What is the Low-Income Housing Tax Credit (LIHTC) and its primary purpose?

The LIHTC, authorized by IRC Section 42, is a federal tax credit designed to incentivize the development and rehabilitation of affordable rental housing for low-income individuals. It provides investors with a dollar-for-dollar reduction in their federal income tax liability. Its primary purpose is to increase the supply of safe, decent, and affordable housing across the United States.

Who qualifies to receive the LIHTC as an investor?

Generally, investors in qualified low-income housing projects, typically corporations or partnerships, are eligible to receive the LIHTC. These investors provide equity financing for the development or rehabilitation of the housing. The credit is passed through to the investors based on their ownership interest in the project.

What types of housing projects are eligible for LIHTC?

Eligible projects must meet specific low-income occupancy and rent restrictions for a minimum of 30 years, as outlined in IRC Section 42(h)(6). These include new construction or substantial rehabilitation of residential rental property. The property must be part of a qualified low-income housing project allocated credits by a state housing agency.

What are the two main types of LIHTC credits available?

There are two main types: the 9% credit (often called the 'new construction' or 'acquisition and rehabilitation' credit) and the 4% credit (often called the 'acquisition' or 'federally subsidized' credit). The 9% credit is more competitive and typically applies to projects without other federal subsidies, while the 4% credit is for projects with federal subsidies like tax-exempt bonds, as per IRC Section 42(b).

How is the amount of the LIHTC calculated for a project?

The credit amount is calculated based on the project's 'qualified basis,' which is the eligible basis multiplied by the applicable fraction (percentage of low-income units). This qualified basis is then multiplied by the applicable credit rate (either 9% or 4%). The credit is claimed annually over a 10-year period, as described in IRC Section 42(a) and (b).

What is the 'qualified basis' and how does it impact the credit?

The 'qualified basis' is a crucial component, representing the portion of the project's eligible basis attributable to low-income units. It's calculated by multiplying the eligible basis (costs of construction/rehabilitation) by the applicable fraction (low-income unit percentage). A higher qualified basis directly translates to a larger annual tax credit, as per IRC Section 42(c).

What IRS forms are required to claim the LIHTC?

Investors typically claim the LIHTC using Form 8609, Low-Income Housing Credit Allocation and Certification, which is issued by the state housing agency. This form is then attached to Form 3800, General Business Credit, which summarizes all general business credits. Partnerships and S corporations also use Schedule K-1 to pass the credit through to their partners/shareholders.

What is the 'compliance period' and 'extended use period' for LIHTC projects?

The 'compliance period' is a 15-year period during which the project must adhere to all LIHTC requirements, as per IRC Section 42(i)(1). Following this, there's an 'extended use period' of at least 15 additional years (totaling 30 years) where the low-income restrictions generally remain in effect. Failure to comply during these periods can lead to credit recapture.

What happens if a LIHTC project fails to meet compliance requirements?

Failure to meet compliance requirements, such as exceeding income limits or rent restrictions, can result in the recapture of previously claimed tax credits. This recapture is calculated with interest and can be a significant financial penalty for investors. IRC Section 44 provides details on the recapture provisions.

Are there any dollar limits on the amount of LIHTC a state can allocate?

Yes, each state receives an annual LIHTC allocation based on its population, as outlined in IRC Section 42(h)(3)(C). For 2023, the per capita amount was $2.75, with a minimum allocation of $3,185,000. This cap ensures a controlled distribution of credits across states.

Can the LIHTC be combined with other federal housing subsidies?

Yes, the LIHTC can be combined with other federal housing subsidies, such as Section 8 rental assistance or HOME Investment Partnerships Program funds. However, the presence of certain federal subsidies can affect the applicable credit rate, often reducing it to the 4% credit, as specified in IRC Section 42(b)(1)(B).

What are common mistakes made when claiming the LIHTC?

