Maximize Tax Savings and Expedite ROI

[Julio Gonzalez]

Are you familiar with Low-Income Housing Tax Credits (LIHTC) or cost segregation studies? Both are individually great tools for real estate investors but when combined, real estate owners can greatly maximize their tax savings.

What is LIHTC?

Per IRC 42, the Low Income Housing Credit Program was enacted by Congress as part of the Tax Reform Act of 1986 to encourage new construction and rehabilitation of existing buildings as low-income rental housing for households with income at or below specified income levels. This is due to the fact that Congress recognized private sector developers may not receive enough rental income from a low-income housing development to cover the costs as well as provide a sufficient return to investors to obtain the necessary equity investments.This program therefore provides tax incentives to investors that make equity investments in such projects. The credit allows the investors to offset federal income taxes for 10 years. The tax benefits along with the cash proceeds from the potential sale of the property represent the investors' return on investment (ROI).

How to Qualify for LIHTC?

The LIHTC supports multiple types of housing including the construction of new buildings or rehabilitation of existing structures, apartments, single-family homes or single occupancy rooms. The property must qualify as a residential property. The tenants must meet both an income test and a gross rent test. The income test can be met by:

1. At least 20 percent of the project’s units are occupied by tenants with an income of 50 percent or less of the area median income (AMI), adjusted for family size.
2. At least 40 percent of the units are occupied by tenants with an income of 60 percent or less of AMI.
3. At least 40 percent of the units are occupied by tenants with income averaging no more than 60 percent of AMI, and no units are occupied by tenants with income greater than 80 percent of AMI.

The gross rent test, the rent must not exceed 30% of the imputed income limit applicable to the unit (either 50 or 60% of AMI). There is a 15 year compliance period in which taxpayers must meet all of the qualifications and continue to offer low-income housing. There is typically an extended use period of an additional 15 years, totaling 30 years of which the taxpayers agree to offer low-income housing.

What is the Added Benefit of a Cost Segregation Study?

"What most real estate owners and investors don't realize is that the LIHTC program has created a massive windfall of tax benefits for affordable housing," said Daryl Petrick, Partner with the CPA firm Bowman & Company, who specializes in tax issues around affordable housing. "And when you combine LIHTC eligibility with a cost segregation study, you can achieve impressive tax savings using bonus depreciation." "Now that bonus depreciation has drastically increased the rate of depreciation, it's helping investors get faster returns on their capital and improving the ROI on these projects," said Petrick. "There's no question—cost segregation greatly magnifies the overall tax benefits for LIHTC projects."

Are you involved in any LIHTC projects?