Low Income Housing Tax Credits and the Opportunity Zones Program
The Low Income Housing Tax Credit (LIHTC) program is the federal government’s primary incentive program to encourage investors and developers to create more affordable housing around the U.S. To do so, the program offers investors in affordable housing a dollar-for-dollar reduction on their federal income taxes. In contrast, Opportunity Zones program allows investors who put sell their investments and re-invest their money into qualified Opportunity Funds to defer their capital gains taxes until 2026, and, if they keep their money in the fund for at last 10 years, they pay no capital gains taxes on any new gains that their investment makes.
In some cases, the LIHTC program can be paired with the Opportunity Zones program to create a project that generates incredibly high investment yields. However, to do so, an Opportunity Fund must first acquire the credits themselves.
How to Pair LIHTCs with Opportunity Fund Investments
LIHTCs allow investors, which are often banks, funds, or, less commonly, high-net worth individuals, to purchase credits. Credits come in two varieties, 4% LIHTCs and 9% LIHTCs. 4% LIHTCs are usually reserved for rehabilitation projects, while 9% LIHTCs are usually intended for new construction. The process for a project to obtain LIHTCs is competitive, as there is only certain number of credits available each year. Properties using LIHTCs generally must reserve a certain number of their units for tenants that make less than or equal to 50% of the area median income (AMI), or, alternatively, must reserve 40% of a project’s units be reserved for residents making less than or equal to 60% of the AMI. Since competition can be fierce for the LIHTC program, many developers choose to offer more affordable units at a lower fraction of the AMI, as this could make it more likely that they are approved by the state or local housing agency offering the credits.
Since the Opportunity Zones program requires that an Opportunity Funds either invest in new construction projects, or if they invest in property rehabilitation, invest more money in property improvements than they did to purchase the property, the 4% LIHTC is usually out of the question. And, in general, Opportunity Funds looking to make use of the LIHTC should focus their efforts into new construction. The rare exception would be an extremely distressed property, or one which is selling well under market value and needs significant re-construction in order to be livable.
New Market Tax Credits (NMTCs) and Historic Tax Credits (HTCs) Can Also Be Used In Opportunity Zone Projects
While LIHTC may be the most visible tax credit program currently on the market, it isn’t the only one. The New Markets Tax Credit (NMTC) is another tax credit program that encourages private investment into low-income areas. Many Opportunity Zones are also NMTC-approved areas, which could make combining these two tax incentives a profitable venture for Opportunity Fund managers. NMTCs last for 7 years, but investors may wish to keep their funds in for longer so the property can continue to appreciate without any additional capital gains tax ramifications.
In comparison, Historic Tax Credits (HTCs) are intended for the rehabilitation of historic buildings. Investors can claim 20% of eligible improvement expenses on their federal income taxes. Banks generally fund these rehabilitation efforts in exchange for the credits, which is an excellent way for Opportunity Funds to generate the investment capital needed to acquire and rehabilitate these properties. Unlike rehabilitating most affordable properties, rehabbing historic properties can be significantly more expensive, so it’s more likely that a property would meet the Opportunity Zones program’s substantial improvement test (i.e. investing more money in property improvements than they did to purchase the property).