Understanding Low-Income Housing Tax Credits

Good afternoon, and thanks for joining us for today's Affordable Housing webinar, Low-Income Housing Tax Credits 101. I'm Elizabeth Harriger, partner and director of our Affordable Housing Services here at McConley & Asbury. McConley & Asbury is an accounting and business advisory services firm with offices in Camp Hill, Lancaster, Bloomsburg, and Philadelphia. We provide a range of services to organizations across a variety of industries, as you can see on the screen, and we encourage you to visit our website to learn more about us. If you've joined us on past webinars, we're glad that you're joining us again. Today, we're going to kick off a three-part webinar series about affordable housing topics, and we'll be giving an introduction to the low-income housing tax credit process today. The next webinar in the series will be affordable housing audit. and Financial Statement Essentials, which is airing on July 25th. And the final webinar in our series will be Acquisition Rehab First Year Credits airing on August 1st. And we hope you'll join us for all three of these webinars. Macaulay & Asbury has been specializing in affordable housing since the late 1980s, and we provide a variety of accounting services to the industry that you can see on your screen here. such as annual audit and tax return preparation, 10% tests, 50% tests, development cost certifications, agreed upon procedures, and a variety of low-income housing tax credit consulting. We also provide property compliance consulting services through our affiliated company, M&L Compliance Management. You can learn more about us and all of these services by visiting our website noted at the bottom of the slide. We'd love to talk to you about how we can help you or how we can work with your organization. So feel free to contact us. Our contact information is at the end of the presentation and you can also find it on our Web site. If you have any questions for us during today's presentation, please submit them through the built in questions function in the webinar control panel. And I'll do my best to answer them either during or after the webinar. For those of you who are looking to obtain CPE credit for today's webinar, please keep in mind that there will be four polling questions throughout today's presentation and you'll need to answer all four of those questions. And they're not set up so there's any right or wrong answer. You just need to answer all four of the questions to get your certificate and we'll email that out to you a few weeks after the webinar. So our first polling question here today is, do you wish to receive CPE for attending today's webinar? You could just select the radio button there, yes or no. So it looks like the majority of people are on the webinar today to get CPE credit. So I guess that dashes my hopes a little bit that all these people just want to learn about low income housing tax credits because I enjoy talking about them. But I hope you'll learn a little something, even if you're just here for the CPE. So our second polling question right away is how many low income housing tax credit deals have you participated in developing? zero, one to three or four or more. Again, if you could just select the radio button that applies to you. Macaulay and Asbury works with owners developing their first affordable housing community, as well as with owners who have dozens of developments that they've participated in and everywhere in between. All right. So it looks like the majority of people here have not participated in any live tech deal. So being at a live tech one on one webinar makes a lot of sense. So today's webinar is broken up into four main parts. We're going to go over an overview of the program. We're going to talk about what happens before the credits are awarded. We are going to talk about what happens when you have the credits. And we are going to go through examples of how to calculate. So just to give you an overview of the program, it was created in by the 1986 Tax Act. So it's been around for a while and the credits are received over a 10 year period. And this is called the credit period. So the credit period is a 10 year period. over which the credits are claimed by the owner of the development. So in other words, this is the 10-year period when the credits are being shown on the owner's tax return. And this period starts in the first year that the tax credits are claimed and runs for 10 consecutive years. That first year can be either when the building is placed in service, or you can defer the first year of your credit period until the year. after the building is placed in service. And that determination is made on the IRS Form 8609, and we will talk about that a bit more later. So there's also a compliance period, which is different from the credit period. The compliance period begins the same year as the credit period that we just talked about and continues for an additional five years. So that's 15 years. During the 15-year compliance period, the development must comply with various low-income housing tax credit requirements from Section 42 of the Internal Revenue Code to avoid losing tax credits. Losing tax credits is known as tax credit recapture. Recapture can be costly, so you'll want to keep your development in compliance with Section 42 of the code. I recently heard an acronym. that I like about the basic rules that must be maintained during this compliance period to stay in compliance and avoid recapture. And ironically, that acronym is IRS. So I stands for income limits. The owner must rent to income qualified households. R stands for rent limits. The owner must keep rents below required limits. And S stands for safety. The development must meet certain physical standards. So it's really important that after your development is up and running, that you have a good management agent or good management company to help you maintain compliance. Because if you break any of those three rules, you will be facing recapture and it can be expensive. So if you just remember to follow the IRS in more ways than one. then you won't be in jeopardy of losing your tax credits. So how long does an owner need to maintain compliance? That's where the extended use period comes in. So the compliance period is only 15 years. However, the owner must agree to provide affordable housing for at least an additional 15 years after the initial compliance. As with the credit and compliance periods, the extended use period begins with the credit period, which is in the year the first year credits are claimed on the tax return. And they can continue or it continues for at least another 29 years. So PHFA is now requiring an even longer extended use period. I believe it's up to 40 years. Don't don't quote me on that, but it's more than 30. And I'm not sure about other states where they're at right now, but I think 30 is probably 30 is definitely the minimum. And this limitation is reflected in a document that all of these low income housing tax credit partnerships execute, which is a restrictive covenant agreement. And it's a deep restriction. The tax credit allocating agency or in Pennsylvania, PHFA. will continue to monitor the property through the extended use period. And during the extended use period, an owner cannot have tax credits taken away or recaptured, like we talked about earlier, so that's good. But if there are findings of noncompliance, PHFA or the allocating agency can still notify the owner of those findings, and there can be repercussions if those findings are not addressed timely. So even though you're out of the compliance period, you still want to make sure you're following all of the Section 42 rules. All right. Now that we know about the credit period, the compliance period and extended use period, let's talk about what kind of credits are there. There's the 9% credit and the 4%. So the 9% credit is applicable to new construction or rehabilitation. 4% credits are used on your acquisition costs and if you have tax-exempt bonds. So it is possible to have 9% and 4% credits on the same deal, assuming that you've purchased. a building that you're going to rehab your your rehabilitation costs the the construction the architect that sort of thing is all um subject to the nine percent and um the four percent would then apply to your acquisition costs so acquiring the building and all the costs that they're associated with that building acquisition um would be eligible for the four percent and With the acquisition credits, as with everything else, there are a lot of rules around that to be eligible for them. So that would be more of a LIHTC 201 webinar. And then the credit is calculated based on the eligible basis of the product. So there are a number of people involved in a tax credit deal. First and foremost is a tax credit allocating state agency or in Pennsylvania, that's PHFA. I mentioned that earlier when we were talking about the different periods. So I might use those terms interchangeably. You'll have an owner slash developer. You may have a housing consultant. Some larger developers have their own development department. in-house, so they typically don't use a housing consultant, but maybe newer or smaller developers will rely on a third-party housing consultant to help them put their application together and get them through the process until they're placed in service. There will also be an investor who will buy the credits. There's a contractor, an architect, a management agent, an attorney, and an accountant. And all that the Contractor, architect, management agent, attorney and accountant should all have LIHTC experience. You'll make your life a lot easier if you surround yourself with professionals who are experts in the LIHTC area. And I recommend using McAuley and Asbury as your accountant. Just a little plug there. So let's talk about how exactly these low-income housing tax credits create a funding source. There's an ownership entity, which is typically a for-profit limited partnership or limited liability company. And for today's purposes, I'm just going to refer to the ownership entity as a limited partner. So the developer or owner will compile and submit an application to the tax credit allocating agency during an open funding round. That application competes against other applications for an award of low-income housing tax credits. And that is no small feat. PHFA just awarded the 2024 low-income housing tax credits last week. And if anybody on the webinar today received an allocation of credits, congratulations. Or I guess I should say an award of credits. Congratulations. We know a lot of hard work went into securing those