Low-Income Housing Tax Credit (LIHTC) Transactions

How the LIHTC Program Works

The Low-Income Housing Tax Credit (LIHTC) program, established under Section 42 of the Internal Revenue Code, is the primary federal mechanism for financing the development and preservation of affordable rental housing in the United States. The program works by allocating federal tax credits to developers of qualifying affordable housing projects. Developers then transfer those credits to private investors — typically through a syndication structure — in exchange for equity capital that is used to finance construction or rehabilitation. The investor's return comes from the credits, which can be claimed against federal tax liability over a ten-year period, along with tax benefits from depreciation.

Credits are allocated by state housing finance agencies (HFAs) in accordance with each state's Qualified Allocation Plan (QAP) — a document that establishes the priorities and scoring criteria the HFA uses to evaluate competing applications. Illinois credits are administered by the Illinois Housing Development Authority (IHDA). The amount of credit a project can receive is based on eligible basis — a calculation of qualifying development costs — multiplied by a credit percentage that reflects the type of credit and the financing structure.

9% Credits and 4% Credits

LIHTC transactions are built around one of two credit types, each with a distinct financing and allocation structure.

9% Tax Credits

The 9% credit (technically a floating rate, but fixed at 9% for most new construction) generates approximately 70 cents of eligible basis in equity per dollar — making it the higher-value credit and the more competitive allocation. Nine-percent credits are awarded through a competitive application process governed by the QAP. Because demand routinely exceeds supply, applications must demonstrate project readiness, site control, financial feasibility, and alignment with the state's affordable housing priorities.

Nine-percent transactions are typically used for new construction of rental housing. They do not require tax-exempt bond financing and can be structured with a range of soft debt sources — HOME funds, CDBG, trust fund money, and other public gap financing.

4% Credits and Tax-Exempt Bonds

The 4% credit (also a floating rate, approximately 4%) is non-competitive — it is available as of right to projects financed with qualified tax-exempt bonds, provided at least 50% of the project's aggregate basis is financed with bond proceeds. Because the credit is not subject to annual per-state credit caps, 4% transactions can scale in ways that 9% deals cannot.

Tax-exempt bond financing in the LIHTC context typically involves bonds issued by a state or local housing authority, with the bond proceeds used to finance construction or acquisition. The bonds are often credit-enhanced or backed by a government-sponsored enterprise. Four-percent transactions are commonly used for acquisition-rehabilitation projects and for larger new construction deals where bond volume is available.

Compliance period. Both credit types carry a 30-year extended use restriction (15-year initial compliance period plus a 15-year extended use period) requiring that the housing remain affordable to income-qualified households. Failure to maintain compliance can result in credit recapture. The regulatory agreement and land use restriction agreement (LURA) recorded against the property are the primary instruments through which these restrictions are imposed and enforced.

Transaction Structure and Participants

LIHTC transactions involve a layered capital structure and a defined set of participants, each with their own role, interests, and legal requirements. Understanding the participant structure is essential to understanding the legal work.

Developer / Sponsor

The developer or sponsor initiates and drives the project — identifying the site, securing financing commitments, managing the development process, and operating the property after completion. In a LIHTC transaction, the developer is typically the general partner of a limited partnership or the managing member of an LLC. The developer controls day-to-day operations but is subject to major-decision approval rights held by the investor and the requirements of the investor documents and loan documents.

Tax Credit Investor

The investor purchases an interest in the tax credit partnership or LLC in exchange for capital contributions made over a defined funding schedule. The investor's return is generated primarily by the tax credits (which offset federal income tax liability dollar-for-dollar) and by tax losses from depreciation. The investor has a limited partner or investor member interest — passive for tax purposes — but holds significant legal rights through the investment documents, including approval rights over major decisions, funding conditions tied to construction milestones, and recourse to the developer through guaranties.

Syndicator

In many LIHTC transactions, a syndicator serves as the intermediary between the developer and the ultimate tax credit investor — pooling credits from multiple projects into a fund that is then sold to investors, or placing credits with a single institutional buyer. The syndicator structures the investment, negotiates the partnership or operating agreement with the developer, manages the investor relationship, and oversees credit delivery and compliance. In some transactions, the syndicator and investor are the same entity (a bank or financial institution investing directly).

Construction Lender

The construction lender provides financing for the development phase. In a LIHTC transaction, the construction loan must be structured to accommodate the investor equity funding schedule, the requirements of the permanent lender, and any other capital sources closing simultaneously. Construction lenders in LIHTC deals require evidence of credit allocation, investor commitment, and a viable permanent takeout before they will fund.

Permanent Lender

The permanent loan replaces or converts from the construction loan after the project is placed in service, the credits are allocated, and the property achieves stabilized occupancy. In LIHTC transactions, permanent loans are often made by mission-driven lenders, community development financial institutions (CDFIs), government-sponsored enterprises (Fannie Mae, Freddie Mac), or FHA/HUD programs, each with their own underwriting and document requirements.