Common mistakes include miscalculating the qualified basis, failing to properly document tenant income and rent, and not adhering to the compliance period requirements. Inaccurate record-keeping and misunderstanding the complex rules of IRC Section 42 are frequent pitfalls. These errors can lead to credit recapture or disallowance.

What are some audit red flags for LIHTC projects?

Audit red flags include inconsistent tenant income certifications, discrepancies between reported rents and actual rents, and inadequate documentation of eligible basis. High vacancy rates in low-income units or significant changes in ownership without proper notification can also trigger IRS scrutiny. Refer to IRS Publication 535 for general business credit audit guidance.

How does the LIHTC interact with the passive activity loss rules?

The LIHTC is generally exempt from the passive activity loss rules, meaning investors can use the credit to offset tax on active income, not just passive income. This makes the credit particularly attractive to high-income investors. This exception is specifically provided under IRC Section 42(k).

What are the potential changes to the LIHTC program in 2026?

While specific legislative changes are always subject to congressional action, discussions often revolve around increasing the state allocation cap, adjusting the 4% credit floor, and simplifying compliance. The 'minimum 4% credit rate' for certain bond-financed projects was made permanent in 2020, but other aspects could be revisited. Tax legislation is dynamic, so monitoring legislative proposals is key.

Can individuals directly claim the LIHTC?

No, individuals typically do not directly claim the LIHTC. The credit is usually allocated to a partnership or S corporation that develops or rehabilitates the housing. Individual investors then receive their share of the credit through their ownership interest in these entities, reported on Schedule K-1.

What is the role of state housing agencies in the LIHTC program?

State housing agencies play a crucial role by allocating the limited LIHTC credits to eligible projects within their state. They also monitor project compliance with federal and state regulations throughout the compliance and extended use periods. These agencies issue Form 8609, which is essential for claiming the credit.

Is there a recapture period for the LIHTC, and how does it work?

Yes, there is a recapture period of 15 years, coinciding with the compliance period. If a project fails to meet the low-income housing requirements during this time, a portion of the previously claimed credits, plus interest, must be repaid to the IRS. IRC Section 42(j) details these recapture provisions.

Where can I find more detailed information and guidance on the LIHTC?

For comprehensive guidance, refer to IRC Section 42 and its accompanying Treasury Regulations. The IRS also publishes various notices and revenue rulings related to LIHTC. Additionally, state housing finance agencies and professional tax advisors specializing in affordable housing can provide invaluable project-specific information and assistance.

Low-Income Housing Tax Credit (LIHTC) — 2026 Guide

Q: What are the income and rent restrictions for tenants in LIHTC projects?

Tenants must have incomes at or below 50% or 60% of the Area Median Gross Income (AMGI), depending on the project's election (IRC Section 42(g)(1)). Rents, including utilities, cannot exceed 30% of the imputed income for a household at the elected AMGI level. These restrictions ensure the housing remains affordable for its target population.

Overview: The Low-Income Housing Tax Credit (LIHTC)

The Low-Income Housing Tax Credit (LIHTC) is a crucial federal program designed to incentivize the development and rehabilitation of affordable rental housing for low- and moderate-income households across the United States. Enacted as part of the 1986 Tax Reform Act, the LIHTC has become the nation's primary tool for creating and preserving affordable housing, generating millions of units since its inception [1, 2].

This guide provides a comprehensive overview of the LIHTC for the 2026 tax year, detailing its purpose, eligibility requirements, claiming procedures, current limits, common pitfalls, and relevant IRS code sections. Our aim is to equip developers, investors, and other stakeholders with the knowledge necessary to navigate this complex yet rewarding tax incentive effectively.

What is the Low-Income Housing Tax Credit?

The LIHTC operates by providing a dollar-for-dollar reduction in federal tax liability to investors who finance the construction or rehabilitation of affordable rental housing. The federal government allocates these tax credits to state and territorial housing agencies, which then award them to private developers through a competitive application process. Developers typically sell these credits to investors to secure the necessary equity for their projects [1].