credits. And that work has just begun. After a partnership is awarded credit, they'll sell them and an ownership position in the partnership, which is typically 99.99% to an invested limited partner. And in exchange for the credits, the ownership position, and the tax losses, which are actually a benefit to the investor, that investor limited partner contributes equity to the partnership. And I like to call this subsidized construction. Because that equity essentially takes the place of amortizing debt, which allows the partnership to keep rents lower because it doesn't have a monthly debt service payment like the owner of a market rate development would have. So typical funding mix for these deals, investor equity. We just talked about that. I tried to look at a couple of deals. that from the 2023 round and what their funding mix looks like. And it looked like the investor equity was running between 50 and 60 percent of the funding mix. So that seemed a little low to me these days. But, you know, let's just say 60 percent. Then you've got a funding gap. So you've got to fill that gap with some kind of additional finance. And typically there is not enough cash flow in these deals to have amortizing debt. Or if you do, it's very small. We rarely, we do sometimes, but it's rare to see amortizing loans. So developers look to the Federal Home Loan Bank's affordable housing program for loans. They look to their local home program. There are now state housing tax credits that can be awarded and then sold. So you can generate additional equity, much like how the equity works for the federal credits. There's fair financing now. And there was just a big win for the affordable housing industry when the 2024-2025 state budget was signed into law last week. Over the next four years, the fair program will increase from $70 million to $100 million a year. So that's significant. And that's a nice win for the affordable housing industry. Your tax credit allocating agency could... provide additional funds. I know PHFA, in addition to fair funds and some other funds, they have Penn Homes loan, Penn Homes, which is, I guess, the home financing that we mentioned again or above. And they also can offer a primary loan. And then you might have to defer part of your developer's fee. All these deals get a developer fee for it. putting the deal together to compensate the developer for the deal. And sometimes that can't all get paid out because it needs to be put back into the deal to close this funding gap. And then last but not least, tax exempt bond financing. So this could be a webinar all unto itself. It's pretty complicated. But if you go this route and you have tax exempt bond financing. You do get an automatic receipt of the 4% credits without allocation, which means you don't have to compete against other applications to get the tax credits. If you meet certain requirements, not the least of which is this 50% test that we mentioned in the services that we provide. And you must also meet minimum threshold criteria. So these tax credit applications all have a minimum threshold that you have to meet of certain things that the tax credit. agency is looking for. So to get the bond, the tax exempt bonds, to get the credits, if you're using tax exempt bonds, you still have to meet a minimum threshold criteria. So what is the tax credit process? First, you'll want to identify an area with a need for affordable housing and identify a property. You'll submit the tax credit application to PHFA. You'll receive a reservation of tax credits from PHFA, assuming your application is successful. You're likely going to need a carryover allocation agreement. You'll go to closing. You'll have a construction period. If you execute a carryover allocation, you'll need a 10% test, and we'll talk about that later in the slides here. You'll hit construction completion or placed in service. A cost certification is going to be required by your state allocating agency. And then your 8609s are issued. So to identify an area with a need, some things to consider, like is there a need for housing in the area that you want to develop? And what does the community support look like? I don't know if you've heard of NIMBY or NIMBYism, that N-I-M-B-Y stands for not in my backyard. We hear this far too often. We hear about communities opposing these low income housing tax credit developments in their neighborhood. And I think it's just lack of understanding about what they are. I actually experienced this firsthand last summer at a community picnic. I was out with my neighbors at the picnic. And somebody said, you know, hey, did you hear what's going in down by? such and such an area. And I'm like, well, yes, I did. Excuse me. And, you know, she was just all up in arms about it. And I was like, well, hey, you know, this is kind of what I do for a living. And, you know, I explained to her about low income housing tax credits and how the process works. And she just had no idea. She had no idea that it was just so positive. So I think it is just a lack of understanding about what these developments are. are. But at any rate, you want to make sure you have community support or you could have a lot of headaches in front of you. You want to make sure you have political support. You want to make sure that you have tenant population interest. You can build a great development, but you need to have people who want to live there. You want to make sure it's compatible with surrounding uses. And if you have a local growth plan that mentions affordable housing, like that is great. That is great if your local plan indicates that there is a need for affordable housing in the area. And neighborhood characteristics are also things to consider. If you're building a general population development, you know, are there schools nearby and how good are the schools? And, you know, if you're building a senior property, are there health care facilities nearby? Um, how close, how close is shopping? And what does transportation look like? Is it, is the area walkable? Can you walk to the grocery store? Can you walk to workplaces? Or is there a public transportation or a bus stop nearby? Or, you know, if you're in a more rural area, and you don't have, you can't walk somewhere, you don't have public transportation, excuse me, is your, is your property? offering van service or offering some sort of transportation. All things to consider. And, you know, something else that I found interesting just lately was when I was looking at PHFA's selection criteria, one of the things that's in there now is you can get a couple points for the PSSA scores, the high school PSSA scores in the district where you're building. If they're at a certain level. So just going back to my neighborhood characteristic comment about schools, I found that interesting. You want to identify a property. So again, a property in an area that is conducive to this. That property, you can either purchase it or you can execute a long term land lease. It could be vacant land. So you're going to do new construction. It could be. a vacant building or an existing building and you're going to rehabilitate it. You know, it's been interesting the different locations we've seen developed into affordable housing. I mean, we've seen warehouses, factories, a church, schools. My first experience with affordable housing, my first time visiting an affordable housing community was an old school building that was. rehabbed into apartments. And I got to go, this was very early in my career, I got to go to an open house. And I mean, I still remember this. We met the residents, it was a senior property, we met the residents, and they were calling their apartments their rooms, and they were referring to the entire building as their house. And I still have a picture of that up on the corner of my bulletin board here in my office. I'm looking at it now. And I'm You know, I knew then that this was a great industry and, you know, something that I wanted to be a part of during my career. And now when I'm driving by places, I'll see a building and if it looks like it could be affordable housing, I'll wonder, what's the zoning here? Has anybody thought about using this site as an affordable housing community? So to get the credits, you have to submit a tax credit application. And this is maybe two binders that are both inches thick that has in which you've compiled a variety of information that is required by the tax credit allocating agency. And a lot of work goes into these applications, but it also makes a great product. So, you know, after you've done this and then you get to go see it after there's people living there and you see how happy they are. You know, it kind of. makes your heart happy that you've gone through all this work but Painful nonetheless. So the first thing that you want to consider when submitting a low income housing tax credit application is the state's qualified allocation plan or QAP. So each state's QAP will indicate preferences and set asides to meet goals that they've set. You can currently read PHFA's draft of the 2025 QAP on their website. I have a copy of it printed off to read here on my desk or to have been glancing through it on my desk. So in that QAP, there is something called ranking criteria. So this is this is what your application is going to be scored on. So you want to make sure that your application scores well. You just you want to make sure that you're going to build what PHFA or the tax credit allocation. agency is looking for. So I looked at the 2025 QAP draft for Pennsylvania, and there were four main areas of points, and it was community and economic impact, resident population and services, development characteristics, and some bonus points for a complete application package. In those binders, after after you decide what you're going to build and is it in accordance with what the QAP says, what the tax credit allocating agency is looking for, some of the things that are going to go into those binders are a market study and a property appraisal, an environmental study, architectural plans. And and that's just that's just a few things. I mean, these are inches thick full of things, but like those things specifically. are not inexpensive. So it is costly to put an application together, but when you're funded, you can recoup most of those costs. You'll need to put together a development team, and their experience will go in the application. You'll need a construction cost estimate to help you build out your budget, and you'll need a letter of intent from an equity partner. So that equity partner is somebody who has looked at your application or looked at your numbers and they're