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HOUSING TAX CREDITS

AN INTRODUCTORY GUIDE

ALABAMA HOUSING FINANCE AUTHORITY

ADMINISTERED BY THE

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Preparing to Apply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 LIHTC Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

About the Housing Credit Program . . . . . . . . . . . . . . . . . . .4 Leveraging Tax Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

First Mortgage Loan ....................................................5 "Soft" Second Mortgages ............................................5

Tax Credit Equity ..........................................................5 Eligibility Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Allocation of Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 Three Credit Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

Owner Equity ................................................................5

AHFA Allocation Procedures . . . . . . . . . . . . . . . . . . . . . . . .9 Compliance Monitoring . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Selection Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Nonprofit Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . .12

This booklet is available in alternative formats as a service to prospective Housing Credit program participants with disabilities. For more information, call AHFA at 334/244-9200.

© 2008, Alabama Housing Finance Authority

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AHFA has established a set of housing priorities to be used in administering the Low-Income Housing Tax Credit (LIHTC) program. These priorities are the guiding force behind AHFA's allocation and distribution of tax credits. Through the LIHTC program, AHFA seeks to promote the following: · Projects which add to or significantly upgrade the existing low-income housing stock; · Projects which, without tax credits, would not likely set aside units for low-income tenants; · Projects which utilize additional assistance through federal, state or local subsidies; · Projects which have a significant portion of units designated for tenants with special needs; · Balanced allocation of tax credits throughout the state in terms of geographical regions, counties and urban/rural areas; and · Projects which minimize the impact on residents who live in buildings that will be acquired or rehabilitated, and will not cause permanent relocation.

LIHTC Priorities

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Tax credits are an effective housing finance tool: Since the creation of the LIHTC program, AHFA has issued credits to help construct or rehabilitate rental housing for tens of thousands of Alabama's economically disadvantaged families. Through the tax credit program, non-profit agencies and forprofit developers can play key roles in meeting the housing needs of Alabama's lower-income residents: This booklet was created to assist those interested in developing rental housing and to help ...this information potential investors understand its inherent risks and rewards. also will help

Introduction

This guide can be a valuable resource both for new and experienced developers: Those new to the LIHTC program will benefit from the general overview this booklet provides. And, since credits can be lost and projects can fail if mistakes are made, this information also will help more experienced users maximize their credits and equity dollars through a better understanding of the program's guidelines.

their credits and equity dollars....

users maximize

experienced

more

This booklet is intended as a general reference guide and should not be relied upon as a sole source of information regarding the LIHTC program. Section 42 of the Internal Revenue Code or LIHTC program guidelines may change after publication or at AHFA's discretion. For more detailed information, use the form in the back of this booklet to contact AHFA.

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Recognizing that the business community often lacks economic incentives to invest in low-income housing, the U.S. Congress in 1986 instituted the LIHTC program. Its special tax incentives help provide equity dollars needed to develop lowincome rental housing through 10-year tax credits, which offset the taxes owners and investors in the property would otherwise pay. The LIHTC program is the largest production and incentive program funded by the federal government for new construction and rehabilitation of low-income housing. It is administered by the U.S. Department of the Treasury and its Internal Revenue Service. To simplify the program, Congress created a special system for allocating the credits in which each state's housing finance agency--like the Alabama Housing Finance Authority-- determines which projects will receive credits each year.

About the LIHTC Program

Preparing to Apply

Before applying for tax credits, developers of a proposed lowincome housing project must complete several basic steps: · The type of housing to be developed--construction of a new multifamily residential rental project or rehabilitation of an existing structure--must be determined.

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· Operating income and expenses must be projected.

· A budget which includes construction costs and financing, tax credit application, legal, accounting and consultants' fees must be developed.

· A site which conforms to existing zoning laws must be selected.

· The project must meet AHFA's Design Quality Standards. Once these steps are accomplished, the most difficult task-- obtaining funds to build and operate the project--still remains.

