What are LIHTC Credits in Commercial Real Estate?
Low Income Housing Tax Credits, or LIHTC credits, are federal tax credits designed to encourage private businesses to invest in affordable housing. In the last three decades, LIHTC has assisted in the financing of nearly 2.5 million affordable rental units across the U.S. While LIHTCs apply to multifamily apartment developments and not purely commercial real estate developments like office buildings or retail projects, many developers of mixed-use projects do use LIHTC credits.
How Multifamily Developments Qualify for the LIHTC Program
In order to qualify for the LIHTC program, developers need to set aside a minimum of 40% of a project's units for tenants earning no more than 60% of the area median income, or AMI (40/60). Or, alternatively, they must set aside 20% of a project's units for tenants earning no more than 50% of the area median income (20/50).
LIHTC Commercial Limits for Mixed-Use Projects
While LIHTC credits are used in many mixed-use projects, there are relatively strict limits when it comes to commercial space. First, no more than 10% of a building's eligible costs can go towards constructing commercial space. In addition, no more than 20% of the project's income can derive from a commercial source. If this rule is broken, the IRS considers the building a commercial space instead of a residential one and the project could lose many of its tax credits.
LIHTC Commercial Limit Workarounds for Developers
If you want to develop a mixed-use project and use LIHTCs, you might find these limits overly restrictive. If so, you should understand that there are multiple ways to effectively increase a development’s commercial space well beyond the standard limits while keeping a project's LIHTC credits.
One of the most popular ways to do this is creating a "master lease," in which a developer or an affiliate of the developer signs a lease to take over the commercial space. Then, the developer (or affiliate) becomes a tenant, and pays a specific, set rent (which is under the income restriction) back to the partnership or entity that owns the project. The developer then can rent out the commercial space to shops, restaurants, or offices, and make a profit. At least as long as they receive more in commercial rents than they pay for the master lease.
Another option is to "condominium-ize" the space. With this option, the ownership of a mixed use project is broken into different pieces, much like a condominium's units are each owned by separate people. In this case, the developer is the sole owner of the commercial part of the project, and is responsible for financing it separately from the residential part of the project tat receives the LIHTC credits.