Low-Income Housing Tax Credit (LIHTC) and Landlord Obligations

The Low-Income Housing Tax Credit (LIHTC) program is the largest federal incentive mechanism for affordable rental housing production in the United States, administered jointly by the Internal Revenue Service (IRS) and state housing finance agencies (HFAs). Landlords and developers who participate in LIHTC accept a structured set of ongoing compliance obligations in exchange for dollar-for-dollar federal tax credits. Understanding those obligations — including income targeting, rent limits, extended-use restrictions, and nondiscrimination requirements — is essential for any owner considering or currently operating a LIHTC property.

Definition and Scope

LIHTC was created under Section 42 of the Internal Revenue Code (26 U.S.C. § 42) as part of the Tax Reform Act of 1986. The program allocates tax credits to states on a per-capita basis; the IRS sets the per-capita dollar amount annually. States distribute these credits through competitive Qualified Allocation Plans (QAPs) administered by their designated HFAs.

Two credit types exist under Section 42:

• 9% credits — used for new construction or substantial rehabilitation of projects that do not use federal tax-exempt bond financing; these provide a larger subsidy relative to project cost.
• 4% credits — used for acquisition of existing buildings or projects financed with tax-exempt bonds; the subsidy is smaller but the bonds separately carry their own financing benefit.

The distinction matters for landlords because the credit type affects project feasibility, the required equity investor structure, and the minimum compliance period. A property receiving 9% credits typically attracts limited partnership equity from institutional investors, while 4% credit projects often pair with bond financing governed by additional HFA rules.

LIHTC is distinct from the Section 8 Housing Choice Voucher program, which is a tenant-based subsidy. LIHTC operates as a project-based credit attached to the physical property, not to any individual renter.

How It Works

Participation in LIHTC follows a structured lifecycle with discrete phases:

1. Application and allocation — A developer submits a proposal to the state HFA under the QAP criteria. Competitive scoring typically weighs factors such as location, income targeting depth, developer experience, and service amenities.
2. Carryover or binding agreement — Once allocated, the developer receives a carryover allocation allowing construction to proceed, typically requiring that at least 10% of project costs are incurred within 12 months (IRS Rev. Proc. 2014-49).
3. Placed-in-service certification — When the building is complete and units are ready for occupancy, the owner files IRS Form 8609 to formally claim credits.
4. 15-year compliance period — The owner must maintain income and rent restrictions for at least 15 years or face credit recapture by the IRS.
5. Extended use period — Under federal law, an additional 15-year extended-use agreement (totaling 30 years minimum) is recorded as a land-use restriction. Many state QAPs require 40 or 55 years.
6. Annual compliance monitoring — State HFAs are required under Treasury Regulation 1.42-5 to conduct annual inspections and tenant file reviews, and to report noncompliance to the IRS on Form 8823.

Rents in LIHTC units are capped based on the Area Median Income (AMI) for the county or metropolitan area, as published annually by the U.S. Department of Housing and Urban Development (HUD Income Limits). The most common set-aside thresholds are:

• 40/60 test — at least 40% of units rented to households at or below 60% of AMI
• 20/50 test — at least 20% of units rented to households at or below 50% of AMI
• Average income test (AIT) — introduced by the Consolidated Appropriations Act of 2018, allowing a portfolio of unit designations averaging at or below 60% AMI, with no single unit designated above 80% AMI (IRS Notice 2020-10)

Rent ceilings are calculated as 30% of the applicable AMI fraction, adjusted for unit bedroom count. Landlords may not charge LIHTC tenants rents — including utilities where the tenant pays utilities — that exceed these statutory ceilings.

Common Scenarios

Owner-occupied rehabilitation projects — A nonprofit or for-profit developer rehabilitates a distressed apartment building. 9% credits are awarded, investors purchase the credits at roughly $0.90 per dollar of credit (market rates fluctuate), generating equity that reduces the debt load and allows below-market rents.

Mixed-income developments — A developer builds a 100-unit complex where 80 units are LIHTC-restricted and 20 units are leased at market rate. Only the 80 designated units are subject to income verification and rent limits; the market-rate units operate under standard landlord-tenant law as covered in landlord-tenant law overview.

Noncompliance and recapture — If a unit falls out of compliance — for example, a tenant's income exceeds 140% of the applicable AMI limit and the next available unit was not rented to a qualifying household (the "available unit rule" under § 42(g)(2)(D)) — the owner may be required to recapture credits plus interest, as reported through Form 8823 to the IRS.

Source-of-income considerations — Landlords operating LIHTC properties in states with source-of-income protections cannot refuse tenancy based on a prospective tenant's use of a housing voucher. This intersects with source of income discrimination rules at the state level.

Fair housing interaction — LIHTC properties are subject to all federal Fair Housing Act requirements in addition to LIHTC-specific tenant selection rules. HFA QAPs typically require an Affirmative Fair Housing Marketing Plan (AFHMP) as a condition of credit allocation.

Decision Boundaries

Owners considering LIHTC participation face several structural thresholds that define whether the program is appropriate for a given project:

Minimum feasibility size — Small properties (typically under 20 units) rarely generate sufficient credit volume to attract institutional equity investors; the transaction costs of syndicating credits make small projects financially unworkable without supplemental subsidy.

Credit type selection — 9% credits require competitive allocation and are capped by state volume. 4% credits paired with tax-exempt bond financing have separate bond volume cap limits under IRS § 146, administered by state authorities. A developer's financing structure determines which path is viable.

Compliance capacity — LIHTC ownership requires annual tenant income certifications, unit inspections, and documentation retention for the entire compliance and extended-use period. Owners without internal compliance infrastructure typically engage a property management company specializing in affordable housing.

Exit strategy constraints — During the extended-use period, an owner cannot evict tenants or convert units to market rate without going through a formal right-of-first-refusal process under § 42(i)(7), which grants qualified nonprofit organizations the right to purchase the property. Owners must understand this restriction before acquisition.

State QAP variability — Because each state issues its own QAP, income targeting requirements, mandatory services, and extended-use terms vary significantly. A project in California may face a 55-year extended-use requirement under the California Tax Credit Allocation Committee's (CTCAC) rules, while a project in another state may face a 30-year minimum. Owners operating across state lines should treat state QAPs as binding addenda to federal requirements.

Intersection with other tax obligations — LIHTC credits reduce federal tax liability dollar-for-dollar but interact with passive activity loss rules under IRC § 469 and depreciation schedules under IRC § 168. Landlords should review these interactions alongside landlord depreciation deductions and landlord tax obligations for a complete picture of tax treatment.

References

• 26 U.S.C. § 42 — Low-Income Housing Credit (U.S. Code, GovInfo)
• IRS Form 8609 and Instructions — Low-Income Housing Credit Allocation and Certification
• IRS Form 8823 — Low-Income Housing Credit Agencies Report of Noncompliance
• Treasury Regulation 1.42-5 — Compliance Monitoring (eCFR)
• HUD Income Limits — Area Median Income Data
• IRS Notice 2020-10 — Average Income Test Guidance
• [IRS Revenue Procedure 2014-49 — LIHTC Carryover Allocations