saying, yeah, we like what they're going to build. This looks good. We're interested in being involved in buying the credits in the future. So the tax credit allocating agency scores the applications and then the top ranked applications will receive credits. The funding round that was just. announced the 2024 credits, if my math is right, it looked like 80 applications were submitted and 41 received awards. So that's basically one in two. I feel like it used to be worse. It used to be maybe one in three or one in four. I feel like the number of applications has been reduced. But yeah, so it looks like one in two applications were funded in the past funding. So next is this carryover allocation agreement that we mentioned before. A development typically has to be placed in service in the year that the tax credits are awarded by the tax credit allocating agency. So these these developments that just got an award last week would have to place their building in service, which means be done with construction, be able to move tenants in by December 31st of 2024. And I've never seen that happen. And in this day and age, I would think it's especially difficult because there's always it seems like there's always some part missing that you can't get a certificate of occupancy to say you're completed. So what happens is the partnership can execute a carryover allocation agreement, which simply extends the place in service date to the end of the second year, the end of the second calendar year after the reservation. So for deals that would execute. a carryover allocation agreement now for their 2024 credits they could place in service through the end of December of 2026. Next in the process you'll go to closing. Everybody will have an equity closing where the partnership agreement is executed and that equity starts to come in. You may have to close on your property if you've only had an option agreement up to this point. purchase the property. There may be a closing on some of the funding that you got. So you'll see funding coming in at closing. So polling question number three, what do you consider to be the most challenging part of developing low-income housing tax credit property? Is it the application process, the construction process, or the process of maintaining compliance after the building is occupied? This question is probably more for people who have developed, but if you haven't, what do you think it would be? Which maybe isn't a fair question because we've really only talked about the application. We always say that developing a low income housing tax credit property is not for the faint of heart. I think all three of these. All three of these times of the life of a property has its own complexities. And this will just give it a few more seconds. Oh, interesting. OK, so the application process, which this might be weighted because we've just talked about how difficult that is. And you might not know about construction and maintaining compliance yet. But, yeah, the application process is definitely difficult. Challenging. So moving on to the next slide, we're going to talk about the 10 percent test. If you've executed a carryover allocation agreement, a 10 percent test is required. So the IRS rule about a 10 percent test is it has to be met. within a year after your tax credit allocation. But PHFA or your state's tax credit allocating agency can set an earlier deadline. They can be more aggressive there. So to meet the 10% test, you have to have incurred 10% of your reasonably expected basis. And earlier, we talked about having three different periods of the tax credit life. There are also multiple types of basis of tax credits. And the first one that you'll encounter here is reasonably expected basis, which is land and depreciable cost. So at the prescribed date, you have to prove that your development has incurred costs of at least 10% in the land and your depreciable, like your construction costs, your architect, a certain amount of your developer fee, have you incurred 10%. It is critical that you meet this test, because if you don't meet this test, you can't keep your tax credits. A CPA certification is required. So next is the construction period. And that might construction may or may not have started when you have your 10 percent test done. If it has started, it's a lot easier to meet it than if you have to do the 10 percent test prior to construction. The average construction period is nine to 18 months. I think nine is probably on the low side. It might just depend on if you're doing rehab or new construction. And then during this time, the equity is typically paid in using draw requests throughout the construction period. And then there's usually two or three-ish draws after the construction period. And it also could be that you have a bridge loan, which you would be drawing on instead of equity. Sometimes the way deals are put together is that the equity will be delayed coming in to try to maybe increase your your pay in rate, because the longer that your investor can hold on to the month to their money, the happier they are. So if you get a bridge loan, you could potentially increase your equity pay in. But, you know, there's. There's that's a balancing act. So then we complete construction and we get a certificate of occupancy. And sometimes we see that there's confusion around the certificate of occupancy and when people can move in. So the rule is that if you get a temporary certificate of occupancy and you're allowed to move tenants in, that is your official place and service date for. starting PHFA's clock ticking. for when the cost certification is due. So you'll really want to be aware of deadlines and if that CO, if you're starting to move people in but you think you don't need to start gathering this information for the cost certification and place and service package, you might want to reach out to your consultant or your accountant to just make sure everybody's on the same page. And then obviously after construction is complete, lease up begins when you get that all-important certificate of occupancy. So what is the development cost certification? That is another topic that could have its own webinar. But in a nutshell, the cost certification is an accounting for the total development costs. So your construction costs, your architecture, engineering, your legal, your developers fee, reserves, PHFA fees. rent up, furnishings, all of those things are your total development costs. And that is what is summarized on the cost certification. And then PHFA or your tax credit allocating agency will use that cost certification to establish eligible basis. And then they use that number to complete the IRS form 8609, which we'll get to here in a minute. Each agency has their own template, but all are essentially doing the same thing. So Delaware's looks a little different from Pennsylvania's, looks a little different from Maryland's, but they're all getting to the same end goal of establishing eligible basis. This is required by the IRS, and again, a CPA is required to certify. So the 8609 is the all-important tax form. Once you get this, this is your golden ticket. And then you can you can celebrate and breathe a sigh of relief only to go into the compliance period and start up a whole new whole new set of rules to follow. But through the development period, once you get your 8609, this is a great thing. So the tax credit allocating agency issues it for each issue, one for each building in the development. So every building is identified by building identification number. So if you have five building identification numbers, then you have five buildings. Sometimes buildings can be grouped together. So you can have two buildings with one building identification number. So every building that has a building identification number will get an 8609. And it's also possible to have two for each building because Earlier, we talked about the 9% credit and the 4% credit. You'll get an 8609 for the 9% credit and an 8609 for the 4%. The tax credit allocating agency will complete part one. They'll send it to you to review and they'll look at, you can look at all their changes. And if you need to go back to them to clarify or discuss anything, you have a small window of time to do that. And then you must complete, the owner must complete part two. must be completed and signed by the owner. So this is part two of the 8609 is pretty critical because there are elections on there that require a private letter ruling from the IRS to change. So we recommend having either your accountant or your consultant review part two before signing it. And we also always recommend, and sometimes investors require it, we recommend that you have your investors sign off on it as well. And then once you're satisfied that it's okay, you can file it with the IRS. And I know PHFA requires a copy to be filed with them. And I would think every tax credit allocating agency would because they need it for compliance reasons. These elections on here dictate the compliance for the next 15 years or 30 years or whatever your extended use period is. So Just taking a look here at the 8609 to point out some highlights. Line 1B is where the amount of credits are being allocated. That goes on line 1B, so that's a pretty important line. Line 3B, we're going to talk about in a few slides back. Line 3B is if you got a basis boost. So we'll talk about that in a minute, but that's a line to pay attention to. And I'll refer back to that in a minute. Your place and service date there goes on line 5A. That's an important date. And then again, down looking at part two, that's what the owner will fill out and sign. And if you look at line 10, these elections are irrevocable. So you need to make sure these are correct. And we talked earlier about being able to defer your credits that you can. We're talking about when we could start the credit and compliance and extended use periods. We said it's either in the year the building is placed in service, which is the year construction is complete. You get that certificate of occupancy or you can defer the credits to the following year. And what typically dictates that is when is when these buildings are leased up. So you can't claim credits until you have people qualified people, people who follow that little IRS acronym living in your development. So that will dictate when whether you can take credits the first year or the second year. And I don't I'm I'm only aware of one time in my career that a building was leased up and they wanted to defer the credits to the next year. And I never really got a good explanation for that. And that's what we showed on the tax return. But I didn't