In return for these credits, developers commit to reserving a certain percentage of units for low-income tenants and adhering to specific rent restrictions for an extended period, usually 15 to 30 years. This mechanism effectively harnesses private capital to address the critical shortage of affordable housing, making it a cornerstone of national housing policy [1, 2].

Who Qualifies for LIHTC?

Qualification for the LIHTC involves several key criteria primarily related to the property itself and the income levels of its tenants. While many types of rental properties can be LIHTC eligible, including apartment buildings and multi-unit homes, the core requirements revolve around tenant income and rent affordability [1].

Tenant Income Requirements

To qualify for LIHTC, projects must meet one of the following minimum set-aside tests [1]:

20-50 Test: At least 20% of the units must be occupied by tenants whose income is 50% or less of the Area Median Income (AMI), adjusted for family size.
40-60 Test: At least 40% of the units must be occupied by tenants whose income is 60% or less of the AMI, adjusted for family size.
Average Income Test: At least 40% of the units are occupied by tenants with income averaging no more than 60% of AMI, and no units are occupied by tenants with income greater than 80% of AMI.

These income limits are determined annually by the Department of Housing and Urban Development (HUD) and vary by location [1].

Gross Rent Test

In addition to income restrictions, the gross rent charged for LIHTC units (including utilities) cannot exceed 30% of the imputed income for a household at the qualifying income level (either 50% or 60% of AMI, depending on the set-aside test chosen) [1].

Compliance Period

LIHTC projects are subject to a mandatory 15-year compliance period, during which the income and rent restrictions must be maintained. State housing agencies often impose an extended compliance period, typically totaling 30 years, to ensure long-term affordability [1]. Failure to comply can result in the recapture of previously claimed tax credits.

How to Claim the Low-Income Housing Tax Credit

Claiming the LIHTC involves a multi-step process that begins with the allocation of credits by a state housing agency and culminates in filing specific forms with the IRS. The primary forms involved are Form 8609 and Form 8586 [3, 4].

Form 8609, Low-Income Housing Credit Allocation and Certification

Form 8609 is issued by the state housing credit agency to the building owner. A separate Form 8609 is required for each qualified building within a project. This form certifies the allocation of the housing credit and provides crucial information about the building and the credit amount. Owners must obtain this form from their respective housing credit agency [3].

Form 8586, Low-Income Housing Credit

Taxpayers (investors) use Form 8586 to calculate the amount of the low-income housing credit they can claim for the tax year. This form summarizes the credits for qualifying buildings and is filed with the taxpayer's federal income tax return. While Form 8609 is for the building owner, Form 8586 is for the investor claiming the credit [4].

Process Overview

Credit Allocation: Developers apply to their state housing agency for LIHTC allocation. If approved, the agency issues Form 8609 for each building.
Project Development: The project is constructed or rehabilitated, and units are leased to qualifying low-income tenants.
Placed in Service: Once the building is ready for occupancy and meets all requirements, it is considered “placed in service.”
Claiming the Credit: Investors claim the credit annually over a 10-year period using Form 8586, supported by the information on Form 8609 [3, 4].

2026 LIHTC Limits, Amounts, and Rates

The LIHTC program involves several key financial parameters that are subject to annual adjustments and specific rules for the 2026 tax year. These include the credit rates, state allocation limits, and income limits for tenants.

Credit Rates

There are generally two types of LIHTC credits, often referred to as the 9% and 4% credits [1]:

9% Credit (New Construction/Substantial Rehabilitation): This credit is typically used for new construction or substantial rehabilitation projects that are not financed with tax-exempt bonds. The actual rate is set monthly by the IRS to yield a present value of 70% of the qualified basis. For 2026, the minimum applicable credit percentage for certain buildings is 4% [3].
4% Credit (Acquisition/Tax-Exempt Bond Financed): This credit is for projects involving the acquisition of existing buildings or new construction/rehabilitation financed with tax-exempt bonds. The actual rate is set monthly by the IRS to yield a present value of 30% of the qualified basis. The 2026 program expansion permanently lowers the private activity bond financing threshold from 50% to 25% for 4% credits [5].

