The low-income housing tax credit (LIHTC), which is also commonly referred to as section 42 (a reference to the tax code that provides tax credits to investors), is the country’s primary tool for encouraging individual and corporate investors to invest in the development, acquisition, and rehabilitation of affordable rental housing. The LIHTC is an indirect federal subsidy that finances low-income housing. This allows investors to claim tax credits on their federal income tax returns.
In short, states allocate LIHTCs to affordable housing developers. Investors bid on those tax credits, and in return for the investments, reap tax benefits over the course of 10 years.
With the election of President Trump in November, investors are hitting the pause button on purchasing those LIHTCs. Why? Because President Trump has called for reducing the corporate tax rate from 35% to 15-20%.
So why does a reduction in the corporate tax rate affect LIHTC investment? For investors, attaining tax credits now would represent a loss in savings if and when the corporate tax rate falls. With LIHTCs, investors receive tax losses based on their investments in real property. If the corporate tax rate falls, those tax losses get reduced. Each subsequent year, the investor is not going to be able to claim as much losses against their taxes as they were planning before the tax rate reduction. By some estimates, a 5% of corporate tax rate reduction translates to a 5-10 cent reduction in credit pricing depending on if the transaction is a 4% or 9% credit deal.
So even though actual tax reform may be a year or more away, the LIHTC market has been rocked by the possibility. Some investors pulled out of funds, others have pulled future commitments, and still others have modified their investment parameters. Affordable Housing Finance recently surveyed more than 20 tax credit equity syndicators on tax credit pricing. In the fourth quarter of 2016 pricing paid an average was $1.02 per dollar of credit (above par value of $1) compared with 99 cents (below par) a year earlier. We are currently hearing pricing of plus or minus 85 cents (below par) today.
2014-16 LIHTC Tax Credit Pricing
Potential tax reform that will reduce yields mean investors will start to look for other areas to invest their money, which could have dire consequences for affordable housing production.
That said, the real fear and pullback is based around uncertainty. Clear guidance from the administration could trigger widespread demand for new deals, causing the market to shift dramatically. Investors should pay close and careful attention to related news coming out of the White House.