Understanding LIHTC: How the Low-Income Housing Tax Credit Works

Overview

The Low-Income Housing Tax Credit (LIHTC) is one of the primary tools used in the United States to develop and preserve affordable housing. While widely used across the real estate industry, it is often misunderstood outside of specialized development and investment circles. 

At its core, LIHTC is not a loan or a grant—it is a federal tax incentive designed to encourage private investment in housing for lower-income households. Understanding how it works requires looking at how government policy, private capital, and real estate development intersect. 

What Is LIHTC? 

The Low-Income Housing Tax Credit was created under the Tax Reform Act of 1986 to address a growing shortage of affordable rental housing in the United States. 

Rather than directly funding housing construction, the program provides tax credits to developers and investors who build or rehabilitate rental housing that meets specific affordability requirements. 

These credits reduce federal tax liability over time, making it financially viable to develop housing that would otherwise not generate sufficient returns through rent alone. 

How the Program Works 

1. Allocation of Credits 

Each year, the federal government allocates LIHTC credits to states based on population. State housing agencies then distribute those credits to qualifying projects through a competitive application process. 

Developers must submit proposals outlining: 

• Project location and design  
• Target income levels  
• Number of affordable units  
• Financial feasibility  

Projects are typically evaluated based on local housing needs and policy priorities. 

2. Equity Investment 

Once awarded tax credits, developers generally sell those credits to investors—often large institutions such as banks or corporations. 

In exchange, investors provide upfront equity to the project. This reduces the amount of debt required, allowing the property to operate with lower rental income while remaining financially stable. 

3. Affordability Requirements 

To qualify for LIHTC, properties must meet strict income and rent restrictions. 

A common structure is: 

• At least 20% of units reserved for tenants earning ≤50% of Area Median Income (AMI), or  
• At least 40% of units reserved for tenants earning ≤60% of AMI  

Rents for these units are capped based on those income levels, ensuring long-term affordability. 

4. Compliance Period 

LIHTC properties are required to maintain affordability for a minimum of 15 years, known as the compliance period. 

In many cases, extended use agreements require affordability to continue for 30 years or more, depending on state requirements. 

Failure to meet these standards can result in the loss or recapture of tax credits. 

Types of LIHTC Programs 

There are two primary types of LIHTC credits: 

9% Credit (Competitive) 

• Covers a larger portion of development costs  
• Awarded through a competitive process  
• Typically used for new construction  

4% Credit (Non-Competitive) 

• Provides a lower subsidy level  
• Often paired with tax-exempt bond financing  
• Commonly used for acquisitions and rehabilitation  

Both structures serve the same purpose but are applied in different development scenarios. 

Who Is Involved? 

LIHTC projects typically involve multiple stakeholders: 

• Developers – Plan and execute the project  
• Investors – Provide equity in exchange for tax credits  
• State Housing Agencies – Allocate credits and oversee compliance  
• Property Managers – Ensure ongoing eligibility and operations  
• Tenants – Individuals and families who meet income qualifications  

This layered structure reflects the complexity of the program, as well as its reliance on both public and private participation. 

Why LIHTC Exists 

The economics of affordable housing are challenging. In many markets, rents that are affordable to lower-income households are not sufficient to cover the cost of development, financing, and operations. 

LIHTC bridges this gap by: 

• Reducing reliance on debt  
• Providing equity capital  
• Enabling projects to operate at lower rent levels  

Since its creation, the program has supported the development of millions of affordable housing units across the United States. 

How LIHTC Fits Into the Broader Housing Market 

LIHTC is one component of a larger housing ecosystem that includes: 

• Market-rate multifamily housing  
• Workforce housing  
• Government-subsidized housing programs  

It is specifically targeted at households earning below median income, helping to address supply constraints in a segment of the market that is often underserved. 

Sources:

• U.S. Department of Housing and Urban Development  
• Internal Revenue Service  
• National Council of State Housing Agencies  
• Urban Institute  
• Novogradac