· An independent third-party market study will be needed.

One of the basic principles in working with tax credits is that, although the tax credits generate equity, the equity must be leveraged. In other words, it is usually not possible to raise enough equity solely through tax credits to purchase the housing without using debt financing. This debt financing usually will take the form of a first mortgage loan and one or more "soft" second mortgages. · The first mortgage loan is most commonly received from a commercial lender, such as a bank. It usually will bear a market rate of interest, with monthly principal and interest payments serviced by rental income received from the project. Because the rental income for lowincome housing projects is low, the amount of this first mortgage loan will also have to be low. Typically, this first mortgage loan will cover between 30 percent and 50 percent of the project's total costs. · A "soft" second mortgage is a loan with no or very low payments, in which most or all of the principal is not due for at least 15 years. Unpaid interest which accrues each year is added to the principal amount of the loan. As a result, at the end of the loan term the amount repayable includes not only the original principal amount but also all of the accrued interest--resulting in a much higher loan balance to repay. This second layer of soft debt financing can consist of more than one loan.

Leveraging Tax Credits

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· The third layer of financing is the tax credit equity layer, consisting of an investment by a corporate taxpayer or group of taxpayers able to use the tax credits generated from the project to offset their taxable income. Based on the value of the tax benefits over the 15-year period in which an investor must be a partner in the project, it is usually possible to raise between 40 percent and 50 percent of the value of a project in tax credit equity. · The fourth layer of financing is the owner equity layer. Though it can be a relatively small contribution, this cash investment signifies the owner's commitment to the project.

Owner Equity First Mortgage Loan "Soft" Loans

Housing Credit Equity

Thus, a low-income housing tax credit project will generally have about 20 percent of its costs financed by a first mortgage loan, about 30 percent from soft loans or grants, about 45 percent from equity raised by tax credit investors, and about 5 percent from the owner's contribution to the project.

Qualified multifamily residential rental projects must meet the basic occupancy and rent restrictions of Section 42 of the Internal Revenue Code. Residential rental projects must be on a single site. Detached units can be on a single site or contiguous sites. Sites may be considered contiguous if separated only by one neighborhood street. These units can be attached or detached. Mobile homes, manufactured homes, prefabricated homes and scattered site developments do not qualify. Further, projects applying for tax credits must contain no fewer than 12 units. To be eligible, a project must have at least 20 percent of its units occupied by households earning less than 50 percent of the area median income, or 40 percent of its units occupied by

Eligibility Requirements

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households earning less than 60 percent of the area median income. Income limits are adjusted for household size and in certain unusually high- or low-cost The housing housing areas. Maximum rents are set for each unit size, based upon 30 percent of the area's maximum allowable income for specified household sizes. Tenant-paid utilities are counted as part of the rent.

amount is based on the costs of

credit

development and the low-income units.

number of qualified

Projects must remain in lowincome use for at least 15 years compliance and 15 years extended use, and low-income tenants are protected against eviction or large rent increases for an additional three years.

The tax credit amount is based on the costs of development and the number of qualified low-income units. The LIHTC program allows three basic types of tax credits: · A 9 percent annual credit for constructing a new building or substantially rehabilitating a building without a federal subsidy; · A 4 percent annual credit for constructing a new building or performing substantial rehabilitation with a federal subsidy; or

Three Credit T ypes

· A 4 percent annual credit for buying an existing building. The acquisition credit can only be earned if there is a minimum amount of rehabilitation spending and, with certain exceptions, if ownership has not changed in the previous 10 years. To be eligible for this credit, at least 10 years must have elapsed between the date that the

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owner acquired the building and the date of the last substantial improvements to the building. Although tax credits are generally referred to as the "9 percent" and "4 percent" credits, these percentages are approximate. Actual credit rates are determined each month based on prevailing Treasury interest rates to provide a "present value" of 30 percent (the 4 percent credits) or 70 percent (the 9 percent credit) over 10 years. The effective credit rate may be increased by 30 percent in qualified census tracts designated by the U.S. Department of Housing and Urban Development. A single project can qualify for one of the three credit types or a combination. These amounts are the upper limits of available credits--the actual credit allocated to a building cannot be more than the amount necessary for the financial feasibility and longterm viability of the project as determined by AHFA.

