The Low-Income Housing Tax Credit (LIHTC) is a 15 year credit, which is typically recognized over a 10-11 year period.
For the first year of the credit period, there is rarely a full year allocation of LIHTC. Internal Revenue Code (IRC) Section 42(f)(2) discusses the special rules for the 1st year of the credit period. As part of these rules, a reduced applicable fraction based on the qualified lease up of the building must be calculated. Any LIHTC disallowed for year 1 under this reduced applicable fraction is pushed out and allowed in the first taxable year after the 10 year credit period, creating a year 11 credit.
Because investor equity pricing is often adjusted based on the amount of the first year credits, it is imperative that a project maximize the amount of the first year credits. The following are some tips to help a project maximize first year credits.
A building is eligible for LIHTC once it has been placed in service for a full month. For example, if a building is placed in service on June 1, then the building is first eligible for credits in the month of June. However, if a building were placed in service on June 2, the second day of the month, then the building does not become eligible for credits until the month of July (i.e. its first full month of being placed in service). This distinction is important since the applicable fraction is a proration based on months occupied over the full year. Knowing this, we recommend to our clients to push to have buildings placed in service either late in the month or on the first day of the month. Buildings placed in service early in a month, but after the first day, lose nearly full month of eligibility.
Any unit occupied by a qualified tenant during the first eligible month, even if the unit were occupied on the last day of that month is deemed to be qualified for the entire month. To magnify the importance of the placed in-service date and subsequently the first eligible month of credits consider situations from the two scenarios above. In scenario 1, a building is placed in service on June 1, and has a qualified tenant move in on June 30. That unit is deemed to be qualified occupied for the entire month of June. Whereas in scenario 2, the building is placed in service on June 2. The first eligible month for credits is July. Therefore, even if a qualified tenant were to occupy a unit on June 2, the unit still does not become qualified occupied until July.
A sound strategy that may be employed is the timing of moving qualified tenants into the units. So many times, we see these tenants occupy the units on the first day of a month. During the period of initial lease up, the month of move in is key. In Scenario 1 above, if a qualified tenant occupied a unit on July 1, the unit would first become qualified for the month of July. If however, that same tenant occupied the unit on June 30, one day earlier, the unit would first become qualified for the month of June. The result is that moving a tenant in one day earlier would add a month of qualification to the reduced applicable fraction and would assist in maximizing the first year credit amount.
What is the importance of maximizing the LIHTC in the first year you might ask? After all, credits disallowed in year 1 because of the reduced application fraction are not lost, they are simply deferred until year 11. It is a time value of money thing, a dollar today is worth more than a dollar eleven years from now. Investors in a LIHTC project will generally include adjusters to their capital contributions (see our December 14, 2017 newsletter article for a discussion on adjusters) based on timing and amount of credits received in the structuring of their investment in the project.
The Sherbert Group has developed procedures to analyze the first year LIHTC calculation, and we are experienced with looking for ways to maximize the allowable credit for the 1st year of the credit period. Please contact us if we can be of assistance with calculating your allowable credit for the 1st year of the LIHTC period at email@example.com.