How Do Housing Tax Credits Work?

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The LIHTC Program, which is based on Section 42 of the Internal Revenue Code, was enacted by Congress in 1986 to provide the private market with an incentive to invest in affordable rental housing. Federal housing tax credits are awarded to developers of qualified projects. Developers then sell these credits to investors to raise capital (or equity) for their projects, which reduces the debt that the developer would otherwise have to borrow. Because the debt is lower, a tax credit property can in turn offer lower, more affordable rents.

Provided the property maintains compliance with the program requirements, investors receive a dollar-for-dollar credit against their Federal tax liability each year over a period of 10 years. The amount of the annual credit is based on the amount invested in the affordable housing. Before we go on, let's take a look at the difference between tax credits and tax deductions:

Credits versus Deductions

Credits: Tax credits are subtracted directly from one's tax liability. Credits reduce tax liability dollar-for-dollar. For example:A $1,000 credit in a 15% tax bracket reduces tax liability by $1,000.	Deductions: Tax deductions are subtracted from a taxpayer's total income to compute his or her tax base. Deductions reduce tax liability by the amount of the deduction times the tax rate. For example:A $1,000 deduction in 15% tax bracket reduces taxable income by $1,000, thereby reducing tax liability by $150.
As the examples illustrate, tax credits can have a much larger impact than tax deductions.