LIHTC 101: How the Program Works, 4% vs 9% Credits Explained

Key Takeaways

What Is LIHTC

The Low-Income Housing Tax Credit is the primary federal subsidy for affordable housing construction and rehabilitation in the United States. Created by Section 252 of the Tax Reform Act of 1986 and codified as IRC Section 42, the program has financed the construction and rehabilitation of affordable rental housing for four decades.

LIHTC doesn't provide direct government funding. Instead, it allocates federal tax credits to state housing finance agencies (HFAs), which award the credits to developers through a competitive application process governed by a Qualified Allocation Plan as required under IRC Section 42(m). Developers don't use the credits themselves; they sell them to investors (typically large banks, insurance companies, and corporate entities with federal tax liability) in exchange for equity. That equity reduces the amount of debt and other capital a project needs, which in turn allows the developer to charge below-market rents and still make the deal financially feasible.

The program operates through two distinct credit types: the 9% credit (also called the "70% present value credit") and the 4% credit (the "30% present value credit"). These aren't just different rates; they represent fundamentally different deal structures, different allocation processes, and different roles in the affordable housing ecosystem. Understanding the distinction is foundational to underwriting any LIHTC deal.

How Credits Generate Equity

The LIHTC equity mechanism works through a three-party transaction that is often confusing to practitioners encountering it for the first time. Here's the chain:

1. Federal law sets each state's credit ceiling based on population. For 2026, the ceiling is the greater of $3.416 per resident or $3,953,600, per Rev. Proc. 2025-32, reflecting the annual inflation adjustment under IRC Section 42(h)(3)(H) and the permanent 12% increase under Section 42(h)(3)(I) from the 2025 One Big Beautiful Bill Act. Each state's HFA distributes these credits through its Qualified Allocation Plan (QAP).
2. The developer applies for credits through the state HFA. For 9% credits, this is a competitive process scored against QAP criteria. For 4% credits, the developer applies for tax-exempt private activity bond financing, and the credits come without a separate ceiling allocation when the bonds finance at least 50% of the aggregate basis of the building and its land, or at least 25% under the test added by the 2025 One Big Beautiful Bill Act (see2026 Legislative Changes). The bonds themselves draw on the state's private activity bond volume cap, which is competitively allocated in many states.
3. Credits are awarded to the project, which generates a specific dollar amount of tax credits per year for 10 years. The annual credit amount is determined by the eligible basis, the applicable fraction, and the credit rate.
4. The developer sells the credits to an investor, typically through a syndicator who aggregates multiple projects into a fund. The investor pays equity into the project in exchange for the tax credits (and depreciation deductions). The two listed multi-investor funds that disclose pricing in the June 2026 CohnReznick Housing Tax Credit Monitor quote net equity pricing of $0.77-$0.92 per dollar of tax credit, and the surveyed median was $0.835 for February-March 2026, the lowest surveyed result in recent years, which the Monitor calls likely indicative of supply increases from OBBBA. Pricing varies with deal quality, market, and investor demand.
5. The equity reduces the project's financing gap. With tax credit equity covering roughly 28% (4%) to 64% (9%) of development costs in the Figure 2 example, the project needs less debt, less soft financing, and lower rents to be financially viable.

The investor's return comes from the tax credits themselves (dollar-for-dollar reduction in federal tax liability) plus depreciation deductions on the property. Multi-investor funds listed in theCohnReznick Housing Tax Credit Monitor (June 2026) list after-tax cash needs IRRs ranging from 5.0% to 10.25%.

The Credit Calculation

The annual tax credit amount is calculated through a specific formula. Every term in this formula matters for underwriting; a misunderstanding at any step cascades through the entire pro forma.

Step 1: Total Development Cost → Eligible Basis

Eligible basis is the total development cost minus items that don't qualify for credits. The excluded items:

• Land costs: land never qualifies for LIHTC (it's not depreciable)
• Permanent financing costs: interest on permanent debt, but construction period interest IS included
• Reserves: operating and replacement reserves are never in eligible basis (some states allow them as eligible development costs in TDC for gap sizing, which is a different test)
• Non-residential commercial space: retail, office, or other commercial components
• Syndication costs: legal and accounting fees related to the tax credit partnership

In the Figure 2 example, eligible basis is 85% of total development cost, an illustrative assumption; the actual share depends on land cost, reserves, and financing structure. For rehabilitation, only the rehabilitation expenditures qualify, not the acquisition cost of the existing building (which is treated separately under the acquisition credit, if applicable).

Step 2: Eligible Basis → Qualified Basis

Qualified basis is eligible basis multiplied by the applicable fraction, the percentage of units (or floor space) set aside for low-income tenants. Two methods:

• Unit fraction: Number of low-income units ÷ total units
• Floor space fraction: Square footage of low-income units ÷ total square footage

The developer uses whichever fraction is smaller (the "lesser of" test). In a 100% affordable project, the applicable fraction is 100%. In a mixed-income project with 80 affordable units out of 100, the applicable fraction is 80%.

