lower interest rate on the mortgage on the development. These programs allow the construction of high-quality, decent affordable housing.
4 Percent Credits and 9 Percent Credits
Depending on how a site is financed, each LIHTC site will either fall in the 9 percent credit category or the 4 percent category. The so-called 9 percent credit is generally reserved for new construction or the cost of rehabilitation. Each year for 10 years a tax credit equal to roughly 9 percent of a project’s qualified basis (cost of construction of the low-income units) may be claimed. The applicable credit rate is not actually 9 percent. Instead, the specific rate that a project will receive is set so that the present value of the 10-year stream of credits equals 70 percent of a project’s qualified basis. The formula used to ensure the 70 percent subsidy is achieved depends in part on current market interest rates that fluctuate over time. These fluctuations have also caused the LIHTC rate to change over time.
Also, there’s a limited amount of 9 percent tax credits made available to the state housing agencies each year as defined in the Internal Revenue Code. Due to the limited amount, the credits are competitive and the state agency allocates a portion of the credit pool for owners with the best applications.
Four percent credits are available for the cost of acquiring an existing building and for projects financed with tax-exempt bonds, says tax credit expert A.J. Johnson. Sites that are financed with tax-exempt bonds are eligible for 4 percent tax credits only. Like the 9 percent credit, the 4 percent credit is claimed annually over a 10-year credit period. The actual credit rate fluctuates around 4 percent, but is set by the Treasury to deliver a subsidy equal to 30 percent of a project’s qualified basis in present value terms. There is no pool for the 4 percent as there is for the 9 percent credits. To get 4 percent tax credits for new construction or rehabilitation costs, an owner must first apply for an allocation of private activity bonds, which if received, leads to a non-competitive application process for the 4 percent tax credits.
The Housing and Economic Recovery Act of 2008 (HERA) temporarily changed the credit rate formula used for new construction. The act effectively placed a floor equal to 9 percent on the new construction tax credit rate. The 9 percent credit rate floor applies only to new construction placed in service before Dec. 31, 2013. The 4 percent credit remained unaltered. And recently, President Obama signed the Tax Increase Prevention Act of 2014 that included, among other provisions, an extension of the 9 percent floor for LIHTC allocations made before Jan. 1, 2015. The floor had expired on Dec. 31, 2013, with the American Taxpayer Relief Act of 2012.
Editor’s Note: Bills were introduced in both houses of Congress earlier this year that would create a permanent 9 percent minimum LIHTC rate for non-tax-exempt bond-financed new buildings or substantially rehabilitated buildings, and a permanent 4 percent minimum rate for acquisition credits. The new floors would apply to buildings placed in service after Dec. 31, 2014. The Senate bill is S. 1193, and the House bill is H.R. 1142.
Program Differences Between LIHTC and Tax-Exempt Bonds
Many sites receive both tax-exempt bond financing and low-income housing tax credits. These sites are, therefore, subject to at least two regulatory agreements with different requirements. Be sure to obtain a copy of all regulatory agreements that may apply to your site.
For compliance purposes, sites are judged by the most restrictive requirements of the applicable programs. It’s important for owners and managers to remember that while there are important similarities between LIHTC and the tax-exempt bond program, there are also differences. We’ll highlight any compliance differences and point out instances where they may be the same.
Minimum set-aside. The owner must select one of the following federal minimum low-income set-asides in its regulatory agreement: (1) at least 40 percent of the units at a property are rented to households earning 60 percent or less of the area median gross income (AMGI); or (2) at least 20 percent of the units at a property are rented to households earning 50 percent or less of the AMGI. In New York City, the 40/60 test is replaced by a 25/60 test.
It’s important to note that while property owners select the minimum set-aside for LIHTC purposes, the bond-issuing agency makes the selection for bond purposes, says Johnson. If your bond issuer chose the 20-50 election in the site’s bond regulatory agreement, you must ensure that at least 20 percent of all households at the site are income-qualified. This is the case even if the owner selects the 40/60 minimum set-aside for LIHTC purposes. In both cases, the minimum set-aside is always a project election, although for bond purposes, all buildings financed by the bonds are considered a project, explains Johnson. For LIHTC purposes, a project could be one building or multiple buildings.