understand that. Typically, you're going to want those credits as soon as you can, because you've promised the investor a certain timing of when the credits are going to come in. And a lot of partnership agreements will give you actually additional equity if you're delivering credits early. And most, if not all, partnership agreements will have a penalty in there if you're behind on delivering. So another important election there is line C, the minimum set aside. It used to be simple. We used to see everybody as a 40, 60 minimum set aside. But. Several years ago, the average income minimum set aside came in as well. So now we need to be clear about what box should be checked. So moving on to calculating the credits. We've talked about the process of how to get them. So now let's talk about how to calculate. So they're based on the cost of the construction or rehab. And then. the percentage of qualified low-income units that you have, and then that 9% or 4% tax credit rate that we talked about. So we've said eligible basis several times during the webinar. So eligible basis includes most depreciable costs. There's a few things that aren't included. Most notable is like a snowblower or a lawnmower, because that is movable equipment. I just use air quotes around movable equipment. I mean, it's not like a chair in your community room is not movable equipment. But you could, in theory, use that lawnmower to be mowing at other properties or other locations. So those are excluded from from eligible basis. But most appreciable costs are included. You know, actually, there are a few more costs. The cost certification fee, interestingly, is now. depreciable but it is not includable in eligible basis. So there are a few costs out there like that. But the big costs that it excludes are land and any associated costs, off-site improvements, building demolition, and this would be full building demolition. You can do some selective internal demolition which would be included in eligible basis. But just like everything else there's special rules around. But if you're demolishing a whole building, That's excluded. It's a land cost. Tax credit fees. So the fees that PHFA or your tax credit allocating agency charges you, they are not tax credit eligible, not includable in eligible basis. Rent up expenses, permanent financing fees, reserves, org fees, syndication fees, the compliance monitoring fee, which is another PHFA fee. reallocation expenses, and like I just mentioned, the cost certification. All these costs go on the cost certification, so they are part of total development costs, but they are not included in tax credit eligible business. So remember we talked about that line 3B of the IRS Form 8609 where I said you could get a boost. So your basis can be boosted by up to 130% if you are in a high-cost area, which is a difficult-to-develop area or qualified census tract that HUD puts out. There's lists of those so that you can you get an automatic hundred thirty percent boost because it's it's difficult, more costly to develop in those areas. And the tax credit allocating agency can give you a discretionary boost between one and 30 percent. So we talked about this equity, this equity gap or this funding gap earlier in the very beginning. If you have all of these loans, you've deferred as much of your developer fee as you can, and you just can't quite make it work, you can request that the agency give you a boost to your eligible basis, which then in turn allows you to calculate more tax credits to be sold to the investor. So this boost essentially lets you get additional equity into the deal. And then we also look at the applicable fraction. which is the percentage of the building that is treated as low income. And this is the lesser of the unit fraction or the floor space fraction. So this rule is in place. So if you have a mixed income property, you can't put all your low income. Well, you can, but if you put all your low income units in the one bedroom and have all the two bedrooms as market rate, a lot of your costs are going to be excluded. So to calculate that, you look at your unit fraction. And you would have if you have a 60 total units in your development and 50 of them are low income, your unit fraction is 83 percent. But 60,000, you have 60,000 low income square feet and your total square feet is 70,000. Then your floor space fraction is 86 percent. And the code says that you have to use the lower of the two. So your fraction then would be the 83 percent. So if you have 50 low income units and 50 total units, then your applicable fraction would be 100. And then the applicable percentage, as we said, is the 9 percent or the 4 percent. So running through a few examples here, I think I have three. Example one, this is a pretty straightforward or plain vanilla deal, as I like to say. I don't know that these even exist out there anymore. There aren't very many of them. The eligible basis is calculated at $8 million. So you're not in a high cost area. Your applicable fraction is 100% because you're 100% low income property. It's a new construction deal. So your applicable percentage is 9%. So your tax credits awarded are $720,000. You get those credits. for your 10-year credit period so that's 720 000 times 10 year you're 7.2 million your investor limited partner bought 99.99 of them so that's what's going to your investor and then they pay um a cents per dollar amount for each credit so in this example it's 95 i'm not sure you can get that on the market today i might have been a little a little high when i put that in there But your equity that you've raised off of this is $6.8 million. So that pay-in rate can be affected by a number of things, specifically the location of your deal, maybe the timing of the pay-in. Your eligible basis, in example two, same $8 million. But this time, you're in a designated... qualified census tract. So now your basis automatically goes up to 10.4 million. You've got 100% low income deal. It's a new construction. Your maximum credits are 936,000 per year. You take those over a 10 year period and now we're at 9.3 million of credits. You sell 99.99% to the investor at 95% at 95 cents on the dollar. So now you're looking at eight. point eight almost eight point nine million dollars so you see what that basis boost does is really increases the amount of credits that you get so you can sell more credits and get in more and then our final example is eight million dollar we got eight million dollar eligible basis we're not in a high cost area but our applicable fractions are only 83 because we've got a few market rate units in this deal So that reduces our qualified basis. down to 83% of our eligible basis. Our applicable percent is still 9%. We're still looking at new construction. So now we're looking at about $600,000 of credits. Over a 10-year period, you're looking at $6,099,999 going to the investor at your pay-in rate. So now all of a sudden, you're only getting equity of $5.6 million. And I would say, hey, In theory, those market rate units should be throwing off enough rent that you can afford to get amortizing debt to help find this. But I mean, whether or not that's really true, you know, I don't I don't know. We have seen we have, you know, a handful of clients who do have mixed income properties and I don't see amortizing debt. So they've done a good job at filling that gap some other way. So I've seen a few questions here, but let's go to our last polling question. So this is pretty simple. It's been a hot summer. What is your favorite summertime activity to keep going swimming, eating ice cream or relaxing in the air conditioning? For me, I'd have to say it's a good book, Relaxing in the Air Conditioning. And that's more evenly split, although I guess most people are like me and they just like to relax in the air conditioning. Let me just hit up a couple of questions here. One question is, have you ever seen a failed? 10% test. No, I have not. But if it looks like you're going to fail the 10% test, I think you have two options. And that is to either go to PHFA and ask them to let you swap your credits for a later year reservation or buy stored materials. So buy construction materials in advance. And there's a lot of rules. around that as well. And so it's just best if you can pass your 10% test with the costs that you have incurred and you don't have to worry about doing a swap or getting stored materials. So, but no, I have never seen a failed 10%. And how many deals get a discretionary boost? We see... that that's the boost that the tax credit allocating agency can give at their own discretion to help close that funding gap. I mean, I think we see a number of those. That is not a rare thing. So we do see that boost. I would say at least a third of the time. Just trying to wrap my brain for the last 86 or nines that I filled out. I think at least a third of the time we see a discretionary boost. Um, why wouldn't you claim credits in the placed in service year? Why would you wait? That's a great question. Um, again, I think it is just if, if your building is not fully leased up, then by IRS rules, you can't. So you would have to claim them in the year. You'd want to quote unquote defer them to the year after your building is placed in service. So if anybody else has any questions, feel free to enter them. Just my contact information should come up here if the screen will advance. And then just to remind you about our upcoming events, the July 25th webinar is coming up, which is the Affordable Housing Audit and Financial Statement. essentials. So if you're in the accounting world for affordable housing, that would be a great webinar. And then our sister company, M&L Compliance Management, will be doing a webinar on August 1st on acquisition rehab first-year credits. So again, in leasing up your properties, I think this is a great topic and I'm interested to tune in myself. And finally, we have AJ Johnson coming back in person on November 7th. So you'll want to mark your calendar. He will be at the Camp Hill Giant on November 7th. We do not have the topics set for that yet, but he'll be here in person and he always is a great presentation. So if nobody else has any questions, I want to thank you for joining us for today's webinar. If you have any further questions. regarding the presentation or anything I've talked about, please feel free to reach out. And a recording of today's presentation will be posted on our website and our social media sites in a few days. And if you requested CPE and answered the polling questions, those certificates will be sent out in the next few weeks. So thank you again for joining us and I hope you have a great afternoon.

