How to Maximize LIHTC Equity: Focus on Investor Goals

Published by Michael Novogradac on Tuesday, June 1, 2021
Journal Cover Thumb June 2021

One of the greatest challenges facing developers of affordable rental housing is raising sufficient financing to enable a development to move forward. As such, it is essential that developers maximize the present value of low-income housing tax credit (LIHTC) equity.

To maximize LIHTC equity, developers must maximize a development’s economic benefits, as well as identify investor goals beyond direct economic benefits and consider how your development can help achieve those goals. To maximize the “present value” of LIHTC equity, developers must accelerate the timing of credits and losses, and determine the optimal time to receive investor equity. Below we discuss steps developers can take. But note, this is only a partial list. In service to our clients, we can suggest considerably more steps and provide greater specificity with respect to each step to increase investor equity.

1. Increase and Accelerate Tax Credits

Increasing the amount and accelerating the claiming of LIHTCs is the most basic way to increase investor equity.

a. Increase Amount of Tax Credits

If the development location has not yet been identified, the easiest way to increase tax credits for a property is to locate a development in a difficult development area (DDA) or in a qualified census tract (QCT), both of which enable LIHTC properties to boost their credits by up to 30%. This is particularly important for private activity bond- (PAB)-financed property, as a credit allocating agency does not have the discretion to allow the 30% basis boost if needed for financial feasibility.

Federal LIHTCs are based on depreciable basis, thus a developer should review estimated project costs and ensure that all depreciable costs are properly identified. This includes a review of the allocation of purchase costs between land, building and other costs, as well as being sure to capitalize eligible soft costs (such as certain taxes, legal fees, loan fee amortization and interest) into depreciable property.

For acquisition-rehabilitation properties, consider whether you should be capitalizing items that may have initially been recorded as repairs and maintenance expense.

Additionally, determine if the development is eligible for other federal and state tax credits.  The Internal Revenue Code (IRC) Section 45L new energy-efficient home credit can provide up to $2,000 per unit in the placed-in-service year for residential buildings of three stories or less. That credit was extended through the end of this year and could be extended again.

Nearly half of states have a LIHTC, designed to make more developments financially feasible. Some states bifurcate their credit–allowing different investors for the state and federal credit–and others require the same investor for both. If you develop in a state with its own credit, be sure to avail yourself of that.

The federal historic tax credit (HTC) is worth 20% of qualified rehabilitation expenditures and some LIHTC properties–including many public housing properties being redeveloped under the U.S. Department of Housing and Urban Development’s (HUD’s) Rental Assistance Demonstration (RAD) program, using LIHTCs–qualify for that. Nearly 40 states have a state-level HTC, which can often double the potential equity for the credit. Similarly, consider renewable energy tax credits.  The federal investment tax credit is available for LIHTC properties that install solar panels.

b. Accelerate Tax Credits

LIHTC developments are eligible to begin claiming tax credits (over a 10-year period) in the year a building is placed in service, based on the portion of the year the building is leased to qualifying tenants. However, if the building is insufficiently leased to entitle the owner to the maximum amount of allocated or eligible credits, then the balance of the credits–to the extent qualified in subsequent years–are claimed over the balance of the 15-year compliance period. To avoid such a result, a developer can defer the start of tax credits to the following year.

This means that developers should seek to lease up a building as rapidly as possible in the year the building is placed in service. If a significant amount of credits is in jeopardy of being postponed due to a few yet-to-be qualified LIHTC units, consider using rental concessions to qualify those last remaining units before year-end.

If qualifying all buildings by the end of the year isn’t achievable, consider focusing on leasing up some buildings to 100% before others, allowing the partnership to claim credits on at least some buildings. Claiming credits on some buildings is better than none.

Another key for developers and property managers is that the households that initially qualify for the LIHTC units in Year 1 of the credit period are more important to the tax credits than any others. That’s because they establish that a property has met its minimum set-aside in Year 1 of any of its buildings’ credit periods and qualify the unit to start taking credits. Errors could lead to 15-year credits or worse: disqualifying a property from meeting its minimum set-aside and ever claiming LIHTCs. When working on accelerating credits, ensure tenants are qualified and the units are correctly leased. It is worth the time and money to make sure they’re done right.

2. Increase and Accelerate Losses

Tax losses are a key component of LIHTC investment tax benefits. Developers should focus on increasing        and accelerating losses.

A cost segregation study is a fundamental step to increasing and accelerating the depreciation expense portion of tax losses. A cost segregation study allows property owners to more properly classify assets, which generally results in greater costs being allocated to property with shorter depreciable lives and to property eligible for bonus depreciation. Cost segregation studies usually generate greater depreciation expense in earlier years.

Beware. Developers and investors should also have an IRC Section 704(b) analysis prepared to ensure that losses (and tax credits) are properly allocable to the limited partner during the credit period and the year after. Improperly managed, accelerating losses can lead to a reallocation of depreciation away from the limited partner during the credit period, leading to a reallocation of LIHTCs as well. Proper upfront planning is needed to forestall this result.