Basis boost: Projects located in Qualified Census Tracts (QCTs) or Difficult Development Areas (DDAs), as designated annually by HUD under IRC Section 42(d)(5)(B), may receive a basis boost of up to 130%: the allocating agency can increase the eligible basis of a new building (or, for an existing building, only its rehabilitation expenditures) by up to 30%. That raises the credit amount by the same percentage, making deals feasible in high-cost markets that wouldn't otherwise pencil.

Step 3: Qualified Basis → Annual Credit

The annual tax credit is the qualified basis multiplied by the applicable credit percentage:

Table 1. The two credit rates. At the statutory floors, the 9% credit generates 2.25x more credit per dollar of qualified basis than the 4% credit. Both are delivered over a 10-year credit period.

The credit is claimed annually for a 10-year credit period, as specified under IRC Section 42(f)(1), beginning with the year the building is placed in service or, by election, the following year. So a project with $20M in qualified basis and a 9% rate generates $1.8M/year in credits for 10 years = $18M in total credits. At the $0.835 median credit price, that's $15.03M in tax credit equity.

The same project with a 4% rate generates $800K/year for 10 years = $8M in total credits = $6.68M in equity. The 9% deal generates more than double the equity, which is why the 9% credit is competitively allocated and the 4% is not.

4% vs 9%: The Core Differences

The distinction between 4% and 9% goes far beyond the credit rate. They are different deal structures with different allocation processes, different capital stacks, and different risk profiles.

Table 2. The structural differences between 4% and 9% LIHTC. The credit rate is just the starting point; the entire deal architecture differs.

When to Use Which

Pursue 9% when:

• The project needs maximum equity. 9% credits generate about 2.25x more equity per dollar of qualified basis (more if 4% pricing is lower). If the deal doesn't pencil with 4% equity levels, and you can't fill the gap with soft debt or other subsidies, you need 9%.
• Your project scores well under the state QAP. Each state's QAP prioritizes different criteria: location in a QCT, serving extremely low-income residents (30% AMI), veteran housing, supportive services, energy efficiency. If your project aligns with the state's priorities, the competitive risk is manageable.
• The deal can wait. 9% allocation cycles are annual. If you can't start construction for a year or more anyway (due to permitting, site preparation, or community engagement), the 9% timeline isn't a constraint.
• Smaller projects. 9% is more efficient for smaller projects because the fixed costs of bond issuance (legal, underwriting, trustee fees) don't scale down proportionally.

Pursue 4% when:

• Speed matters. 4% credits don't require a competitive credit allocation, though the bond volume cap award can be competitive in many states. The bond process can move faster than the annual QAP cycle, which is critical for acquisitions with closing deadlines or sites with expiring entitlements.
• The project is large. Bond issuance costs are relatively fixed, so larger projects absorb those costs more efficiently. The lower per-unit equity from 4% credits is offset by scale.
• You have access to soft debt. The gap between 4% equity and total development cost is filled by soft debt (state HFA loans, HOME funds, AHP grants, deferred developer fee). If your state has robust soft debt programs, 4% deals are viable.
• Acquisition/rehab deals. Buying and rehabilitating an existing property typically uses 4% credits paired with bonds. The acquisition component gets the 4% acquisition credit, and the rehab component gets either the 4% new construction credit (if financed with bonds) or the 9% rehab credit (if competitively allocated).
• The state's 9% pipeline is oversubscribed. In states where QAP competition is intense, developers with time-sensitive projects or lower-scoring applications may be better served by the 4% path.

2026 Legislative Changes

The One Big Beautiful Bill Act (OBBBA, Pub. L. 119-21, signed July 4, 2025) made two significant changes to the LIHTC program in section 70422, with different effective dates (see the amendment notes to IRC Section 42):

Bond financing test: a 25% option alongside 50%

Before OBBBA, tax-exempt private activity bonds had to finance at least 50% of the aggregate basis of the building and the land on which it sits for the whole building's credit to come without a ceiling allocation. That 50% test still exists. Under amended IRC Section 42(h)(4)(B), a building can instead qualify at 25% or more of that basis, but only if at least one of the bond issues financing it has an issue date after December 31, 2025 and finances at least 5% of the same building-and-land basis. The change applies to buildings placed in service in taxable years beginning after December 31, 2025. For 4% deals that qualify, this is a major change:

• Smaller bond allocations needed. On an illustrative $27M of aggregate building-and-land basis, the 50% test requires at least $13.5M of bond financing; the 25% test requires $6.75M, of which at least $1.35M must come from a bond issue dated after 2025. This frees up bond volume cap for more projects.
• More flexible capital stacks. With bonds covering 25% instead of 50% of basis, there's more room for conventional debt, soft debt, or other financing sources in the stack.
• More deals become feasible. Projects that couldn't access enough bond allocation now have a lower threshold to clear. States with constrained bond caps benefit most.

Per-capita allocation ceiling increased 12%

For calendar years beginning after December 31, 2025, the inflation-adjusted per-capita and small-state minimum amounts that set each state's credit ceiling are multiplied by 1.12 under IRC Section 42(h)(3)(I), regardless of when a building is placed in service. That provides more 9% credits for competitive allocation in every state. This doesn't change the credit mechanics but increases the supply of 9% credits, potentially reducing the intense competition that pushes many developers toward 4%.