The next webinar in the series will be affordable housing audit. and Financial Statement Essentials, which is airing on July 25th. And the final webinar in our series will be Acquisition Rehab First Year Credits airing on August 1st.

And we hope you'll join us for all three of these webinars. Macaulay & Asbury has been specializing in affordable housing since the late 1980s, and we provide a variety of accounting services to the industry that you can see on your screen here. such as annual audit and tax return preparation, 10% tests, 50% tests, development cost certifications, agreed upon procedures, and a variety of low-income housing tax credit consulting. We also provide property compliance consulting services through our affiliated company, M&L Compliance Management.

You can learn more about us and all of these services by visiting our website noted at the bottom of the slide. We'd love to talk to you about how we can help you or how we can work with your organization. So feel free to contact us. Our contact information is at the end of the presentation and you can also find it on our Web site.

If you have any questions for us during today's presentation, please submit them through the built in questions function in the webinar control panel. And I'll do my best to answer them either during or after the webinar. For those of you who are looking to obtain CPE credit for today's webinar, please keep in mind that there will be four polling questions throughout today's presentation and you'll need to answer all four of those questions. And they're not set up so there's any right or wrong answer.

You just need to answer all four of the questions to get your certificate and we'll email that out to you a few weeks after the webinar. So our first polling question here today is, do you wish to receive CPE for attending today's webinar? You could just select the radio button there, yes or no.

So it looks like the majority of people are on the webinar today to get CPE credit. So I guess that dashes my hopes a little bit that all these people just want to learn about low income housing tax credits because I enjoy talking about them. But I hope you'll learn a little something, even if you're just here for the CPE.

So our second polling question right away is how many low income housing tax credit deals have you participated in developing? zero, one to three or four or more. Again, if you could just select the radio button that applies to you. Macaulay and Asbury works with owners developing their first affordable housing community, as well as with owners who have dozens of developments that they've participated in and everywhere in between. All right.

So it looks like the majority of people here have not participated in any live tech deal. So being at a live tech one on one webinar makes a lot of sense. So today's webinar is broken up into four main parts. We're going to go over an overview of the program.

We're going to talk about what happens before the credits are awarded. We are going to talk about what happens when you have the credits. And we are going to go through examples of how to calculate. So just to give you an overview of the program, it was created in by the 1986 Tax Act. So it's been around for a while and the credits are received over a 10 year period.

And this is called the credit period. So the credit period is a 10 year period. over which the credits are claimed by the owner of the development. So in other words, this is the 10-year period when the credits are being shown on the owner's tax return.

And this period starts in the first year that the tax credits are claimed and runs for 10 consecutive years. That first year can be either when the building is placed in service, or you can defer the first year of your credit period until the year. after the building is placed in service.

And that determination is made on the IRS Form 8609, and we will talk about that a bit more later. So there's also a compliance period, which is different from the credit period. The compliance period begins the same year as the credit period that we just talked about and continues for an additional five years. So that's 15 years.

During the 15-year compliance period, the development must comply with various low-income housing tax credit requirements from Section 42 of the Internal Revenue Code to avoid losing tax credits. Losing tax credits is known as tax credit recapture. Recapture can be costly, so you'll want to keep your development in compliance with Section 42 of the code. I recently heard an acronym. that I like about the basic rules that must be maintained during this compliance period to stay in compliance and avoid recapture.

And ironically, that acronym is IRS. So I stands for income limits. The owner must rent to income qualified households.

R stands for rent limits. The owner must keep rents below required limits. And S stands for safety. The development must meet certain physical standards. So it's really important that after your development is up and running, that you have a good management agent or good management company to help you maintain compliance.

Because if you break any of those three rules, you will be facing recapture and it can be expensive. So if you just remember to follow the IRS in more ways than one. then you won't be in jeopardy of losing your tax credits.

So how long does an owner need to maintain compliance? That's where the extended use period comes in. So the compliance period is only 15 years. However, the owner must agree to provide affordable housing for at least an additional 15 years after the initial compliance. As with the credit and compliance periods, the extended use period begins with the credit period, which is in the year the first year credits are claimed on the tax return.

And they can continue or it continues for at least another 29 years. So PHFA is now requiring an even longer extended use period. I believe it's up to 40 years. Don't don't quote me on that, but it's more than 30. And I'm not sure about other states where they're at right now, but I think 30 is probably 30 is definitely the minimum.

And this limitation is reflected in a document that all of these low income housing tax credit partnerships execute, which is a restrictive covenant agreement. And it's a deep restriction. The tax credit allocating agency or in Pennsylvania, PHFA.

will continue to monitor the property through the extended use period. And during the extended use period, an owner cannot have tax credits taken away or recaptured, like we talked about earlier, so that's good. But if there are findings of noncompliance, PHFA or the allocating agency can still notify the owner of those findings, and there can be repercussions if those findings are not addressed timely. So even though you're out of the compliance period, you still want to make sure you're following all of the Section 42 rules. All right.

Now that we know about the credit period, the compliance period and extended use period, let's talk about what kind of credits are there. There's the 9% credit and the 4%. So the 9% credit is applicable to new construction or rehabilitation.

4% credits are used on your acquisition costs and if you have tax-exempt bonds. So it is possible to have 9% and 4% credits on the same deal, assuming that you've purchased. a building that you're going to rehab your your rehabilitation costs the the construction the architect that sort of thing is all um subject to the nine percent and um the four percent would then apply to your acquisition costs so acquiring the building and all the costs that they're associated with that building acquisition um would be eligible for the four percent and With the acquisition credits, as with everything else, there are a lot of rules around that to be eligible for them.

So that would be more of a LIHTC 201 webinar. And then the credit is calculated based on the eligible basis of the product. So there are a number of people involved in a tax credit deal. First and foremost is a tax credit allocating state agency or in Pennsylvania, that's PHFA. I mentioned that earlier when we were talking about the different periods.

So I might use those terms interchangeably. You'll have an owner slash developer. You may have a housing consultant. Some larger developers have their own development department.

in-house, so they typically don't use a housing consultant, but maybe newer or smaller developers will rely on a third-party housing consultant to help them put their application together and get them through the process until they're placed in service. There will also be an investor who will buy the credits. There's a contractor, an architect, a management agent, an attorney, and an accountant. And all that the Contractor, architect, management agent, attorney and accountant should all have LIHTC experience. You'll make your life a lot easier if you surround yourself with professionals who are experts in the LIHTC area.

And I recommend using McAuley and Asbury as your accountant. Just a little plug there. So let's talk about how exactly these low-income housing tax credits create a funding source. There's an ownership entity, which is typically a for-profit limited partnership or limited liability company.

And for today's purposes, I'm just going to refer to the ownership entity as a limited partner. So the developer or owner will compile and submit an application to the tax credit allocating agency during an open funding round. That application competes against other applications for an award of low-income housing tax credits. And that is no small feat.

PHFA just awarded the 2024 low-income housing tax credits last week. And if anybody on the webinar today received an allocation of credits, congratulations. Or I guess I should say an award of credits. Congratulations.

We know a lot of hard work went into securing those credits. And that work has just begun. After a partnership is awarded credit, they'll sell them and an ownership position in the partnership, which is typically 99.99% to an invested limited partner.

And in exchange for the credits, the ownership position, and the tax losses, which are actually a benefit to the investor, that investor limited partner contributes equity to the partnership. And I like to call this subsidized construction. Because that equity essentially takes the place of amortizing debt, which allows the partnership to keep rents lower because it doesn't have a monthly debt service payment like the owner of a market rate development would have.

