The first step in determining the amount of tax credits a project is eligible to receive and how much equity can be raised from the tax credits is to put together a development budget – a budget of all of the project’s costs.
Once the development budget has been prepared, it is important to determine which line items in the development budget are depreciable costs – this is known as the “Eligible Basis”.
Eligible Basis includes:
• A project’s depreciable costs related to the construction of new residential rental housing, or
• Its depreciable costs related to the substantial rehabilitation of existing residential rental housing.
Another way to calculate the Eligible Basis is to take the total development costs and subtract out those items not eligible. Among those costs not eligible are:
• land and land-related costs
• building acquisition and related costs
• fees and costs related to any permanent loan financing
• fees and costs related to post-construction period operations
• syndication-related costs
• project reserves
• post-construction period working capital (e.g., marketing expenses included in the development budget)
• federal grants
• the residential housing portion of any historic tax credits taken
• the non-residential portion of project costs (e.g., any commercial space and any community space if its use is not restricted to project tenants)
Commercial space is not eligible for low-income housing tax credits because it is not residential in nature. Actual costs for commercial space should be used if available. Often, commercial construction is less costly than residential work. This helps to preserve tax credit basis. Certain soft costs may also need to be adjusted, and normally the developer fee is pro-rated, as well.
Calculation of Applicable Fraction
Eligible Basis must be adjusted so that it includes only the depreciable costs related to qualifying residential rental units. Costs related to residential units that are rented to tenants with incomes above 60% of area median income levels are not eligible for tax credits. Costs for non-residential housing purposes, such as commercial space in a project, must also be excluded.
The adjustment of Eligible Basis to eliminate these costs is done by applying what is known as the project’s “Applicable Fraction”. This is a 2-step process. The Applicable Fraction is defined as the lesser of:
• the number of qualifying rent-paying residential units as a fraction of all rent-paying residential units (the “Unit Percentage”), and
• the square footage fraction of qualifying rent-paying residential units as a fraction of all units (the “Square Footage Percentage”). It is developed for each building or group of buildings for which you receive a “Building Identification Number (“BIN”).
Do not include the rent-free super’s unit in either Applicable Fraction calculation. However, the cost of the super’s unit is, in fact, pro-rated when the Applicable Fraction is applied, because the cost of the super’s unit is included in Eligible Basis.
Applying the 30% Basis Boost
Eligible Basis (as adjusted by the Applicable Fraction) may be increased by up to 30% if the project’s buildings are located in Qualified Census Tracts (i.e., tracts with relatively low incomes) or if they are in a Difficult Development Area (i.e., a county or metropolitan area with a high cost/ income ratio). QCT’s and DDA’s are designated by HUD & the IRS, and the list may change from year to year. The list of QCT’s and DDA’s is published in the federal register. ESIC’s website http://www.esic.org/ has a link to these lists.
This results in a higher basis for calculating tax credits and provides an economic incentive to invest in such projects. The Basis Boost applies to the 9% rehab/construction tax credits and the 4% rehab/construction credits but does not apply to the 4% acquisition tax credit.
• Special HOME Rules for the Basis Boost. There are special rules that apply to using the basis boost if a project also uses HOME financing.
The resulting adjusted depreciable basis is known as the project’s Qualified Basis. Tax credits are calculated on the project’s Qualified Basis.
Annual Tax Credit
The total amount of tax credits a project is eligible to receive is determined by multiplying the Qualified Basis times the tax credit rate (4% or 9% – remember the actual tax credit rate is published monthly and has been slightly less than 4% and 9%). The result is the amount of tax credits the project is eligible to receive. For a project to receive tax credits, groups must apply to their state housing agency and receive a reservation. Since the number of applicants is high and the supply limited, it is not uncommon for a project to receive less in tax credits from the state than the project is eligible to receive.
Total Tax Credits
Since the project receives tax credits for 10 years, the annual tax credits is multiplied by 10 to get the total tax credits the investor will receive.
Tax Credit Equity
The tax credit investor will look at all of the tax credits the project can receive over 10 years and pay a price for the tax credits. Often, a project with 4% credits will have a higher raise (price) per tax credit dollar than a comparable deal with 9% tax credits. The higher raise is because the non-tax credit benefits such as depreciation are a greater percentage of total tax benefits, and investors value them, as well.