LIHTC Revenue’s Contribution to Tax Reform

Published by Michael Novogradac on Wednesday, October 12, 2011 - 12:00am

One of the goals of tax reform is to “broaden the base” to “lower income tax rates.”  In this effort, various tax expenditures will be reduced or eliminated as part of “broadening the base.”  

“Broadening the base” creates tax revenue to lower income tax rates. If tax reform is revenue neutral, all base-broadening efforts will be converted into lower rates. If tax reform is revenue positive, then some base-broadening will not be offset by lower rates, and instead will be used to reduce the budget deficit.

In this world of shared sacrifice, the volume cap of low-income housing tax credits (LIHTCs) does not have to be reduced to accomplish deficit reduction and tax reform, which is welcome news because such a reduction will force low-income tenants and low-income communities to share the pain of tax reform

In fact, the tax expenditure cost of the LIHTC will cost less under several current tax reform proposals, even if the volume cap is left unchanged.

Let’s look at two proposals: a reduction in the top tax rate from 35% to 25%, and an extension of residential rental depreciation lives from 27.5 to 40 years. 

Corporate and Individual Rate Reduction

A drop in the top tax rate from 35% to 25% will reduce the tax benefit of the losses that an investor gets from an LIHTC investment.  Similarly, it reduces the lost revenue (the tax expenditure) associated with that depreciation. We estimate that over the 15-year life of the LIHTC, the cost of the LIHTC tax expenditure is about 7% to 8% less. (Note: These calculations assume a 9% volume cap new construction investment.  A tax-exempt bond financed and/or acquisition rehabilitation investment will have an even larger percentage reduction in total associated tax expenditures.)

Regarding investor yields—in case you were wondering—very rough estimates show that a drop in the top tax rate from 35% to 25% reduces investor yields 75 to 100 basis points.

Extension of Depreciable Life of Residential Rental Property

If the depreciable life of residential rental property is lengthened from 27.5 to 40 years, then the value of depreciation deductions over the first 10years a property is in service will be less. We estimate that the cost of the LIHTC tax expenditure over the first 10 years will be another 4% less. (Note: These calculations assume a 9% volume cap new construction investment.  A tax-exempt bond financed and/or acquisition rehabilitation investment will have an even larger percentage reduction in total associated tax expenditures.)

Conclusion: Volume Cap Reduction Is Not Needed For LIHTC to Do Its Part

The above analysis demonstrates that the LIHTC tax expenditure cost will be less under tax reform, without any reduction in volume cap. Depending on various assumptions, we estimate the reduction in the cost of the LIHTC over the first 10 years will be approximately 10%.