State Allocation Limits

Each state receives an annual allocation of LIHTCs based on its population. For 2025, the per capita allocation was $3.00, with a minimum small state allocation of $3,455,000 [2]. These figures are adjusted annually for inflation. For 2026, the state Private Activity Bond (PAB) cap is $135 times the state's population, with a small state minimum of $397,625,000 [6]. States then competitively allocate these credits to developers based on their Qualified Allocation Plans (QAPs) [1].

Income and Rent Limits

Tenant income limits are set by HUD and are based on a percentage of the Area Median Income (AMI), adjusted for family size. These limits are updated annually and vary significantly by metropolitan area and non-metropolitan county. Gross rents (including an allowance for utilities) cannot exceed 30% of the imputed income for a household at the qualifying income level [1].

Common Mistakes that Cost Taxpayers Money

Navigating the complexities of the LIHTC program can be challenging, and several common mistakes can lead to significant financial penalties or loss of credits. Awareness of these pitfalls is crucial for successful project compliance.

Non-Compliance with Income and Rent Restrictions: The most frequent and costly mistake is failing to maintain the required tenant income and rent restrictions throughout the compliance period. Even minor deviations can trigger credit recapture [1].
Inadequate Recordkeeping: Proper documentation is paramount. Failure to maintain accurate records of tenant incomes, rents, and property expenses can lead to audit issues and credit disallowance.
Failure to Meet Placed-in-Service Deadlines: Developers must adhere to strict deadlines for placing buildings in service after receiving a credit allocation. Extensions may be available in certain circumstances, such as qualified disaster zones, but these must be properly documented and approved [3].
Misunderstanding Qualified Basis Calculations: Incorrectly calculating the qualified basis of a project can lead to an overstatement of credits and subsequent recapture. This often involves errors in determining eligible basis or the percentage of low-income units [1].
Lack of Ongoing Compliance Monitoring: LIHTC projects require continuous monitoring to ensure ongoing compliance with all program rules. Many owners fail to implement robust internal controls or engage experienced compliance professionals, leading to inadvertent violations.
Ignoring State QAP Requirements: Each state has its own Qualified Allocation Plan (QAP) that outlines specific criteria for awarding credits and ongoing compliance. Developers must thoroughly understand and adhere to their state's QAP, as non-compliance can jeopardize credit allocations [1].
Improper Use of Form 8609 and 8586: Errors in completing or filing Form 8609 (issued by the housing agency) or Form 8586 (used by the taxpayer to claim the credit) can result in delays or disallowance of credits. It is essential to follow IRS instructions meticulously [3, 4].

IRS Code Section Reference

The Low-Income Housing Tax Credit is primarily governed by Section 42 of the Internal Revenue Code [3]. This section outlines the statutory framework for the credit, including eligibility requirements, credit amounts, compliance periods, and recapture provisions. Developers and investors should consult IRS Section 42 and its accompanying regulations for the definitive legal guidance on the LIHTC program.

Ready to Optimize Your Affordable Housing Investments?

The Low-Income Housing Tax Credit offers significant opportunities for investors and developers committed to providing affordable housing. However, its intricate rules and compliance requirements demand expert guidance. Don't leave potential tax savings on the table or risk costly mistakes.

At Uncle Kam, our senior tax strategists and CPAs specialize in navigating complex tax incentives like the LIHTC. We can help you understand eligibility, optimize your credit claims, ensure compliance, and maximize the financial benefits of your affordable housing projects.

Book a consultation with Uncle Kam today to discuss your LIHTC strategy and secure your financial future.

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