More Tax Credits In Big Beautiful Bill

The Real Estate Espresso Podcast

More Tax Credits In Big Beautiful Bill

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More Tax Credits In Big Beautiful Bill

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host Victor Menasce.

On today’s show we’re talking about access to the US federal low income housing tax credits. There’s a recent change that frankly has not been making headlines. The low income housing tax credit program is the primary federal program for encouraging development and preservation of affordable rental housing access. But there’s a link between the bonding capacity to the low income housing tax credits and recent legislation has changed the requirements.

The linkage revolves primarily around the 4% low income housing tax credit. These are also known as the as-of-right or volume cap credits. There’s two types of low income housing tax credits. There are 9% low income house credits that are competitive. These are allocated by state household finance agencies through a highly competitive process based on each state’s annual allocation authority from the federal government. Projects receiving 9% credits typically do not require tax exempt bond financing. The 4% low income housing tax credits are known as the non competitive or as-of-right.

These credits are automatically available for projects where at least a certain percentage, historically 50% of the development’s qualified basis meaning the eligible costs tax-exempt private activity bonds. These bonds are subject to a state’s private activity bond volume gap, which is an annual limit on the amount of tax-exempt private activity bonds that can be issued in each state. The 50% test, historically, has been required to qualify for the 4% low income housing tax credit. At least 50% of the aggregate basis of the building and the land on which the building is located had to be financed with tax-exempt private activity bonds.

That 50% test meant a significant portion of the project’s financing had to come from these tax exempt bonds. It’s a form of public financing. So the bonding capacity is limited to each state. Each state receives an annual allocation of these private activity bonds from the federal government. The cap limits the total amount of tax exempt private activity bonds that can be issued in a state for various purposes, including affordable housing. Because the 4% tax credit was tied to these bonds, the bond cap effectively limited the 4% housing tax credit that could be financed, even though the 4% credits themselves were not directly capped by the federal government. Developers would compete for access to this limited bonding capacity from their state housing finance agencies.

Through this competitive process, once they secure the bond financing, meeting the 50% test, they would automatically qualify for the 4% housing tax credit. They would then sell these tax credits to investors in exchange for upfront equity, which usually helps to finance the project and allows for lower rents to be charged to low income tenants.

While the most recent significant federal legislation, the One Big Beautiful Bill, which passed the house and was signed into law by the president on July the 4th, has made a critical change to the bonding requirement for these 4% low income housing tax credits. They’ve reduced the 50% bond test to 25%. The act permanently reduces the threshold for private activity bonds from 50% to 25% of the aggregate basis for the building and the land costs.

That permanent 25% test applies to properties placed in service after December 31st, 2025, provided that at least 5% of the aggregate land and building costs are financed with bonds issued after December 31st, 2025. So the impact is actually fairly significant. It increases the production of affordable housing. By lowering the bonding requirement from 50% to 25%, more projects will be able to qualify for the 4% credit using a smaller allocation of the state’s limited private activity bond volume cap.

That effectively stretches the available bonding further, allows for more projects to access these noncompetitive tax credits. And that’s projected to finance a substantial number of additional affordable rental homes over the next decade. It makes more efficient use of the bond cap. Developers had to secure bond financing for 50% of the project even if they could get away with less. That would tie up valuable bond cap that could have been used for other projects. The 25% test allows for a more right-sized approach to bond financing, potentially freeing up the bond cap for a wide array of affordable housing projects.

And while tax-exempt bonds offer favorable financing terms, the process of securing and administering the bond financing can be complex and it does add to the cost of the project. A lower bond requirement might simplify the financing stack for some developments. Many states have faced a scarcity of private activity bonds, leading to long waiting lists for projects seeking those 4% housing tax credits.

This change is intended to alleviate that bottleneck and may help clear some of the backlog. In essence, the new legislation directly addresses a constraint in the Low-Income Housing Tax Credit program. It makes it easier and more efficient for developers to utilize the 4% credit and boosts the supply of affordable housing across the country. They effectively doubled the impact of the bonding capacity, and therefore doubled the LHTCs that are possible for the same amount.

In order to have an impact this year, the states may need to reallocate some of their 2025 bond allocations. Perhaps, developers who have already received their bond might be able to sell a portion to another developer. This is a significant change that developers should be absolutely paying attention to.

As you think about that, have an awesome rest of your day.

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