26 U.S.C. § 42 — Low-income housing credit

(a) In general This section sets up the low-income housing credit. For any year in a building's credit period, the credit equals: the "applicable percentage" (set in (b)) times the "qualified basis" (set in (c)) of each qualified low-income building. This amount feeds into the general business credit under section 38. (b) Applicable percentage "Applicable percentage" is a rate the Secretary sets each month. It applies to a building based on the earlier of two dates: the month the building is placed in service, or, if the taxpayer elects, the month the taxpayer and the state housing agency lock in a binding deal on the credit dollar amount (or, for bond-financed buildings, the month the tax-exempt bonds are issued). This election must be made within 5 days after the elected month ends, and once made it cannot be undone. The Secretary must set the monthly percentages so that, spread over 10 years, they produce a credit whose present value equals: 70% of qualified basis for a new building that is not federally subsidized that year, or 30% of qualified basis for any other building (an existing building, or a federally subsidized one). To find that present value: measure it as of the end of year 1 of the 10-year period; use a discount rate equal to 72% of the average of the federal mid-term and long-term rates for the relevant month, compounded yearly; and assume each year's credit is received on the last day of that year. Two floors apply. A new building that is not federally subsidized and is placed in service after the date this rule was enacted must get at least 9%. Any other new or existing building placed in service after December 31, 2020 must get at least 4%. This subsection cross-references three other rules: rehabilitation spending can count as a separate new building (see (e)); a building's applicable percentage can change if its qualified basis grows after year 1 (see (f)(3)); and a state housing agency can cap the percentage and basis it will recognize for a building (see (h)(7)). (c) Qualified basis; qualified low-income building Qualified basis for a taxable year equals the "applicable fraction" (measured at year end) times the building's "eligible basis" (defined in (d)). The applicable fraction is the smaller of two fractions: the unit fraction (low-income units divided by all residential rental units in the building) or the floor-space fraction (floor space of low-income units divided by floor space of all residential rental units). If the building is a homeless-transitional-housing building described in (i)(3)(B)(iii), its qualified basis is bumped up by the smaller of: the eligible basis spent all year on services that help tenants find and keep permanent housing, or 20% of the qualified basis (figured without this bump). A "qualified low-income building" is a building that stays part of a qualifying low-income housing project for the whole compliance period, and that the 1986 tax reform amendments apply to. (d) Eligible basis For a new building, eligible basis is simply its adjusted basis at the end of credit-period year 1. For an existing building, eligible basis is that same adjusted basis only if the building was bought (not received in some other way), at least 10 years passed between that purchase and when the building was last placed in service, the building was never placed in service before by this taxpayer or someone related to them, and (with an exception under (f)(5)) a rehabilitation credit is allowed under (e). Otherwise, an existing building's eligible basis is zero. Adjusted basis for this purpose ignores any basis carried over from other property the buyer already owned. Certain transfers do not count as "placing the building in service" when checking the 10-year gap: transfers where the new owner's basis carries over from the old owner, property inherited from someone who died, placements by a government or qualifying nonprofit organization whose income is tax-exempt, foreclosure purchases that are resold within 12 months, and a person's own single-family home used only as their residence. "Related person" here borrows the relationship tests from sections 267(b) and 707(b)(1), plus common control under section 52. Eligible basis must be cut if some units are built to a noticeably higher standard than the low-income units — the cut equals the cost of that extra quality in the non-low-income units. A taxpayer can skip this cut for a unit if the "excess" cost of that unit is no more than 15% of what it would have cost at the average low-income per-square-foot rate, and the taxpayer elects to exclude that excess from eligible basis instead. The Secretary may allow measuring the excess some way other than by square footage. In figuring adjusted basis: non-residential property is normally excluded, but property in common areas or amenities shared by all residential units is included. For a building in a "qualified census tract," the cost of a "community service facility" (one built mainly to serve people at 60% or less of area median income) is also