The amount of annual Low-Income Housing Tax Credit (LIHTC) a building may receive is dependent on four factors: (1) Eligible Basis; (2) the Applicable Fraction; (3) qualified basis; and (4) the Applicable Percentage. Of these four elements, the “Applicable Percentage” is one of the most confusing.
The applicable percentage is the discount factor used to account for the present value of the credit over the ten-year credit period. This applicable percentage is dependent on three basic factors:
- When the low-income building was placed in service, unless the taxpayer elects otherwise;
- Whether the housing is new or an acquired existing building; and
- Whether the housing is federally subsidized.
For buildings placed in service in 1987, the applicable percentage was an annual rate of 9% for the 70% present value credit and 4% for the 30% present value credit. Although the present value of the credit is based on fluctuating interest rates and varies from month to month, the IRC §42 credit is commonly described as the “9%” and “4%” credits.
Applicable Percentage Defined
The applicable percentage is the factor which, when multiplied by the building’s qualified basis, equals the credit allowable to the building.
For buildings placed in service after 1987 but before July 31, 2008, under former IRC §42(b)(2)(B), the applicable percentage was prescribed by the IRS such that it would yield, over the ten-year credit period, an amount of credit having a present value equal to:
- 70% of the qualified basis of a new building that is not federally subsidized for the taxable year (the “9%” credit); or
- 30% of the qualified basis of (1) a new building that is federally subsidized for the taxable year or (2) an existing building (the “4%” credit).
For buildings placed in service after July 30, 2008, the Code was amended to provide for a present value of:
- 70% of the qualified basis of a new building that is not federally subsidized for the taxable year (the “9%” credit); or
- 30% of the qualified basis of all other buildings.
Congress amended §42 to provide a temporary minimum applicable percentage of 9% for new buildings that are:
- not federally subsidized;
- placed in service after July 30, 2008; and
- received an allocation of credit before December 31, 2013.
Rehabilitation expenditures are treated as a separate new building qualifying for the 70% present value credit or the 30% present value credit if federally subsidized.
Determining the Applicable Percentage
A project uses the applicable percentage for the earlier of:
- the month in which the low-income building is placed in service, or
- at the taxpayer’s election, (1) the month in which the taxpayer and the state agency enter into an agreement as to the amount of credit to be allocated to the building, or (2) if the aggregate basis of a building and land upon which the building is located is financed at least 50% with tax-exempt bonds, the month in which the tax-exempt bonds are issued.
The election must be made no later than the fifth day after the close of such month and once made, the election is irrevocable.
State Agency Authority to Specify Applicable Percentage
IRC §42(m)(2) requires that state agencies limit the amount of credit allocated to a project to the amount required to ensure project feasibility through the credit period.
The limit on the credit amount can be accomplished by limiting the applicable percentage used to compute the credit. The applicable percentage specified on Line 2 of the 8609 can be less than, but never more than, the applicable percentage otherwise prescribed. In most cases however, the state agencies use the prescribed applicable percentage and simply adjust Line 3a (Maximum Qualified Basis) in order to restrict the annual credit amount to the amount required for project feasibility.
The IRS publishes the applicable percentages on a monthly basis in the IRS Bulletin.
Federally Subsidized – Buildings Placed in Service Before July 31, 2008
For new buildings placed in service before July 31, 2008, federally subsidized buildings included any building with tax-exempt bonds (under Section 103 of the IRC) or any below market federal loan. A new building is not considered federally subsidized if the taxpayer elected to reduce eligible basis by the principal amount of the loan, or in the case of a tax-exempt obligation, the proceeds of the obligation. This election is made on Form 8609, Line 9a.
A new building is also not considered federally subsidized if the tax-exempt obligations or below market federal loans used to provide financing during construction are redeemed or repaid before the building is placed in service.
With some exceptions, below market loans made from Community Development Block Grant (CDBG) funds are considered below market federal loans.
HOME or NAHASDA Assistance and the 40-50 Rule
Buildings placed in service prior to July 31, 2008, with HOME or Native American Housing Assistance and Self-Determination Act of 1996 (NAHASDA) funds provided a below market rates and included in eligible basis may claim the 9% credit if 40% or more of the residential units in the building are occupied by individuals whose income is 50% or less of the area median gross income (40-50 rule). If the building is located in New York City, then 25% is substituted for 40%.
If the building is subject to the 40-50 rule, the building does not qualify for the increase in eligible basis for buildings located in qualified census tracts or difficult to develop areas.
Federally Subsidized – Buildings Placed in Service After July 30, 2008
A new building placed in service after July 30, 2008 is treated as federally subsidized only if it was financed by tax-exempt bonds (under IRC §103). Other types of federal financing no longer impact whether a building may claim the 4% or 9% credit. Since tax-exempt bond financing normally makes up a significant percentage of total project costs, it is highly unlikely any taxpayer will make the line 9a election to remove the federal subsidy from eligible basis.
If the tax-exempt obligation is redeemed before the building is placed in service, the building is not considered to have been federally subsidized.