So typical funding mix for these deals, investor equity. We just talked about that. I tried to look at a couple of deals. that from the 2023 round and what their funding mix looks like.

And it looked like the investor equity was running between 50 and 60 percent of the funding mix. So that seemed a little low to me these days. But, you know, let's just say 60 percent.

Then you've got a funding gap. So you've got to fill that gap with some kind of additional finance. And typically there is not enough cash flow in these deals to have amortizing debt.

Or if you do, it's very small. We rarely, we do sometimes, but it's rare to see amortizing loans. So developers look to the Federal Home Loan Bank's affordable housing program for loans. They look to their local home program. There are now state housing tax credits that can be awarded and then sold.

So you can generate additional equity, much like how the equity works for the federal credits. There's fair financing now. And there was just a big win for the affordable housing industry when the 2024-2025 state budget was signed into law last week.

Over the next four years, the fair program will increase from $70 million to $100 million a year. So that's significant. And that's a nice win for the affordable housing industry.

Your tax credit allocating agency could... provide additional funds. I know PHFA, in addition to fair funds and some other funds, they have Penn Homes loan, Penn Homes, which is, I guess, the home financing that we mentioned again or above. And they also can offer a primary loan.

And then you might have to defer part of your developer's fee. All these deals get a developer fee for it. putting the deal together to compensate the developer for the deal.

And sometimes that can't all get paid out because it needs to be put back into the deal to close this funding gap. And then last but not least, tax exempt bond financing. So this could be a webinar all unto itself.

It's pretty complicated. But if you go this route and you have tax exempt bond financing. You do get an automatic receipt of the 4% credits without allocation, which means you don't have to compete against other applications to get the tax credits. If you meet certain requirements, not the least of which is this 50% test that we mentioned in the services that we provide.

And you must also meet minimum threshold criteria. So these tax credit applications all have a minimum threshold that you have to meet of certain things that the tax credit. agency is looking for. So to get the bond, the tax exempt bonds, to get the credits, if you're using tax exempt bonds, you still have to meet a minimum threshold criteria. So what is the tax credit process?

First, you'll want to identify an area with a need for affordable housing and identify a property. You'll submit the tax credit application to PHFA. You'll receive a reservation of tax credits from PHFA, assuming your application is successful.

You're likely going to need a carryover allocation agreement. You'll go to closing. You'll have a construction period.

If you execute a carryover allocation, you'll need a 10% test, and we'll talk about that later in the slides here. You'll hit construction completion or placed in service. A cost certification is going to be required by your state allocating agency.

And then your 8609s are issued. So to identify an area with a need, some things to consider, like is there a need for housing in the area that you want to develop? And what does the community support look like? I don't know if you've heard of NIMBY or NIMBYism, that N-I-M-B-Y stands for not in my backyard.

We hear this far too often. We hear about communities opposing these low income housing tax credit developments in their neighborhood. And I think it's just lack of understanding about what they are.

I actually experienced this firsthand last summer at a community picnic. I was out with my neighbors at the picnic. And somebody said, you know, hey, did you hear what's going in down by?

such and such an area. And I'm like, well, yes, I did. Excuse me. And, you know, she was just all up in arms about it. And I was like, well, hey, you know, this is kind of what I do for a living.

And, you know, I explained to her about low income housing tax credits and how the process works. And she just had no idea. She had no idea that it was just so positive.

So I think it is just a lack of understanding about what these developments are. are. But at any rate, you want to make sure you have community support or you could have a lot of headaches in front of you. You want to make sure you have political support.

You want to make sure that you have tenant population interest. You can build a great development, but you need to have people who want to live there. You want to make sure it's compatible with surrounding uses.

And if you have a local growth plan that mentions affordable housing, like that is great. That is great if your local plan indicates that there is a need for affordable housing in the area. And neighborhood characteristics are also things to consider. If you're building a general population development, you know, are there schools nearby and how good are the schools?

And, you know, if you're building a senior property, are there health care facilities nearby? Um, how close, how close is shopping? And what does transportation look like? Is it, is the area walkable? Can you walk to the grocery store?

Can you walk to workplaces? Or is there a public transportation or a bus stop nearby? Or, you know, if you're in a more rural area, and you don't have, you can't walk somewhere, you don't have public transportation, excuse me, is your, is your property?

offering van service or offering some sort of transportation. All things to consider. And, you know, something else that I found interesting just lately was when I was looking at PHFA's selection criteria, one of the things that's in there now is you can get a couple points for the PSSA scores, the high school PSSA scores in the district where you're building.

If they're at a certain level. So just going back to my neighborhood characteristic comment about schools, I found that interesting. You want to identify a property. So again, a property in an area that is conducive to this.

That property, you can either purchase it or you can execute a long term land lease. It could be vacant land. So you're going to do new construction.

It could be. a vacant building or an existing building and you're going to rehabilitate it. You know, it's been interesting the different locations we've seen developed into affordable housing. I mean, we've seen warehouses, factories, a church, schools. My first experience with affordable housing, my first time visiting an affordable housing community was an old school building that was.

rehabbed into apartments. And I got to go, this was very early in my career, I got to go to an open house. And I mean, I still remember this.

We met the residents, it was a senior property, we met the residents, and they were calling their apartments their rooms, and they were referring to the entire building as their house. And I still have a picture of that up on the corner of my bulletin board here in my office. I'm looking at it now. And I'm You know, I knew then that this was a great industry and, you know, something that I wanted to be a part of during my career.

And now when I'm driving by places, I'll see a building and if it looks like it could be affordable housing, I'll wonder, what's the zoning here? Has anybody thought about using this site as an affordable housing community? So to get the credits, you have to submit a tax credit application.

And this is maybe two binders that are both inches thick that has in which you've compiled a variety of information that is required by the tax credit allocating agency. And a lot of work goes into these applications, but it also makes a great product. So, you know, after you've done this and then you get to go see it after there's people living there and you see how happy they are.

You know, it kind of. makes your heart happy that you've gone through all this work but Painful nonetheless. So the first thing that you want to consider when submitting a low income housing tax credit application is the state's qualified allocation plan or QAP. So each state's QAP will indicate preferences and set asides to meet goals that they've set.

You can currently read PHFA's draft of the 2025 QAP on their website. I have a copy of it printed off to read here on my desk or to have been glancing through it on my desk. So in that QAP, there is something called ranking criteria.

So this is this is what your application is going to be scored on. So you want to make sure that your application scores well. You just you want to make sure that you're going to build what PHFA or the tax credit allocation. agency is looking for.

So I looked at the 2025 QAP draft for Pennsylvania, and there were four main areas of points, and it was community and economic impact, resident population and services, development characteristics, and some bonus points for a complete application package. In those binders, after after you decide what you're going to build and is it in accordance with what the QAP says, what the tax credit allocating agency is looking for, some of the things that are going to go into those binders are a market study and a property appraisal, an environmental study, architectural plans. And and that's just that's just a few things.

I mean, these are inches thick full of things, but like those things specifically. are not inexpensive. So it is costly to put an application together, but when you're funded, you can recoup most of those costs.

You'll need to put together a development team, and their experience will go in the application. You'll need a construction cost estimate to help you build out your budget, and you'll need a letter of intent from an equity partner. So that equity partner is somebody who has looked at your application or looked at your numbers and they're saying, yeah, we like what they're going to build. This looks good.

We're interested in being involved in buying the credits in the future. So the tax credit allocating agency scores the applications and then the top ranked applications will receive credits. The funding round that was just.

announced the 2024 credits, if my math is right, it looked like 80 applications were submitted and 41 received awards. So that's basically one in two. I feel like it used to be worse.

It used to be maybe one in three or one in four. I feel like the number of applications has been reduced. But yeah, so it looks like one in two applications were funded in the past funding. So next is this carryover allocation agreement that we mentioned before.