included, capped at 25% of the first $15,000,000 of the project's eligible basis plus 10% of the rest (all such facilities in one project are treated as a single facility for this cap). Adjusted basis is never reduced for depreciation already taken. Other basis rules: costs paid for with a federal grant are never part of eligible basis. Eligible basis is boosted to 130% of what it would otherwise be (and rehab expenditures likewise boosted to 130%) for buildings in a "qualified census tract" or a "difficult development area." A qualified census tract is one HUD designates because at least 50% of its households earn less than 60% of area median income, or its poverty rate is at least 25%; a difficult development area is one HUD designates for unusually high construction, land, and utility costs relative to income. Both designations are capped so that no more than 20% of a metro area's population falls inside them (nonmetro areas count as a single area per state); population is based on the latest census. A state housing agency can also designate an individual building as needing this boost to be financially workable, with a limited exception for buildings the ceiling rules in (h) don't otherwise apply to. The 10-year "last placed in service" test in this subsection does not apply to federally- or state-assisted buildings, and the Secretary can waive it for buildings bought from a failed, federally insured depository institution (or its receiver). Finally, if a taxpayer buys a building before the prior owner's compliance period ends, the new owner does not restart the eligible-basis clock; instead, they simply keep getting the same credit the prior owner would have gotten had that owner kept the building. (e) Rehabilitation expenditures treated as separate new building Money a taxpayer spends fixing up a building (capital costs for depreciable property, not the cost of buying the building itself, and not basis already excluded under (d)(3) or (d)(4)) is treated as if it created a brand-new separate building for credit purposes. This only counts if the spending helps or benefits low-income units, and if, over any 24-month stretch, the amount spent is at least the larger of: 20% of the building's adjusted basis at the start of that period (ignoring depreciation already taken), or an amount such that the qualified basis from that spending, divided by the number of low-income units, comes to $6,000 or more (this $6,000 figure rises with inflation for years after 2009, rounded to the nearest $100). If the taxpayer bought the building from a government, they can skip the 20%-of-basis test and instead just use the credit rate that would apply under (b)(2)(B)(ii). This new "building" is treated as placed in service at the end of that 24-month period, and it uses the same applicable fraction as the original building. A taxpayer cannot double-count the same rehab spending under both this subsection and the "existing building" rules in (d)(2)(A)(i) — they must pick one. The Secretary may write rules letting a group of units, rather than a whole building, count as a separate new building under this subsection. (f) Credit period rules The "credit period" is the 10 taxable years starting with the year a building is placed in service — or, if the taxpayer irrevocably elects, the next year, but only if the building already qualifies as low-income by the end of that first year. For year 1 of the credit period, the credit is prorated: instead of the normal applicable fraction, use a fraction whose top number is the sum of the monthly applicable fractions for each full month the building was in service that year, and whose bottom number is 12. Whatever credit is lost to this proration in year 1 is not lost forever — it becomes allowable in the 11th year (the year right after the credit period ends). If a building's qualified basis grows after year 1, the taxpayer usually only gets two-thirds of the applicable percentage that would otherwise apply to that extra basis (a similar year-1-style proration applies to the year the increase happens, too). If a building (or an interest in it) changes hands during a year the credit applies, the credit for that year is split between buyer and seller by the number of days each held it, with matching adjustments to the recapture rules in (j). For an existing building, the credit period cannot start before the credit period for its rehabilitation spending starts. And if a building's owner got a waiver of the 10-year rule under (d)(6)(B), but that owner still wouldn't qualify for a rehab credit under the usual dollar threshold, the credit period for that building is instead keyed to when it would have qualified for a rehab credit if the $6,000-type threshold were two-thirds of the normal amount and the acquisition-basis rule in (d)(2)(B)(iv) didn't apply. (g) Qualified low-income housing project A project qualifies as low-income housing if it passes one of three tests, whichever the taxpayer elects: The "20-50 test": at least 20% of the residential units are both rent-restricted and rented to tenants earning 