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

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 or rehabilitation of roughly 3.6 million affordable housing units since its inception, according to the National Council of State Housing Agencies (NCSHA) — more than any other federal housing program.

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. The IRS allocates credits to states based on population — currently $2.75 per capita (base amount, adjusted annually for inflation per IRC Section 42(h)(3)(H), plus the 12% increase from the 2025 legislation). 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 bond financing, and the credits are generated automatically when the bonds finance more than 25% of the project's aggregate basis (reduced from 50% by the 2025 One Big Beautiful Bill Act).
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). Current pricing: roughly $0.84-$0.92 per dollar of tax credit, according to the CohnReznick Housing Tax Credit Monitor (Q1 2026), depending on deal quality, market, and investor demand.
5. The equity reduces the project's financing gap. With tax credit equity covering 30-70% of development costs (depending on whether 4% or 9%), 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. Investor yields currently range from 7.25% to 9.0%, depending on credit quality and pay-in timing.

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 reserves, replacement reserves (though some states allow reserves in basis)
• Non-residential commercial space — retail, office, or other commercial components
• Syndication costs — legal and accounting fees related to the tax credit partnership

For new construction, eligible basis typically represents 85-92% of total development cost. 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), receive a 130% basis boost — their eligible basis is multiplied by 1.30 before applying the applicable fraction. This can increase the credit amount by 30%, 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. The 9% credit generates roughly 2.5x 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). 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 $0.90/credit pricing, that's $16.2M in tax credit equity.

The same project with a 4% rate generates $800K/year for 10 years = $8M in total credits = $7.2M 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 2-2.5x more equity per dollar of basis. 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 12-18 months anyway (due to permitting, site preparation, or community engagement), the 9% timeline isn't a constraint.
• Smaller projects. 9% is more efficient for projects under 100 units 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 competitive allocation. The bond process can move significantly faster than the annual QAP cycle — critical for acquisitions with closing deadlines or sites with expiring entitlements.
• The project is large. Bond issuance costs are relatively fixed, so larger projects (150+ units) 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 (2-3x oversubscription is common), 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, signed July 2025) made two significant changes to the LIHTC program that affect underwriting for projects placed in service after December 31, 2025, as tracked by Novogradac's legislative analysis:

Bond financing threshold reduced: 50% → 25%

Previously, tax-exempt bonds had to finance at least 50% of a project's aggregate basis to trigger 4% LIHTC credits. The threshold is now 25%. This is a major change for 4% deals:

• Smaller bond allocations needed. A $30M project previously needed at least $15M in bonds; now it needs $7.5M. This frees up bond volume cap for more projects.
• More flexible capital stacks. With bonds covering only 25% instead of 50%, 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%

The 9% credit per-capita allocation ceiling increased by approximately 12%, providing 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 20% error in a mixed-income deal.
• Applying the basis boost incorrectly. The 130% QCT/DDA boost applies to eligible basis, not qualified basis. Applying it after the applicable fraction reduces the boost. Order of operations matters: eligible basis × 130% × applicable fraction, not eligible basis × applicable fraction × 130%.
• Using the old 50% bond threshold. As of 2026, the bond financing threshold is 25%, not 50%. Models built with the old threshold will oversize the bond tranche, increasing debt service and reducing feasibility.
• 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 15-25% 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 that's 80% affordable doesn't generate 80% of the credits that a 100% affordable project would — it generates 80% of the credits on the basis attributable to the affordable units, which may differ from 80% if units are different sizes.

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 calculation → 25% threshold test → minimum bond amount → bond sizing based on debt service coverage (DSCR typically 1.15-1.20x for LIHTC) → 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 (typically 90% occupancy for 90 days), 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 (typically 5-7% for LIHTC), 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 25% test, 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.