State Tax Credits, Affordable Housing, and Best Practices

State Tax Credits, Affordable Housing, and Best Practices
News| Amy Wolff Sorter
Apartment Buildings

Cost-burdened renters and issues with housing affordability aren’t going away. According to the Joint Center for Housing Studies of Harvard University, “rental affordability has continued to worsen as a growing share of household income has been devoted to rent.”

One obvious solution is—build more housing. A recent article published in the Novogradac Journal of Tax Credits pointed out that the federal low-income housing tax credit (LIHTC) has been “the most effective tool to provide critically needed affordable rental homes.”

But the federal government can’t do everything, so states are creating their own tax incentives for affordable housing development. The Novogradac article said that more than 25 states have developed models in tandem with the LIHTC so far.

Best practice suggestions for state governments that want to participate include keeping tax incentives simple and to “build on the existing federal housing credit.” Also important? Steps to boost investor appetites for such programs.

“To increase demand, states should consider allowing bifurcation of the state tax credit from the federal credit,” the article advised. This action means that state tax credits could help offset state taxes. The result would be that investors could claim state credits before receiving the Form 8609 Low-Income Housing Credit Allocation and Certification or equivalent approval.

The article listed additional considerations for new estate housing credits that would also impact affordable housing investors:

Allocation versus Certification

Allocated credits are generated from equity contributions to a project. Meanwhile, certified credits are purchased from a project or participants. While allocated credits can provide “a structured, long-term approach with potential tax benefits for investors,” they also come with a bevy of compliance obligations and a slower impact on state revenues.

Meanwhile, certified credits offer “immediate fiscal effects and greater market flexibility, increasing demand and pricing.” The downside is that certified credits lead to higher taxable proceeds and enforcement challenges.

“Both structures necessitate careful planning and the involvement of experienced tax professionals to optimize outcomes and avoid pitfalls,” the article noted.

Impact on Pricing

Investors price credits based on returns or yields. In this case, a longer credit period doesn’t automatically mean higher yields. Rather, equity pricing per dollar of credit is lower because of the time value of money. At the same time, a shorter credit period—and higher equity pricing—can mean a less efficient use of tax dollars funding the program.

“While a shorter credit period may yield higher equity pricing, investors will need to be able to redeem the credits faster,” the article said. This costs the state more money versus spreading the costs out over a longer term.

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