50% or less of area median income. The "40-60 test": at least 40% of the units are both rent-restricted and rented to tenants earning 60% or less of area median income. The "average income test": at least 40% of the units (25% for certain bond-financed projects) are rent-restricted and rented to tenants at or under an income cap the taxpayer assigns to each unit. The taxpayer must assign a cap to every unit counted this way; the average of all assigned caps cannot exceed 60% of area median income; and each cap must be one of these steps: 20%, 30%, 40%, 50%, 60%, 70%, or 80% of area median income. Whichever test is elected, the election is irrevocable once made. Using part of the building for non-residential purposes does not disqualify it as residential rental property. A unit is "rent-restricted" if its gross rent is no more than 30% of the income cap that applies to it, and that cap can never be set lower than the one that applied when the building first joined the project. Gross rent leaves out Section 8 (or similar) rental assistance payments, but includes any utility allowance the Secretary sets; it also leaves out certain supportive-service fees paid by a qualifying government or nonprofit rent-and-services program, and leaves out rent an owner passes straight through to the Farmers' Home Administration under Housing Act section 515. The "imputed income limitation" for a unit is the income cap that would apply based on an assumed household size: 1 person for a unit with no separate bedroom, or 1.5 people per separate bedroom. If a tenant's income rises above the cap after they move in, the unit generally keeps counting as low-income as long as it stays rent-restricted — but there are limits. Under the 20-50 or 40-60 test, that grandfathering ends for a unit once the tenant's income tops 140% of the cap and another comparable-or-smaller unit in the building is then rented to a new, over-cap tenant. Under the average income test, a similar rule applies at 140% of the greater of 60% of area median income or the unit's own assigned cap. For "deep rent skewed" projects (a special bond-related category), 170% is used instead of 140%, with a different trigger keyed to 40% of area median income. Separately, a unit whose rent-plus-subsidy is legally required to grow as a tenant's income rises still counts as rent-restricted, as long as the combined rent and federal rental assistance never exceeds what it would have been had the tenant stayed under the income cap. A project generally must meet one of the three tests by the end of credit-period year 1 for each building. A "prior" building can count later buildings placed in service within the same 12-month window toward qualifying, if the taxpayer elects to apply special timing rules to each of those later buildings; in that case, the prior building is treated as placed in service on the date of the last such later building. Except for the first building in a project (or one placed in service within that same 12-month window), a later building must make the project qualify on its own, as of the date it is placed in service. A project with more than one building is treated as just one building unless every building that is or will be part of it is formally identified before the end of the first calendar year of the project period. Several rules from the tax-exempt bond program (section 142(d), paragraphs (2) through (7), and the section 6652(j) penalty) apply here too, using this subsection's own definition of "gross rent." After a building's compliance period ends, the taxpayer can elect to drop it from project status. A refundable, voluntary deposit a tenant makes toward eventually buying their unit does not disqualify the property, as long as it is refunded if the tenant leaves and no sale can happen until after the compliance period ends; such a deposit still counts as rent when checking rent restriction. Buildings in different locations can still count as a single project if every unit in every building is rent-restricted. The Secretary may waive recapture for de minimis compliance errors, and may waive annual tenant-income recertification for a building that is entirely low-income occupied. Finally, giving preference to tenants with special needs, tenants in a supported federal or state program, or tenants involved in artistic or literary activities does not violate the requirement that the project serve the general public. (h) Limit on total credit allowed per state A building's credit cannot exceed the dollar amount of credit the state housing agency actually allocated to it. That allocation normally must happen by the end of the calendar year the building is placed in service, with several exceptions: a binding written commitment made by that deadline to allocate a set amount starting in a later year; an allocation tied to an increase in qualified basis, capped at the credit that increase would generate on its own; an allocation for a building placed in service within two years of the allocation, if the taxpayer has already spent more than 10% of the project's expected