From a small northwestern observatory…

OK, folks, this gets complicated, so follow along with me.  The Reagan era tax cuts, and specifically the U.S. Tax Reform Act of 1986, adversely affected many of the incentives for investing in low income rental housing.  To provide some balance, the Low Income Housing Tax Credit (LIHTC) program was added to the Act.  This program provides a tax credit which can either be used or sold by the developer.

Usually, the tax credits are sold or syndicated, and corporations that anticipate that they’ll have taxable income over the next 15 years will buy the credits, which can be used to offset future tax bills.  The developer uses the proceeds from the tax credit sales as the equity for the low income housing development.  Coupled with the program is a substantial emphasis on fiscal discipline (audited financial statements, regular reporting, etc.) and as such, these low income multi-family developments have had a foreclosure rate of less than 0.1%, which is far better than comparable market-rate properties.

Typically, a developer will cobble together several programs, such as FNMA debt financing, Section 8 vouchers, and state and local incentives.  The LIHTC program is administered by State Housing Authorities, and of course has oversight from the IRS.

Here’s where it gets both interesting and complicated.  The selling price for the credits is a function of two things — the discount rate (which is very low now-a-days) and a company’s forward-looking tax burden.  Let’s say, just as an example, I believe my company will have $1 million per year in net income in the coming fifteen years.  My tax rate is 40%, so I’ll end up paying $400,000 in annual federal income taxes, and I’d be willing to pay for credits which would erase that tax burden.  In short, I’m agnostic as to whether I send the money to the IRS or to a developer who wants to use the money to build an apartment complex.  (Actually, it’s w-a-a-a-a-y more complicated than this, but bear with me.)  Now, my tax burden over the coming 15 years will be $6 million ($400,000 per year times 15), but the present value of that cash flow is what I’d pay today instead of the $6 million.  If my cost of capital is 5%, the present value of that 15 year tax bill is actually closer to $4.15 million.  So, I’d be willing to pay $4.15 million to avoid paying $6 million in taxes in the next 15 years.   A given developer is awarded a certain level of tax credits based on the overall value of the project being proposed.

So, what’s the problem?  Ahhh…. “problem” depends a bit on your perspective.  As it happens, the new administration, and Congress for that matter, are bent on cutting corporate tax rates.  Good for them.  I own a couple of corporations.  I’d like to save some money.  However, if a corporation envisions that their tax bills over the next 15 years will be much lower than previously anticipated, then the amount they’re willing to pay TODAY to avoid those tax bills is much lower.  How much, you say?  Well, let’s assume our company had it’s effective tax rate lowered from 40% to 15%.  The tax bill over the next 15 years would only be $2.25 million, and the present value of THAT is only $1.56 million.  Ahem…..

I’m not knocking tax cuts, but everything has a cost, and building low income housing employs a lot of people, provides a much-needed private sector solution to a public problem, and creates investment.  We’re already seeing this market dry up.  An article in today’s Pittsburgh Post-Gazette, by Kate Giammarise, outlines the problems that developers are already facing.  One solution may be for Congress to increase the level of available tax credits, so that developers can be left whole even with the tax cuts.  This will, by its nature, be a nationwide problem.