Can The LIHTC Program Be Used in Opportunity Zones?
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.
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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).
Related Questions
What are the benefits of using the Low-Income Housing Tax Credit (LIHTC) program in Opportunity Zones?
The Low-Income Housing Tax Credit (LIHTC) program offers developers a 10-year credit on their federal income taxes for creating low-income housing. Combining the LIHTC program with Opportunity Zones can provide investors with a greater tax benefit. In general, Investors looking to fund LIHTC properties in Opportunity Zones will have to do so via new construction, as it’s unlikely that an LIHTC property rehabilitation would cost more than the price of acquiring a property, as is required for the Opportunity Zones program. Utilizing HUD multifamily loans, such as the HUD 221(d)(4) loan for the construction and substantial rehabilitation of multifamily properties may add to the benefits for investors. This loan program offers between 87-90% LTV for affordable properties and a reduced mortgage insurance premium (MIP) of 0.45% with a fixed-rate 40-year loan term (with an additional 3-year construction period). LIHTCs and Opportunity Zone tax credits can also be combined with rental assistance demonstration (RAD) properties in rare cases for eligible properties. Source and Source.
How does the LIHTC program work in Opportunity Zones?
The LIHTC program and Opportunity Zones can work together for certain high net worth individuals and investment partnerships for the purpose of gaining a greater tax benefit. In general, Investors looking to fund LIHTC properties in Opportunity Zones will have to do so via new construction, as it’s unlikely that an LIHTC property rehabilitation would cost more than the price of acquiring a property, as is required for the Opportunity Zones program. Utilizing HUD multifamily loans, such as the HUD 221(d)(4) loan for the construction and substantial rehabilitation of multifamily properties may add to the benefits for investors. This loan program offers between 87-90% LTV for affordable properties and a reduced mortgage insurance premium (MIP) of 0.45% with a fixed-rate 40-year loan term (with an additional 3-year construction period). LIHTCs and Opportunity Zone tax credits can also be combined with rental assistance demonstration (RAD) properties in rare cases for eligible properties.
To learn more about your multifamily loan options, you can speak to a specialist.
What are the eligibility requirements for the LIHTC program in Opportunity Zones?
In order to be eligible for the LIHTC program in Opportunity Zones, the property must generally be a new construction. If the property is an acquisition/rehabilitation, the fund must invest more money in improvements than the amount of money that was used to originally acquire the property. Additionally, investors looking to fund LIHTC properties in Opportunity Zones will have to do so via new construction.
The Low-Income Housing Tax Credit (LIHTC) program is a federal government program that incentivizes developers to create low-income housing by offering them a 10-year credit on their federal income taxes. HUD multifamily loans, such as the HUD 221(d)(4) loan for the construction and substantial rehabilitation of multifamily properties, may add to the benefits for investors. This loan program offers between 87-90% LTV for affordable properties and a reduced mortgage insurance premium (MIP) of 0.45% with a fixed-rate 40-year loan term (with an additional 3-year construction period). LIHTCs and Opportunity Zone tax credits can also be combined with rental assistance demonstration (RAD) properties in rare cases for eligible properties.
For more information on the LIHTC program and Opportunity Zones, please click here.
To learn more about your multifamily loan options, please click here and speak to a specialist.
What are the tax incentives associated with the LIHTC program in Opportunity Zones?
The Low-Income Housing Tax Credit (LIHTC) program offers developers a 10-year credit on their federal income taxes for creating low-income housing. The Tax Cuts and Jobs Act of 2017 also authorized the creation of the Opportunity Zones program, which allows individuals and corporations to defer their capital gains taxes for between 5-7 years if they invest in an Opportunity Fund. Opportunity Funds can also invest in LIHTC properties, though, in practice, the property must generally be a new construction. If the property is an acquisition/rehabilitation, the fund must invest more money in improvements than the amount of money that was used to originally acquire the property— and this is not likely to occur in the case of LIHTC-funded properties. Additionally, HUD multifamily loans, such as the HUD 221(d)(4) loan for the construction and substantial rehabilitation of multifamily properties, may add to the benefits for investors. This loan program offers between 87-90% LTV for affordable properties and a reduced mortgage insurance premium (MIP) of 0.45% with a fixed-rate 40-year loan term (with an additional 3-year construction period). LIHTCs and Opportunity Zone tax credits can also be combined with rental assistance demonstration (RAD) properties in rare cases for eligible properties.
What are the risks associated with using the LIHTC program in Opportunity Zones?
The main risk associated with using the LIHTC program in Opportunity Zones is that LIHTC investors are often banks, which cannot own equity investments— and therefore do not generate any capital gains that can be offset by the Opportunity Zones tax incentive. Additionally, it is unlikely that an LIHTC property rehab would cost more than the price of acquiring the property in the first place (as is required for the Opportunity Zones program).
For more information, please see A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors and Opportunity Zones and the Low-Income Housing Tax Credit (LIHTC) Program.
Are there any other financing options available for Opportunity Zones?
Yes, there are other financing options available for Opportunity Zones. For office, retail, and industrial properties, borrowers will typically need to get commercial construction financing from a bank, which they then may wish to refinance into a fixed-rate CMBS loan, or, if the property is extremely high quality, a life company loan. For multifamily properties, borrowers may wish to obtain a short-term bank construction loan, and then refinance into longer-term fixed-rate financing such as a 5-7 year CMBS loan or a Fannie Mae® or Freddie Mac® multifamily mortgage. They may also want to refinance with a HUD multifamily loan, such as the HUD 223(f) loan for property acquisitions and refinances. Additionally, Freddie Mac has a wide variety of financing products specifically designed to assist with this process, including Freddie Mac Bond Credit Enhancement with 4% LITHC, which provides forward commitments for both the new construction and substantial rehabilitation of LIHTC properties, and the Freddie Mac LIHTC Enhancement which insures investors against potential losses should an LIHTC-funded property owner default. Fannie Mae also offers LIHTC-focused products such as the Fannie Mae Credit Enhancement of Variable Rate Tax-Exempt Bonds (Index Bonds), which allows LTVs up to 90% for properties using 4% LIHTCs.
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