The Low-Income Housing Tax Credit (LIHTC) under IRC Section 42 is the primary federal program for financing affordable rental housing — providing tax credits to developers who set aside units for low-income households, which are then sold to investors to raise equity capital for construction.
The Low-Income Housing Tax Credit (LIHTC) was enacted in the Tax Reform Act of 1986 and is codified at IRC §42 (irs.gov/credits-deductions/individuals/earned-income-tax-credit/low-income-housing-tax-credit). It is the largest federal affordable housing production program: since 1987, LIHTC has financed more than 3.5 million affordable rental units. The IRS administers the federal program; state housing finance agencies (HFAs) allocate credits through competitive Qualified Allocation Plans (QAPs). Two credit types: the 9% credit (for new construction or substantial rehabilitation not financed with tax-exempt bonds, allocated by competitive state QAP process) and the 4% credit (for projects financed with tax-exempt Private Activity Bonds under IRC §142(d), available as-of-right when 50% or more of eligible basis is financed with bonds). Credits are claimed annually for 10 years and equal a percentage of the building's qualified basis (eligible basis × applicable fraction of low-income units). Affordability restrictions: LIHTC projects must serve tenants at or below 60% of Area Median Income (AMI) under the 20-50 or 40-60 tests, or 80% AMI with average income restriction under the 2018 Consolidated Appropriations Act amendment to §42(g). Affordability covenants run with the property for 30 years (initial 15-year compliance period + 15-year extended use period). Annual per-state credit allocation is $2.75 per capita (2024, inflation-adjusted under §42(h)(3)(C)(ii)), plus additional allocations from Treasury for difficult-development areas. IRS Revenue Procedure 2022-20 sets current allocation amounts (irs.gov).
The 9% credit is the more valuable allocation — state housing finance agencies award it competitively based on QAPs prioritizing public housing waitlists, permanent supportive housing, rural areas, etc. The 4% credit is available as-of-right (no competition) when a project uses tax-exempt Private Activity Bond financing for at least 50% of eligible basis. Both generate 10-year credit streams, but the 9% credit typically generates 55–65% of project costs in equity vs. 25–35% for 4% credits (irs.gov/credits-deductions/individuals/earned-income-tax-credit/low-income-housing-tax-credit).
LIHTC investors are typically large corporate taxpayers — banks (motivated by Community Reinvestment Act compliance), insurance companies, and Fortune 500 corporations with significant federal tax liability. Investors acquire limited partnership interests in LIHTC partnerships, receive the credit allocation over 10 years, and exit after the 15-year compliance period. Syndicators (National Partnership Investments, Raymond James Affordable Housing Investments, etc.) pool credits from multiple projects to create diversified tax credit funds (irs.gov/pub/irs-pdf/p4078.pdf).
Noncompliance triggers credit recapture under IRC §42(j): the investor must repay previously claimed credits with interest, plus a 10% recapture penalty. Common noncompliance causes include: renting to over-income tenants, failing to maintain physical standards, missing annual certifications to the state HFA, or disposing of the property before the end of the extended use period. States monitor compliance annually and report violations to the IRS. Recapture can be mitigated by cure within the applicable correction period (irs.gov/credits-deductions/individuals/earned-income-tax-credit/low-income-housing-tax-credit).