A single project can qualify for three credit types or a combination. one of the

The annual credit amount is the credit rate multiplied by eligible costs for the number of low-income units. Non-depreciable costs (such as land), the amount of any grants, and costs in excess of AHFA's reasonable cost standards are excluded from eligible costs. Additional units which qualify after the first year earn two-thirds of the annual credit amount for the balance of the 15-year compliance period.

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AHFA receives an annual allotment of tax credits based on the state's population which is determined by the IRS and adjusted for inflation. Any credits AHFA does not allocate can be used in the following year. Projects can be completed up to two years after the allocation year ends if at least 10 percent of project costs are spent by the end of the allocation year or within six months of the allocation.

Allocation of Credits

Recapture of some credits can occur if the number of qualified low-income units is not maintained for 15 years. Tenants' household income can rise up to 140 percent of the qualifying income limit for the current year for their family size and the unit can remain qualified. Qualifying non-profit organizations are allocated a minimum of 10 percent of AHFA's total tax credits (see page 12 for more information).

Reserved for Non-Profit Organizations

For Allocation to Developers or NonProfit Organizations

Because the supply is limited, AHFA has created a prioritizing system to determine which projects receive credits. AHFA develops and implements a Tax Credit Allocation Plan each year which includes selection criteria, an evaluation process, and compliance monitoring procedures. To apply for tax credits, developers must request and complete AHFA's multifamily funding application, which is available online at AHFA.com. A nominal fee to cover package preparation and mailing costs is charged. Applications are submitted to AHFA only during application cycles and selected according to specific criteria set forth in AHFA's allocation plan. To ensure that a maximum number of projects can receive assistance, AHFA takes care to award no more tax credits than a project needs to be feasible. Applications are evaluated on a competitive basis and must be accompanied by a non-refundable fee. Requests for the credits must be made during AHFA's annual application cycles. Notices of the dates for each cycle are published in major Alabama newspapers and emailed to interested parties who have asked to be placed on AHFA's email distribution list. Those wishing to receive notifications of application cycles and other related AHFA activities must

AHFA Allocation Procedures

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submit a request form which is available on AHFA.com. Refer to the back of this booklet for more information.

Selection Criteria

To determine which projects should receive tax credits, AHFA evaluates each application according to the following criteria: · Completeness. A complete application must be submitted to AHFA. The application package contains a checklist outlining items necessary to complete the application. All pages must be submitted on original forms with original signatures and legible, and all applicable spaces must be fully completed. Failure to meet any of these criteria will result in deductions using the Point Scoring System. If, after notification by AHFA of the missing documents and the time allowed for submission of these items, the application remains incomplete, it will be rejected and no further consideration will be given. · Point Scoring System. Once the application is checked for completeness, it will be further evaluated using AHFA's Point Scoring System, which awards points to projects which best meet the state's identified housing priorities. Projects are ranked in categories which cover special housing needs, project location, project characteristics, applicant characteristics, rent affordability, type of construction, energy conservation, health living environment and readiness issues. · Financial Feasibility. Once the application is point-scored, the project will be evaluated for financial feasibility by examining the market in which the project is located and by performing an initial review of costs in connection with the proposed sources of funds. Applicants must document the following:

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· Need and demand for the type of housing proposed; · Market feasibility of the proposed rent structure; · Development cost projections and the expected sources of financing; · Income and expense projections and the method by which deficits in rental income from the lowincome units will be covered; and · The purpose for which the tax credit will be applied. · Reasonableness of Project Costs. Any line item costs, square footage costs or total unit costs exceeding a range of reasonableness, based on project type and location, may be disallowed at AHFA's discretion. Additional information and documentation may be required to substantiate costs. Applications will be evaluated at least three times: at the time of application, when the allocation is made, and when the project is placed in service.

