GENERAL ECONOMICS OF THE TAX CREDIT
By receiving Tax Credits every year for ten years, the program provides the additional return that is needed by owners of affordable housing developments to compensate for reduced rental income.
The types of costs that qualify for the credit are acquisition and rehabilitation expenses or new construction costs. These costs, excluding land, determine the basis for the calculation of Tax Credits. A development will receive in Tax Credits, the equivalent of 9% of the basis for new construction each year and 4% of the basis on rehabilitation. It should be noted that Tax Credits do not reduce the tax basis of an investment.
To qualify, an affordable housing development is generally any residential rental property that satisfies, within one year of occupancy, one of two minimum requirements known as the 20-50 or the 40-60 Set-Aside Tests. In exchange for receiving this Credit, the Internal Revenue Service also mandates that development owner(s) must agree to rent the units to low income individuals at reduced rental rates. These reduced rental rates can equal no more than 30% of the individuals income, which is usually substantially below market rates.
As a result, these parameters make it difficult to qualify and build affordable housing in major cities because of the high land and construction costs. However, additional federal and state subsidy programs can make development in these cities feasible.
These programs include:
Housing Subsidies-The primary subsidy is Section 8, which is paid by the United States Department of Housing and Urban Development and administered by the local county housing authority. This subsidy, paid directly to the landlord, equals the difference between fair market rent and the reduced rental rate paid to the landlord by the tenant.
By using some or all of these programs to establish a low debt service, offset by fair market rents, an investor may realize substantial cash flow in addition to Tax Credits.