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Tax Reform Discussion Draft Threatens Future Supply of Affordable Rental Housing
A recently released Joint Committee on Taxation letter estimates that the certain changes contained in the tax reform discussion draft written by House Ways and Means Chairman David Camp would increase the number of rental units supported by the 9 percent low-income housing tax credit (LIHTC). However, while some changes would increase the number of units, numerous others would cost units. On balance, the discussion draft’s LIHTC reforms would reduce the aggregate number of newly constructed and rehabilitated units. Furthermore, the ability of LIHTC developments to serve lower income families, provide social services and include project amenities would be made considerably more challenging.
The Joint Committee on Taxation (JCT) estimates that passage of certain portions of Camp’s tax reform proposals regarding the LIHTC would mean that eligible basis for 9 percent (70 percent present value) LIHTC developments would increase by $519 million in 2015 relative to present law. The JCT estimates that the increase in eligible basis would translate into an increase of as few as 1,500 and as many as 4,100 new qualified low-income units in 2015.
In an effort to better understand the impact of the discussion draft on the number of affordable rental units supported by the LIHTC, we have conducted our own analysis. We identified the following distinct changes that would positively or negatively affect the number of units built or renovated by the LIHTC:
- change from $2.30 per capita tax credit to $31.20 per capita qualified basis,
- eliminate the 30 percent basis boost for qualified census tracts (QCTs), difficult development areas (DDAs) and state agency designated developments,
- eliminate use of volume cap tax credits to finance acquisition costs,
- remove energy efficiency and historic preservation from the statutory list of allocation selection criteria,
- lengthen the credit period from 10 to 15 years,
- eliminate the national pool,
- lower the corporate tax rate,
- lengthen depreciation lives, and
- eliminate private activity bonds and associated LIHTCs.
The following analyzes the directional effect of each change and provides a rough estimate of the degree to which each change would affect the number of affordable rental housing units supported by the LIHTC each year.
1. Change from $2.30 per capita tax credit to $31.20 per capita qualified basis
The Camp discussion draft shifts from a per capita allocation of tax credits to a per capita allocation of qualified basis. The 2014 per capita tax credit amount is $2.30 and the per capita tax credit amount is projected to be the same in 2015. The Camp discussion draft provides for a per capita qualified basis amount of $31.20 in 2015.
We estimate additional eligible basis from this change of $300 million to $400 million, which translates to about 3 to 4 percent more basis, or approximately 1,400 to 3,000 more affordable rental housing units.
2. Elimination of 30 percent basis boost
The elimination of the 30 percent basis boost means the maximum amount of tax credits that can be allocated per dollar of basis is less, such that the same volume of tax credits supports more basis. The 30 percent basis boost is currently available to LIHTC developments in difficult development areas (DDAs), qualified census tracts (QCTs) or designated as requiring the increase by the state housing credit agency. This provision currently exists to assist the financial feasibility of developments situated in areas with comparatively high construction, land and utility costs relative to area median gross income and to assist developments in areas with comparatively high rates of poverty and low-income families.
The table below assesses the impact of the elimination of the 30 percent basis boost. The results depend on the underlying estimate of the number of developments currently claiming the 30 percent basis boost. If you assume that about 33 percent of all tax credits go to developments that claim the 30 percent basis boost (which is roughly the percentage of credits allocated to properties that claimed the boost in 2011), then considering 9 percent developments, there should be roughly $8.6 billion of eligible basis in the status quo, and removing the 30 percent boost would increase eligible basis by about $708 million.
However, while a property may receive the 30 percent basis boost, states often choose not to allocate to properties the total amount of credits such a boost could qualify them for, resulting in some uncertainty about total basis levels. If you assume that 33 percent of credits would be allocated to properties claiming the basis boost, and those properties have excess basis of 5 percent, then the net increase in eligible basis is about $590 million. This could lead to the financing of about 2,800 to 4,200 more units.
3. Elimination of use of volume cap tax credits to finance acquisition costs
Volume cap credits for acquisition costs are calculated according to the 4 percent (30 percent present value) tax credit percentage, rather than the 9 percent rate. This means that for the same amount of basis, a property’s acquisition costs are eligible for less tax credit allocation. The elimination of the acquisition credit will result in fewer, if any, acquisition rehabilitation properties being developed. Acquisition rehabilitation developments generally have lower average tax credits per dollar of basis. The Camp discussion draft would divert 4 percent acquisition credits to 9 percent new construction, resulting in 4,100 to 6,000 less total additional and/or preserved affordable rental housing units.
4. Elimination of energy efficiency and historic preservation in allocation selection criteria
The Camp proposal removes the mandate that allocating agencies include in their selection criteria consideration of energy efficiency and historic renovations. Without the energy efficiency selection criteria mandate, presumably some properties will have lower eligible basis such that existing credits will support more properties. Conversely, historic properties are by definition acquisition rehabilitation and the historic tax credit reduces basis, so the elimination of selection criteria for such developments likely means more 9 percent credits will be used by properties with higher average credits per unit. We also note that eliminating the energy efficiency and historic preservation from the federally mandated allocation selection criteria would not prevent allocating agencies from continuing to use them.
5. Lengthening credit period from 10 to 15 years
Lengthening the credit period from 10 to 15 years would generally reduce the present value of credits. The Camp proposal however retains the 70 present value calculation, theoretically maintaining the status quo. Unfortunately, this fails to account for the fact that private investors have a higher investment return rate than the after-tax federal discount rate used in the LIHTC statute. The statute uses a discount rate based on a combination of the mid-term and long term applicable federal rate, adjusted downward by the highest corporate tax rate. In the current interest rate environment, the after-tax discount rate under the Camp discussion draft is about 2 percent. Private investors have higher risk adjusted rate of return hurdles, which means that the present value of credits for investors is lower than the theoretical 70 percent retained by the Camp plan. A lower present value means that investors will pay less per credit, resulting in less equity, and, ultimately, less housing is generated. Rough initial estimates are that this expansion of the credit period would result in a loss of about 5 percent to 10 percent of investor equity, which would translate into a loss of about 3,400 to 5,100 units.
6. The elimination of the national pool
In 2013, the national pool was $2.51 million. Camp’s proposal to eliminate the national pool would reduce the total amount of credits available, and would result in a loss of roughly 150 to 170 units.
7. Lower the corporate tax rate
The reduction of marginal tax rates would reduce the tax benefits of LIHTC investments, since the value of depreciation expense deductions would be reduced. A study by Novogradac and Company found that the reduced value of depreciation expense for 9 percent investments would lead to an estimated loss of $348 million to $619 million in investor equity. This loss of investor equity translates into loss of up to 2,700 to 5,700 units a year, or more.
8. Longer depreciation lives
Camp’s plan would slow down depreciation. The Novogradac tax reform study found that when combined with a top tax rate of 25 percent, longer depreciation periods translate into an additional equity loss of $100 million to $131 million. This loss of investor equity translates into an additional loss of 600 to 1,500 units a year, or more.
9. Elimination of private activity bonds and associated LIHTCs
The National Council of State Housing Agencies reported that in 2010, 34,045 affordable rental housing units were financed with tax-exempt bonds, in 2011 that number was 38,801, and in 2012 it was 37,852. Based on this, repeal of the 4 percent credit for tax-exempt bonds means roughly 30,000 to 40,000 fewer units would be subsidized.
On balance, it appears that Chairman Camp’s LIHTC reforms would reduce, not increase, the total amount of LIHTC supported rental affordable housing units by roughly 33,000 to 54,000 units a year. Furthermore, the changes would also result in units that would serve higher average income levels, and provide fewer amenities and social services.