Common Mistakes

These are the errors we see most frequently in LIHTC underwriting, and the ones that cause the most damage when they reach an investor or state HFA reviewer:

• Confusing eligible basis with qualified basis. Eligible basis is development cost minus exclusions. Qualified basis is eligible basis times the applicable fraction. The credit is calculated on qualified basis, not eligible basis. Mixing them up overstates the credit by the inverse of the applicable fraction: a 25% overstatement at an 80% applicable fraction.
• Applying the basis boost incorrectly. The QCT/DDA boost of up to 130% applies to the eligible basis of new buildings and only to the rehabilitation expenditures of existing buildings, not to land or acquisition basis. Applying it to ineligible items, or applying it twice, overstates the credit. The state-designated boost under IRC Section 42(d)(5)(B)(v) is not available to a building if any portion of its eligible basis is exempt from the state ceiling because of tax-exempt bond financing under Section 42(h)(4).
• Getting the bond test wrong. Models hard-coded to the old 50% test oversize the bond tranche on deals that qualify for the 25% test, increasing debt service and reducing feasibility. Models that apply 25% to a building without a bond issue dated after 2025 financing at least 5% of building-and-land basis, or placed in service in a taxable year beginning before 2026, fail the test; the portion of the credit not financed by bonds would then need an allocation from the state ceiling.
• Forgetting that land is excluded from basis. This sounds obvious but is the most common error in preliminary pro formas. Land is not depreciable and never qualifies for LIHTC. In high-cost markets where land is a large share of TDC, this exclusion significantly reduces the credit amount.
• Assuming credit pricing is fixed. Credit pricing fluctuates with market conditions. Using $0.92/credit when the market has moved to $0.85 overstates equity by 8%. Always use current pricing from your syndicator or the CohnReznick Housing Tax Credit Monitor.
• Ignoring the applicable fraction in mixed-income deals. A project where 80% of units are affordable doesn't automatically generate 80% of the credits that a 100% affordable project would. It generates credits on the smaller of the unit fraction and the floor space fraction, which is below 80% if the affordable units are smaller than the market-rate units.

How to Model It

A properly structured LIHTC pro forma has specific tabs and calculations that don't exist in a market-rate acquisition model. Here's what the Excel workbook should contain:

Sources & Uses tab

Uses: land, hard costs (by CSI division or lump sum), soft costs (architecture, engineering, legal, accounting, permits), financing costs (construction interest, bond issuance, permanent loan origination), developer fee, reserves. Sources: tax credit equity, tax-exempt bonds, state HFA soft debt, HOME funds, deferred developer fee, AHP grants, other gap financing, developer equity.

Credit Calculation tab

Total development cost → exclusions → eligible basis → basis boost (if QCT/DDA) → applicable fraction → qualified basis → applicable credit rate → annual credit → 10-year total → credit pricing → tax credit equity. Each step should be a separate row with a clear formula, not a single combined calculation.

Bond Sizing tab (4% deals)

Aggregate basis of building and land → 50% test, or 25% test with a check that a bond issue dated after 2025 finances at least 5% of that basis → minimum bond amount → bond sizing based on debt service coverage (DSCR per lender and HFA requirements) → bond interest rate → annual debt service → net operating income check.

Investor Pay-In tab

Capital contribution schedule tied to milestones: closing, construction start, 50% completion, placed-in-service, stabilization (as defined in the partnership agreement), 8609 delivery. Each installment as a percentage of total equity, with dates. Bridge loan interest calculation for the gap between expenditures and equity receipts.

Operating Pro Forma tab

Revenue: gross potential rent by AMI tier and unit type, vacancy (per lender and HFA underwriting standards), other income. Expenses: by line item, benchmarked against appraisal and comparable properties. NOI. Debt service on permanent financing. Cash flow. Replacement reserve deposits. Deferred developer fee repayment from surplus cash.

The test of a good LIHTC model: change the credit pricing from $0.92 to $0.88 and see if the gap financing amount adjusts automatically. If it doesn't (if you have to manually recalculate the sources & uses), the model isn't properly linked.

Related Articles

This article is part of the LIHTC underwriting series. Each article goes deeper into a specific aspect of tax credit deal structuring:

• 4% LIHTC with Tax-Exempt Bonds: Bond deal mechanics, the 50% and 25% bond tests, and how to size the bond tranche.
• 9% LIHTC Competitive Allocation: QAP scoring strategies, basis boost qualification, and managing competitive risk.
• LIHTC Investor Returns: Credit pricing mechanics, investor yield calculations, and pay-in schedule structuring.
• Year 15 Exit Strategies: Compliance period obligations, resyndication, and disposition options.
• Rent and Income Limits: AMI calculations, maximum rents by household size, and set-aside elections.
• The LIHTC Capital Stack: Soft debt, deferred developer fee, HOME funds, and gap financing.
• Acquisition/Rehab with 4% Bonds: Modeling existing property deals with rehabilitation credits.