On June 27th, 2016, Governor Brown signed into law important changes to the State Low Income Housing Tax Credit (LIHTC) program that will substantially increase equity pricing for nonprofit developers of LIHTC-financed properties by allowing them to certificate state housing credits and sell them separately from federal LIHTCs. The California Housing Partnership and State Treasurer John Chiang co-sponsored and helped draft this legislation as this year’s SB 873, which was authored by Senator Jim Beall. Senator Beall demonstrated great fortitude and tenacity in passing this bill with nearly unanimous support after having his first attempt (SB 377) vetoed last year by the Governor. This newsletter explains how the final version of the bill, now incorporated into the budget bill, SB 837, will increase the value of State LIHTCs substantially for housing developments receiving awards beginning in 2017.
Certificated versus Allocated Credits
Previously, the California Tax Credit Allocation Committee (TCAC) could only allocate State LIHTCs to the sponsor of an affordable housing development. Allocated credits require that the developer “sell” them to an investor, most often in the form of a 99.99% limited partnership interest. Under this traditional allocated LIHTC structure, the equity investor pays for 99.99% of the State LIHTCs allocated to the low-income housing developer.
However, while traditional allocated State LIHTCs reduce an investor’s state tax liability, allocated state credits also effectively increase an investor’s federal tax liability. Here’s how: Normally, state taxes can be deducted from federal taxable income. By reducing state tax liability through the purchase of State LIHTCs, an investor loses the ability to deduct that amount of state taxes from their federal liability. Assuming an investor’s marginal tax rate is 35%, for every $1.00 of State Tax Credits an investor receives, they lose $0.35 in value from foregone federal income tax deductions. Thus, the baseline economic value of an allocated State Tax Credit is only 65% of the face value.
With the passage of Senator Beall’s legislation, developers can choose to have the State LIHTCs certificated instead of allocated. At the developer’s election, the State will now issue a certificate to the developer. The certificate represents a right to the credits in connection with the development of qualified low-income housing. Certificated credits can then be sold directly to an investor as if they are personal property. The investor does NOT need to have an ownership interest in the development’s ownership entity. However, the legislation requires that only investors who have previously purchased LIHTCs (federal or state) may purchase the new certificated LIHTCs.
Because certificated credits are considered personal property by the IRS and not redeemable as cash, the certificated credit can still be used to reduce an investor’s state tax liability, but does NOT impact an investor’s ability to deduct state taxes from their federal taxable income. While certificating the sale of the State LIHTC retains the benefits of the federal income tax deduction, the sale of the certificate does create a capital gains tax liability for the partnership, which can be avoided if the General Partner is an affordable housing nonprofit, tax-exempt organization.
Economic Value of Certificated Credits
In the current State LIHTC market, housing development sponsors are typically receiving between $0.65 and $0.75 for the sale of each $1.00 of State LIHTC. Certificating State LIHTCs under SB 837 should allow pricing to reach the $0.90-$0.95 range, thus finally fulfilling the original promised economic value of the State LIHTC. In addition, separating the ownership of the credit from an ownership interest in the development means that an investor purchasing State LIHTCs does not need to be affiliated with the housing development. It is our expectation that this separation could greatly expand the market for State LIHTCs.
How to Take Advantage of Certificated Credits
CHPC’s financial consulting staff will be working with the LIHTC investment community to encourage the development of a strong market for certificated LIHTCs in California that will result in favorable pricing and bring substantially more equity dollars to affordable housing developments. TCAC staff has indicated that they will begin implementation of certificated credits in 2017. Please contact any CHPC financial consultant for more information.