Time for meeting the minimum set-aside. As long as all low-income units are leased prior to the end of the first year credits are claimed, the owner of a LIHTC project may choose to rent market units before renting any low-income units during lease up, says Johnson. However, once 10 percent of units are leased in a property with tax-exempt bonds, the minimum set-aside must be met. For example, once 10 units in a 100-unit bond property with a 40/60 minimum set-aside are leased, at least four of the units would have to be low income, and that ratio must be maintained throughout lease-up.
Compliance periods. LIHTC sites must remain affordable for at least 30 years. The compliance period for LIHTC sites is a period of 15 taxable years beginning with the first taxable year of the credit period. An additional 15 years is required by the IRS without recapture for a total of 30 years. In addition, regulatory agreements for LIHTC sites can indicate a longer compliance period due to state agency requirements.
But tax-exempt bond sites are subject to a “Qualified Project Period” terminating on the later of when no private activity bonds are outstanding, the date when Section 8 assistance (if any) terminates, or the date which is 15 years from when 50 percent of the units are first occupied.
Rent restrictions. Tax-exempt bond-financed sites are income-restricted only. They generally are not subject to federal rent restrictions unless such restrictions are outlined in the regulatory agreement. LIHTC sites are both income- and rent-restricted.
Income and asset verification. HUD Handbook 4350.3 outlines the requirements for verification of income and assets for both tax-exempt bond program sites and LIHTC sites. One difference to note is the verification of household assets not exceeding $5,000.
Revenue Procedure 94-65 allows households with assets not exceeding $5,000 to self-certify the income from those assets with a signed, sworn statement. However, the IRS issued this revenue procedure only for the LIHTC program. So be sure to check if your bond-financed site has stricter requirements. The compliance monitor or bondholder trustee may require a full verification of assets in all your site’s bond-financed low-income units.
Over-income units. For both tax-exempt bond sites and tax credit sites, household income may increase above the applicable income limit if the household was initially qualified. However, if a household’s income increases over 140 percent of the limit, then the next available unit of comparable or smaller size in the building must go to a qualified household for the over-income household to continue to be qualified.
Prior to HERA, the next available unit rule was applied by building for the LIHTC program and by project for bonds. With the passage of HERA, an owner of a bond-finance site with tax credits is required to apply only the building-based LIHTC available unit rule.
Student status. Since HERA, all bond-financed sites follow the LIHTC student rule. According to the rules, units occupied entirely by full-time students are generally disqualified for low-income housing tax credits, unless one of five exceptions applies. Full-time student households may occupy a low-income unit if the household member is:
- Receiving assistance under Title IV of the Social Security Act (TANF or Foster Care);
- Enrolled in a federal, state, or local job training program receiving assistance;
- Single parents with children who are not dependents of anyone except a parent;
- Married and eligible to file a joint return; or
- Someone previously under the care of the state foster system.
Utility allowance. Generally, there are no rent or utility restrictions in regulatory agreements for the bond program. However, for tax credit sites, rents must be reduced by a utility allowance for the utilities household members pay themselves. The household rent amount plus the utility allowance for tax credit sites must not exceed the maximum allowable rent.
Reporting requirements. For the tax-exempt bond program, owners must file Form 8703 annually during the qualified project period. The form asks for information related to unit turnover and it certifies an owner’s compliance with the minimum set-aside and the deep rent skew election, where applicable. Section III of the form asks for bond issuer information and a description of the bonds that financed the site. The form is due by March 31 after the close of the calendar year for which the certification is made. The most current version of IRS Form 8703 was issued in September 2013.
LIHTC sites, on the other hand, must file IRS Form 8609 the first credit year with the IRS. The housing credit allocating agency may require LIHTC site owners to submit a copy of the form to it as well. Also, Form 8609-A is required to be filed for each year of the 15-year compliance period.
Household transfers. At tax-exempt bond sites, all households that transfer from one unit to another, even in the same building, must be income recertified.
But for LIHTC sites, only transfers between buildings may require recertification. Households that transfer from one unit to another in the same building don’t need to be re-qualified. And as long as a household is under 140 percent of their applicable income limit, they may also transfer to a unit located in another building at the site.
Unit sizes. At a tax credit property, low-income units may be restricted to units based on size (for instance, only the smaller units on a site may be designated as LIHTC). The calculation of the applicable fraction prevents the taxpayer from receiving a tax benefit for doing this. However, on a bond property, there is no applicable fraction and low-income units must be distributed among all unit types, explains Johnson.
A.J. Johnson, HCCP: President, A.J. Consulting Services, Inc., 3521 Frances Berkeley, Williamsburg, VA 23188; www.ajjcs.net.