A development typically has to be placed in service in the year that the tax credits are awarded by the tax credit allocating agency. So these these developments that just got an award last week would have to place their building in service, which means be done with construction, be able to move tenants in by December 31st of 2024. And I've never seen that happen. And in this day and age, I would think it's especially difficult because there's always it seems like there's always some part missing that you can't get a certificate of occupancy to say you're completed. So what happens is the partnership can execute a carryover allocation agreement, which simply extends the place in service date to the end of the second year, the end of the second calendar year after the reservation. So for deals that would execute.

a carryover allocation agreement now for their 2024 credits they could place in service through the end of December of 2026. Next in the process you'll go to closing. Everybody will have an equity closing where the partnership agreement is executed and that equity starts to come in. You may have to close on your property if you've only had an option agreement up to this point. purchase the property.

There may be a closing on some of the funding that you got. So you'll see funding coming in at closing. So polling question number three, what do you consider to be the most challenging part of developing low-income housing tax credit property? Is it the application process, the construction process, or the process of maintaining compliance after the building is occupied? This question is probably more for people who have developed, but if you haven't, what do you think it would be?

Which maybe isn't a fair question because we've really only talked about the application. We always say that developing a low income housing tax credit property is not for the faint of heart. I think all three of these.

All three of these times of the life of a property has its own complexities. And this will just give it a few more seconds. Oh, interesting.

OK, so the application process, which this might be weighted because we've just talked about how difficult that is. And you might not know about construction and maintaining compliance yet. But, yeah, the application process is definitely difficult.

Challenging. So moving on to the next slide, we're going to talk about the 10 percent test. If you've executed a carryover allocation agreement, a 10 percent test is required.

So the IRS rule about a 10 percent test is it has to be met. within a year after your tax credit allocation. But PHFA or your state's tax credit allocating agency can set an earlier deadline.

They can be more aggressive there. So to meet the 10% test, you have to have incurred 10% of your reasonably expected basis. And earlier, we talked about having three different periods of the tax credit life. There are also multiple types of basis of tax credits. And the first one that you'll encounter here is reasonably expected basis, which is land and depreciable cost.

So at the prescribed date, you have to prove that your development has incurred costs of at least 10% in the land and your depreciable, like your construction costs, your architect, a certain amount of your developer fee, have you incurred 10%. It is critical that you meet this test, because if you don't meet this test, you can't keep your tax credits. A CPA certification is required. So next is the construction period.

And that might construction may or may not have started when you have your 10 percent test done. If it has started, it's a lot easier to meet it than if you have to do the 10 percent test prior to construction. The average construction period is nine to 18 months. I think nine is probably on the low side. It might just depend on if you're doing rehab or new construction.

And then during this time, the equity is typically paid in using draw requests throughout the construction period. And then there's usually two or three-ish draws after the construction period. And it also could be that you have a bridge loan, which you would be drawing on instead of equity.

Sometimes the way deals are put together is that the equity will be delayed coming in to try to maybe increase your your pay in rate, because the longer that your investor can hold on to the month to their money, the happier they are. So if you get a bridge loan, you could potentially increase your equity pay in. But, you know, there's.

There's that's a balancing act. So then we complete construction and we get a certificate of occupancy. And sometimes we see that there's confusion around the certificate of occupancy and when people can move in.

So the rule is that if you get a temporary certificate of occupancy and you're allowed to move tenants in, that is your official place and service date for. starting PHFA's clock ticking. for when the cost certification is due.

So you'll really want to be aware of deadlines and if that CO, if you're starting to move people in but you think you don't need to start gathering this information for the cost certification and place and service package, you might want to reach out to your consultant or your accountant to just make sure everybody's on the same page. And then obviously after construction is complete, lease up begins when you get that all-important certificate of occupancy. So what is the development cost certification?

That is another topic that could have its own webinar. But in a nutshell, the cost certification is an accounting for the total development costs. So your construction costs, your architecture, engineering, your legal, your developers fee, reserves, PHFA fees.

rent up, furnishings, all of those things are your total development costs. And that is what is summarized on the cost certification. And then PHFA or your tax credit allocating agency will use that cost certification to establish eligible basis.

And then they use that number to complete the IRS form 8609, which we'll get to here in a minute. Each agency has their own template, but all are essentially doing the same thing. So Delaware's looks a little different from Pennsylvania's, looks a little different from Maryland's, but they're all getting to the same end goal of establishing eligible basis. This is required by the IRS, and again, a CPA is required to certify. So the 8609 is the all-important tax form.

Once you get this, this is your golden ticket. And then you can you can celebrate and breathe a sigh of relief only to go into the compliance period and start up a whole new whole new set of rules to follow. But through the development period, once you get your 8609, this is a great thing.

So the tax credit allocating agency issues it for each issue, one for each building in the development. So every building is identified by building identification number. So if you have five building identification numbers, then you have five buildings.

Sometimes buildings can be grouped together. So you can have two buildings with one building identification number. So every building that has a building identification number will get an 8609. And it's also possible to have two for each building because Earlier, we talked about the 9% credit and the 4% credit.

You'll get an 8609 for the 9% credit and an 8609 for the 4%. The tax credit allocating agency will complete part one. They'll send it to you to review and they'll look at, you can look at all their changes.

And if you need to go back to them to clarify or discuss anything, you have a small window of time to do that. And then you must complete, the owner must complete part two. must be completed and signed by the owner. So this is part two of the 8609 is pretty critical because there are elections on there that require a private letter ruling from the IRS to change.

So we recommend having either your accountant or your consultant review part two before signing it. And we also always recommend, and sometimes investors require it, we recommend that you have your investors sign off on it as well. And then once you're satisfied that it's okay, you can file it with the IRS. And I know PHFA requires a copy to be filed with them. And I would think every tax credit allocating agency would because they need it for compliance reasons.

These elections on here dictate the compliance for the next 15 years or 30 years or whatever your extended use period is. So Just taking a look here at the 8609 to point out some highlights. Line 1B is where the amount of credits are being allocated. That goes on line 1B, so that's a pretty important line.

Line 3B, we're going to talk about in a few slides back. Line 3B is if you got a basis boost. So we'll talk about that in a minute, but that's a line to pay attention to. And I'll refer back to that in a minute. Your place and service date there goes on line 5A.

That's an important date. And then again, down looking at part two, that's what the owner will fill out and sign. And if you look at line 10, these elections are irrevocable.

So you need to make sure these are correct. And we talked earlier about being able to defer your credits that you can. We're talking about when we could start the credit and compliance and extended use periods.

We said it's either in the year the building is placed in service, which is the year construction is complete. You get that certificate of occupancy or you can defer the credits to the following year. And what typically dictates that is when is when these buildings are leased up. So you can't claim credits until you have people qualified people, people who follow that little IRS acronym living in your development. So that will dictate when whether you can take credits the first year or the second year.

And I don't I'm I'm only aware of one time in my career that a building was leased up and they wanted to defer the credits to the next year. And I never really got a good explanation for that. And that's what we showed on the tax return. But I didn't understand that. Typically, you're going to want those credits as soon as you can, because you've promised the investor a certain timing of when the credits are going to come in.

And a lot of partnership agreements will give you actually additional equity if you're delivering credits early. And most, if not all, partnership agreements will have a penalty in there if you're behind on delivering. So another important election there is line C, the minimum set aside. It used to be simple.

We used to see everybody as a 40, 60 minimum set aside. But. Several years ago, the average income minimum set aside came in as well. So now we need to be clear about what box should be checked. So moving on to calculating the credits.