Analysis is also needed to make the proper election under IRC Section 163(j), relating to the deductibility of business interest expense: choosing to deduct more interest or receive more depreciation. Once a property is placed in service, there is a trade-off between those expenses. Note that under Rev. Proc. 2020-22, taxpayers who operate as a real property trade or business (which includes LIHTC owners) can withdraw their election for their 2018, 2019 and 2020 tax returns until Oct. 15 of this year. Now is a rare time to consider whether to change a previous election.

For developers loaning money to the operating partnership from grant proceeds received by the partner, it’s important to have a true debt analysis performed to ensure those loans won’t actually be considered grant income for tax purposes, thereby offsetting losses. Furthermore, if the “loan now deemed to be a grant” is from a federal source and is used to reimburse development costs, the grant will also have the adverse effect of reducing eligible basis (thereby reducing potential tax credits) by the amount of the grant.

Some LIHTC properties can also benefit from the IRC Section 179D commercial property energy efficiency deduction that was made permanent in legislation at the end of 2020. That deduction–of up to $1.80 per square foot–can be used for energy-efficient upgrades and improvements in residential properties of four stories or more that reduce energy costs by 50% below energy-efficiency standards. That deduction amount could increase in the future, making this deduction even more valuable.

3. Identify Investor Goals and Consider How your Development Can Help Achieve Them

Identifying investor goals beyond direct economic benefits and considering how your development can help achieve those goals is often a significant opportunity to increasing investor equity.

Most LIHTC investors are banks and a major incentive for investing in LIHTC properties is to improve their Community Reinvestment Act (CRA) ratings. Banks have assessment areas, and a property in one of those areas, particularly a “hot” area, will generally draw extra interest among bank investors and result in higher equity pricing.

LIHTC investors are acutely focused on the tax benefits expected from an LIHTC investment. In their underwriting, they are most attracted to investments with lower development and operating risks.

In assessing development risk, great attention is placed on the development team. Developers with a strong record of success–including the ability to fund operating deficits, secure construction completion and provide tax credit guarantees–make investors more comfortable and more willing to invest at a higher level. Market your development experience and your assembled development team: construction company, property manager and other experienced professionals engaged to help. (Yes, including the tax credit accountant!)

In assessing lease-up and operating risk, focused attention is given to the 15-year operating proforma. An affordable housing property built in an area with a clear, identifiable need–with the expectation of a tenant waiting list–is attractive to investors as there will likely be relatively few vacancies and the property will be better able to meet its debt obligations through the steady collection of rent. Developers can document sufficient-income qualified tenants and strong rental demand with a detailed market study. Documenting near-term rent growth helps demonstrate the ability of a property to maintain or increase its initial net operating income.  Novogradac’s Rent and Income Limit Estimator© is a source for reports of how maximum allowable rent and tenant income levels are currently forecast to change in any area over the next couple years, using the same calculation methodology that HUD uses to establish rent and income limits.

Also, be aware of other investor desires and goals that can increase equity. For instance, properties that are environmentally friendly and/or are near transit have been particularly popular in recent years. Another example: Enterprise Community Partners has a five-year, $3.5 billion nationwide initiative to provide both entity-level and project-level capital to Black, Indigenous, and People of Color and other historically marginalized housing providers.

4. Correctly Time the Equity Arrival

Investor yield or return on investment (ROI) is a key calculation for equity payments made in installments in exchange for tax benefits received over several years. We’ve already discussed the value of accelerating the tax credit and losses. But an investor benefits to the extent they are able to delay equity contributions from the beginning of development to during development and/or until development completion, or even later. Generally, the later an investor is allowed to contribute equity, the greater the nominal amount of equity they are willing to contribute.

While waiting to receive scheduled equity installments, developers will often need to seek short-term financing to cover development costs during the earlier months of development. Especially when interest rates are low and borrowing is relatively easy, developers often find bridge financing to be a reasonable trade-off for ultimately higher equity later in the development cycle.


Equity pricing involves both financial and nonfinancial factors. The financial factors are grounded in the timing and amount of investor contributions, tax credits and tax losses. The nonfinancial factors are grounded in the desires and motivations of tax credit equity investors, beyond tax benefits.

These considerations are best addressed with a detailed financial model and brag sheet, highlighting a development’s nonfinancial features and strengths. Time spent up front addressing these matters will lead to greater financial feasibility of your transaction, as you will be maximizing the present value of the tax credit equity portion of your project’s sources of funds.

Please note, this article only provides a high-level overview of ways to increase the present value of tax credit equity. In serving our clients, we are able to go into considerably greater detail advising on matters beyond what the space allowed in this article affords. Every developer and type of development has its own unique opportunities, including acquisition rehabilitation developments, PAB-financed properties, mixed-use and mixed-income developments, and more.