Public Agency and Soft Debt Providers

Most LIHTC transactions — particularly 9% deals — include subordinate financing from public agencies, local governments, or program sources such as HOME Investment Partnerships, Community Development Block Grant funds, state housing trust funds, or local affordable housing programs. These sources each carry their own regulatory requirements, loan documents, approval processes, and closing conditions, and must be coordinated within the overall closing.

The Legal Work in a LIHTC Transaction

LIHTC closings are among the most document-intensive in commercial real estate. Legal work spans multiple disciplines and must be coordinated across all participants simultaneously.

Entity and Investment Structure

Formation of the tax credit partnership or LLC
Limited partnership agreement or operating agreement
Master tenant or master lease structures where applicable
Investor subscription and admission documentation
Co-general partner and co-developer arrangements

Capital Contributions and Credit Delivery

Investor capital contribution schedules and funding conditions
Credit delivery and basis adjuster mechanisms
Pay-in structures tied to construction progress and credit events
Bridge loan documentation where investor equity is funded in advance

Guaranties and Risk Allocation

Completion and construction guaranty
Operating deficit guaranty
Tax credit delivery and recapture indemnity
Environmental indemnity
Guaranty carve-outs, limitations, and burn-off provisions

Loan Documentation

Construction loan agreement and security documents
Permanent loan documentation and program-specific requirements
Subordinate loan documentation for each soft debt source
Intercreditor and subordination agreements among lenders
Title insurance and endorsements for each lender

Regulatory and Program Compliance

Regulatory agreement with the state housing finance agency
Land use restriction agreement (LURA) recorded against the property
HOME, CDBG, and other program-specific regulatory agreements
Section 8 HAP contract coordination where applicable
Declaration of covenants and affordability restrictions

Project and Development Documentation

Development agreement between the sponsor and the tax credit entity
Management agreement with the property manager
Construction contract and design agreements
Ground lease documentation where the site is publicly owned
Organizational diligence across all transaction entities

Year-15 and the Extended Use Period

At the end of the initial 15-year compliance period — commonly referred to as "Year-15" — the investor's tax credit claim period is complete and the investment partnership or LLC enters its extended use period. Year-15 is a legally significant transition point that requires planning well in advance of its occurrence.

The primary legal issues at Year-15 involve the investor's exit from the tax credit entity. Under Section 42(i)(7) of the Internal Revenue Code, nonprofit general partners and their affiliates hold a right of first refusal to acquire the property at a formula price — typically the outstanding debt plus exit taxes — which is designed to preserve affordability following the investor's exit. Structuring and exercising this right correctly is a critical part of Year-15 planning for nonprofit sponsors.

For-profit developers typically negotiate a buy-sell mechanism, put/call option, or other exit structure in the original partnership agreement, with pricing keyed to appraised value, debt balance, or a negotiated formula. Exit tax obligations — generated by the investor's remaining tax basis in the entity — must be accounted for in the exit price and transaction structure. Failure to plan for Year-15 in the original documents can result in significant disputes and delays at the time of exit.

Year-15 often coincides with a recapitalization or resyndication — where the project is restructured with a new investor and a new credit allocation to generate fresh equity for rehabilitation or preservation. These transactions layer a new LIHTC closing onto the existing regulatory and ownership structure, requiring coordination among the new investor, the existing lenders, the housing finance agency, and any public agency stakeholders.

Layered Credit Transactions

LIHTC transactions are frequently structured in combination with other federal tax credit programs, each of which adds a layer of documentation, investor requirements, and regulatory compliance.

Historic Tax Credits (HTC) are available for the rehabilitation of certified historic structures and are commonly combined with LIHTC on preservation and adaptive reuse projects. Historic and housing tax credits are allocated to different investor interests and require a lease pass-through or master tenant structure to separate the credit streams while satisfying the requirements of both programs. The interplay between HTC and LIHTC investor requirements — particularly around the master lease, the fee structure, and the basis calculation — requires careful structuring.

New Markets Tax Credits (NMTC) are available for investments in low-income communities and are sometimes layered into mixed-use or community facility components of affordable housing projects. NMTC transactions involve a distinct investor, entity, and document structure — including a Community Development Entity (CDE), a leverage lender, and a qualified low-income community investment (QLICI) loan — that must be coordinated with the LIHTC structure and the project's overall financing.

LIHTC Counsel at Snow LLP

Snow LLP advises developers, sponsors, nonprofit organizations, and other participants in LIHTC transactions — both 9% and 4%/bond — including new construction, rehabilitation, preservation, and recapitalization. The practice handles the transactional legal work associated with the tax credit structure, the investment entity, the financing stack, and the regulatory framework, and coordinates with tax counsel, syndicators, lenders, and public agency counsel as required by each transaction.

LIHTC closings are complex, multi-party, and time-sensitive. Snow LLP focuses on managing the legal workstreams efficiently, maintaining the closing schedule, and identifying the issues that require attention before they become closing delays.

Low-Income Housing Tax Credit Transactions