Compliance Monitoring

All projects which receive tax credits must comply with the terms of the LIHTC program and Section 42 of the Internal Revenue Code. AHFA periodically inspects each project to ensure it is operating in compliance. Monitoring procedures may include mail-in audits, on-site visits and review of tenant incomes, rent records and living conditions.

Project owners are responsible for maintaining compliance. AHFA may assist in this effort, but owners should consult their legal or tax counsel for guidance in maintaining compliance with the Internal Revenue Code and program regulations.

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Non-profit organizations have a special dilemma: Though the housing they wish to develop may qualify for tax credits, the credits are useless to them because they generally do not pay taxes. Joint ownership is the solution to this problem. Tax credits cannot be sold to individuals or entities without an ownership interest in the project, but tax law allows buildings and projects to be owned jointly by non-profit organizations and for-profit organizations in partnerships. The non-profit must materially participate throughout the compliance period. In this way, the aspects of ownership can be divided to benefit each partner. In most cases, the non-profit organizations want control over the project to ensure it will be used for low-income housing in the future. The for-profit investors primarily want the credits that the building generates to offset their federal taxes. They are willing to pay the non-profit for these credits, and the non-profit can use the investors' money to reduce the amount of other financing needed to develop the project. This additional source of financing is one of the principal advantages of the tax credit program for non-profit organizations. Even for a small project, the time and cost involved can be heavy. The non-profit should have at least a half-time staff person capable of operating under the tax credit program, ensuring compliance requirements are met, and dealing with legal, accounting and other development responsibilities. Non-profit organizations also must remember that obtaining a tax credit allocation for a project does not guarantee the project can be developed. The tax credits simply provide the non-profit with something to trade for an investor's equity in a project. The non-profit still must obtain the other loans and grants necessary to fund the project and make sure the rent levels it can charge can sustain the project's operation.

Non-Profit Organizations

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Sources

Guggenheim, Joseph. Tax Credits for Low Income Housing: Opportunities for Developers, Non-Profits, and Communities Under Permanent Tax Act Provisions. 8th ed. Glen Echo, MD: Simon Publications, 1994. Internal Revenue Service. Section 42 of the Internal Revenue Code of 1986. Excerpted from Housing and Development Reporter. Boston: Warren, Gorham & Lamont, 1994. Low-Income Housing Tax Credit 2008 State Qualified Allocation Plan. Montgomery, AL: Alabama Housing Finance Authority, 2008. Novogradac, Michael J., Eric J. Fortenbach and Jon Krabbenschmidt. Low-Income Housing Tax Credit Handbook. Deerfield, IL: Clark Boardman Callaghan, 1994. Stevens, Herbert and Thomas Tracy. A Developer's Guide to the Low Income Housing Tax Credit. 3rd ed. National Council of State Housing Agencies, 1994.

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Information Request

¡

s Please add my name to your email distribution list to receive notification of LIHTC application cycles. s Please send me a State-Qualified Allocation Plan for Alabama's LIHTC program.

Name __________________________________________________ Organization ____________________________________________ _______________________________________________________ Address ________________________________________________ _______________________________________________________ City ___________________________________________________ State _______________Zip Code____________________________ Telephone ______________________________________________ FAX ___________________________________________________ E-mail Address __________________________________________

Detach or copy form and send to:

Alabama Housing Finance Authority Housing Credit Coordinator P.O. Box 230909 Montgomery, AL 36123-0909 FAX 334/244-9214 [email protected] or www.AHFA.com

ALABAMA HOUSING FINANCE AUTHORITY

P.O. Box 230909 Montgomery, AL 36123-0909

Information

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