We've talked about the process of how to get them. So now let's talk about how to calculate. So they're based on the cost of the construction or rehab. And then.

the percentage of qualified low-income units that you have, and then that 9% or 4% tax credit rate that we talked about. So we've said eligible basis several times during the webinar. So eligible basis includes most depreciable costs. There's a few things that aren't included. Most notable is like a snowblower or a lawnmower, because that is movable equipment.

I just use air quotes around movable equipment. I mean, it's not like a chair in your community room is not movable equipment. But you could, in theory, use that lawnmower to be mowing at other properties or other locations.

So those are excluded from from eligible basis. But most appreciable costs are included. You know, actually, there are a few more costs. The cost certification fee, interestingly, is now. depreciable but it is not includable in eligible basis.

So there are a few costs out there like that. But the big costs that it excludes are land and any associated costs, off-site improvements, building demolition, and this would be full building demolition. You can do some selective internal demolition which would be included in eligible basis. But just like everything else there's special rules around.

But if you're demolishing a whole building, That's excluded. It's a land cost. Tax credit fees. So the fees that PHFA or your tax credit allocating agency charges you, they are not tax credit eligible, not includable in eligible basis.

Rent up expenses, permanent financing fees, reserves, org fees, syndication fees, the compliance monitoring fee, which is another PHFA fee. reallocation expenses, and like I just mentioned, the cost certification. All these costs go on the cost certification, so they are part of total development costs, but they are not included in tax credit eligible business.

So remember we talked about that line 3B of the IRS Form 8609 where I said you could get a boost. So your basis can be boosted by up to 130% if you are in a high-cost area, which is a difficult-to-develop area or qualified census tract that HUD puts out. There's lists of those so that you can you get an automatic hundred thirty percent boost because it's it's difficult, more costly to develop in those areas. And the tax credit allocating agency can give you a discretionary boost between one and 30 percent.

So we talked about this equity, this equity gap or this funding gap earlier in the very beginning. If you have all of these loans, you've deferred as much of your developer fee as you can, and you just can't quite make it work, you can request that the agency give you a boost to your eligible basis, which then in turn allows you to calculate more tax credits to be sold to the investor. So this boost essentially lets you get additional equity into the deal.

And then we also look at the applicable fraction. which is the percentage of the building that is treated as low income. And this is the lesser of the unit fraction or the floor space fraction. So this rule is in place. So if you have a mixed income property, you can't put all your low income.

Well, you can, but if you put all your low income units in the one bedroom and have all the two bedrooms as market rate, a lot of your costs are going to be excluded. So to calculate that, you look at your unit fraction. And you would have if you have a 60 total units in your development and 50 of them are low income, your unit fraction is 83 percent.

But 60,000, you have 60,000 low income square feet and your total square feet is 70,000. Then your floor space fraction is 86 percent. And the code says that you have to use the lower of the two. So your fraction then would be the 83 percent. So if you have 50 low income units and 50 total units, then your applicable fraction would be 100. And then the applicable percentage, as we said, is the 9 percent or the 4 percent.

So running through a few examples here, I think I have three. Example one, this is a pretty straightforward or plain vanilla deal, as I like to say. I don't know that these even exist out there anymore.

There aren't very many of them. The eligible basis is calculated at $8 million. So you're not in a high cost area.

Your applicable fraction is 100% because you're 100% low income property. It's a new construction deal. So your applicable percentage is 9%. So your tax credits awarded are $720,000. You get those credits.

for your 10-year credit period so that's 720 000 times 10 year you're 7.2 million your investor limited partner bought 99.99 of them so that's what's going to your investor and then they pay um a cents per dollar amount for each credit so in this example it's 95 i'm not sure you can get that on the market today i might have been a little a little high when i put that in there But your equity that you've raised off of this is $6.8 million. So that pay-in rate can be affected by a number of things, specifically the location of your deal, maybe the timing of the pay-in. Your eligible basis, in example two, same $8 million. But this time, you're in a designated...

qualified census tract. So now your basis automatically goes up to 10.4 million. You've got 100% low income deal.

It's a new construction. Your maximum credits are 936,000 per year. You take those over a 10 year period and now we're at 9.3 million of credits.

You sell 99.99% to the investor at 95% at 95 cents on the dollar. So now you're looking at eight. point eight almost eight point nine million dollars so you see what that basis boost does is really increases the amount of credits that you get so you can sell more credits and get in more and then our final example is eight million dollar we got eight million dollar eligible basis we're not in a high cost area but our applicable fractions are only 83 because we've got a few market rate units in this deal So that reduces our qualified basis.

down to 83% of our eligible basis. Our applicable percent is still 9%. We're still looking at new construction. So now we're looking at about $600,000 of credits.

Over a 10-year period, you're looking at $6,099,999 going to the investor at your pay-in rate. So now all of a sudden, you're only getting equity of $5.6 million. And I would say, hey, In theory, those market rate units should be throwing off enough rent that you can afford to get amortizing debt to help find this.

But I mean, whether or not that's really true, you know, I don't I don't know. We have seen we have, you know, a handful of clients who do have mixed income properties and I don't see amortizing debt. So they've done a good job at filling that gap some other way.

So I've seen a few questions here, but let's go to our last polling question. So this is pretty simple. It's been a hot summer.

What is your favorite summertime activity to keep going swimming, eating ice cream or relaxing in the air conditioning? For me, I'd have to say it's a good book, Relaxing in the Air Conditioning. And that's more evenly split, although I guess most people are like me and they just like to relax in the air conditioning.

Let me just hit up a couple of questions here. One question is, have you ever seen a failed? 10% test. No, I have not. But if it looks like you're going to fail the 10% test, I think you have two options.

And that is to either go to PHFA and ask them to let you swap your credits for a later year reservation or buy stored materials. So buy construction materials in advance. And there's a lot of rules.

around that as well. And so it's just best if you can pass your 10% test with the costs that you have incurred and you don't have to worry about doing a swap or getting stored materials. So, but no, I have never seen a failed 10%. And how many deals get a discretionary boost?

We see... that that's the boost that the tax credit allocating agency can give at their own discretion to help close that funding gap. I mean, I think we see a number of those. That is not a rare thing.

So we do see that boost. I would say at least a third of the time. Just trying to wrap my brain for the last 86 or nines that I filled out. I think at least a third of the time we see a discretionary boost.

Um, why wouldn't you claim credits in the placed in service year? Why would you wait? That's a great question. Um, again, I think it is just if, if your building is not fully leased up, then by IRS rules, you can't. So you would have to claim them in the year.

You'd want to quote unquote defer them to the year after your building is placed in service. So if anybody else has any questions, feel free to enter them. Just my contact information should come up here if the screen will advance.

And then just to remind you about our upcoming events, the July 25th webinar is coming up, which is the Affordable Housing Audit and Financial Statement. essentials. So if you're in the accounting world for affordable housing, that would be a great webinar. And then our sister company, M&L Compliance Management, will be doing a webinar on August 1st on acquisition rehab first-year credits.

So again, in leasing up your properties, I think this is a great topic and I'm interested to tune in myself. And finally, we have AJ Johnson coming back in person on November 7th. So you'll want to mark your calendar. He will be at the Camp Hill Giant on November 7th. We do not have the topics set for that yet, but he'll be here in person and he always is a great presentation.

So if nobody else has any questions, I want to thank you for joining us for today's webinar. If you have any further questions. regarding the presentation or anything I've talked about, please feel free to reach out. And a recording of today's presentation will be posted on our website and our social media sites in a few days.

And if you requested CPE and answered the polling questions, those certificates will be sent out in the next few weeks. So thank you again for joining us and I hope you have a great afternoon.

Transcript for:Understanding Low-Income Housing Tax Credits

Transcript for:
Understanding Low-Income Housing Tax Credits