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Comprehensive DDA Changes Require Early Developer Action to Maximize Potential Benefit
Affordable housing developers and public housing authorities have a brief window to preserve a significant potential benefit for low-income housing tax credit (LIHTC) developments in the pipeline, but interested parties must act now to secure a key designation that could disappear at the end of this calendar year.
Being located in difficult development area (DDA) or qualified census tract (QCT) allows a LIHTC development as much as an additional 30 percent of eligible basis for new construction and rehabilitation costs, which in turn means a greater maximum allocation and a larger equity investment. More equity means less debt, allowing for deeper income targeting. Therefore, real estate within these areas confers a very valuable benefit to affordable housing developers and low-income residents.
Experienced practitioners know these designations are subject to change from one year to the next. However, 2016 will involve much more significant changes.
About the Change
Internal Revenue Code (IRC) Section 42 charges the U.S. Department of Housing and Urban Development (HUD) with determining DDAs. Historically, HUD has used a methodology based on the ratio of fair market rents (FMRs) to area median gross incomes (AMGI) that divides counties between those within and outside of metropolitan statistical areas (MSAs). But for the first time in 2016, DDAs inside of MSAs (known as “metropolitan”) will be divided by ZIP codes rather than counties. As a result, there will be many more DDAs, and each will be substantially smaller than in previous years. The areas will boast new name: small area difficult development areas (SADDAs).
What May Happen and Why
Currently the best way to evaluate what will happen is looking at two lists.
- A list of the DDAs in effect for the calendar year 2015 shows that DDAs are heavily concentrated in California, Florida and New York.
- HUD has prepared a tool that shows the hypothetical outcomes if the new policy had been in effect this year. This tool reveals that instead of 35 metro DDAs total, the revised methodology produces at least one SADDA in 233 MSAs. (The designation of nonmetro DDAs will remain at a county level and, like QCTs, will be subject to the same possibility of change as in the past). This will result in maps reflecting DDA designations looking like Swiss cheese rather than metro-wide dots.
- HUD has indicated there will be several methodological improvements for calculating small area fair market rents that will be implemented for the 2016 designations, and cautions use of the hypothetical 2015 list beyond illustrative use. This list may not be representative of the expected changes in many of the areas that are currently DDAs.
Novogradac’s geographic informational systems experts are generating a map depicting the differences once the new determinations are available. Stay tuned for updates in future blog postings as well as via Novogradac’s Industry Alert email service.
According to a presentation by Katherine O’Regan, HUD’s Assistant Secretary Policy Development and Research, at the National Council of State Housing Agencies’ (NCSHA’s) Housing Credit Connect, the purpose of the methodology change is to open up “opportunity areas” throughout the country. The following table shows examples of how these ZIP codes have lower poverty levels than their surrounding MSAs.
How to Preserve Maximum Potential Benefit
While the revised system will create many new opportunities in MSAs, the extent of jurisdictions losing the DDA designation will be greater than before; specifically, the vast majority of land in the current 35 DDA counties is expected to no longer be designated as such. The good news is that LIHTC developments in the pipeline do not necessarily have to miss out on the basis boost associated with DDA designation.
First, some areas that are not designated as a 2016 SADDA may end up falling within a QCT, allowing them to retain access to the basis boost. Second, the state allocating agency has the option to apply its discretionary basis boost. How this process works must be spelled out in the applicable qualified allocation plan (QAP), and under IRC Section 42 is not available for developments financed with tax-exempt bonds.
But, what if your upcoming development
- is in a current metro DDA,
- depends on the additional 30 percent basis boost to be feasible,
- will not be in a QCT, and
- is ineligible for the agency’s discretionary boost?
- One possible solution remains.
An LIHTC development will be considered as though still in a DDA if it is the subject of an application submitted in 2015. HUD describes this approach as extending the effective date.
To use this approach, the application must be “complete,” meaning:
no more than de minimis clarification of the application is required for the agency to make a decision about the allocation of tax credits or issuance of bonds requested in the application.
The allocating agency will decide what counts as complete for this purpose. This approach also is available to applications in nonmetro DDAs.
Developers and public housing authorities with upcoming activities in the 35 metro DDAs should reach out their allocating agencies right away about the possibility of submitting a complete application by Dec. 31, 2015. Doing so will be especially important for any Rental Assistance Demonstration (RAD) program developments that are using tax-exempt bonds. Such redevelopments must meet federal deadlines and often depend on tax exempt bonds with LIHTCs.
Novogradac is prepared to assist the affordable housing community with this significant transition. If you’re not already in touch with a Novogradac LIHTC expert, you can find one in an office near you.