total basis within a year of getting the allocation (existing buildings only qualify here if a rehab credit is coming); and, for a multi-building project, a single project-level allocation covering buildings placed in service during or after the allocation year, as long as each building's specific share is set by the end of the year it is placed in service. An allocated dollar amount, once made, applies to that building for every year of its compliance period from the allocation year onward, but it only counts against the state's ceiling for the single year it was allocated. The amount a state agency can allocate in a year is that state's "State housing credit ceiling," equal to: last year's unused ceiling, plus the greater of $1.75 times the state's population or $2,000,000, plus any ceiling amount "returned" that year (from projects that failed to spend 10% of basis in time, never became qualifying, or had their allocation cancelled by mutual agreement), plus any amount reallocated to the state from the national pool. States that use their entire ceiling and apply by May 1 of the following year can draw from that national pool of unused amounts from other states, split by population among such "qualified states." A state containing a "constitutional home rule city" (as defined in section 146(d)(3)(C)) gives that city its own slice of the ceiling, based on the city's share of the state's population, and reduces the rest of the state's ceiling accordingly. States may adopt different allocation formulas under rules similar to section 146(e). Population is measured under section 146(j). The $2,000,000 and $1.75 figures rise with inflation for years after 2002 (rounded down to the nearest $5,000 and nearest 5 cents), and for calendar years after 2025, both figures — after that inflation adjustment — are further multiplied by 1.12. Credit is not counted against a state's ceiling at all for the portion financed by certain tax-exempt bonds already subject to the separate private-activity-bond volume cap, as long as bond principal is timely used to redeem those bonds or the bonds are refunded. This ceiling exemption also covers an entire building if at least half its cost (building plus land) is financed by such bonds, or — for bonds issued after 2025 — if at least a quarter of its cost is financed by such bonds and at least one of those bonds alone covers 5% or more of the cost. At least 90% of a state's ceiling must go to projects other than ones involving a "qualified nonprofit organization" — in other words, at least 10% is reserved for projects where a nonprofit (tax-exempt under section 501(c)(3) or (4), not controlled by a for-profit, with a low-income-housing purpose, and not affiliated with a for-profit as determined by the state agency) owns an interest and materially participates in developing and running the project throughout the compliance period. A nonprofit still counts if it works through a corporation it wholly owns. States cannot use their own allocation rules to get around this 10% set-aside. No credit is allowed for a building unless an "extended low-income housing commitment" is in effect at year end. That is a recorded, legally binding agreement between the taxpayer and the state agency that: locks in a minimum applicable fraction for the whole "extended use period" and bars the actions described below; lets qualifying tenants (past, present, or prospective) sue in state court to enforce it; blocks selling off part of the building without selling all of it; bars refusing to rent to a Section 8 voucher holder because they hold a voucher; binds all future owners; and is recorded as a restrictive covenant under state law. The credit dollar amount allocated to a building cannot exceed what is needed to support the fraction locked in by this commitment (an amended commitment can raise that fraction). The "extended use period" runs from the start of the compliance period until the later of the date the agency's agreement specifies or 15 years after the compliance period ends. This period can end early on the date a building is foreclosed on (unless the Secretary finds the foreclosure was arranged just to escape the commitment), or, starting after year 14, if the taxpayer asks the agency to find a buyer and, within the following year, the agency cannot produce a "qualified contract" — a real offer to buy the low-income portion for at least the sum of outstanding secured debt (excluding debt from the last five years), the taxpayer's inflation-adjusted invested cash ("adjusted investor equity"), and other capital contributions, minus cash the project could distribute, plus fair market value for any non-low-income portion. Even after this early termination, existing low-income tenants cannot be evicted (except for good cause) or have their rent raised beyond what this section otherwise allows for three more years. "Adjusted investor equity" grows each year with a cost-of-living adjustment, but that adjustment is capped so a single year's inflation spike above 5% never gets baked in. If it turns out no valid commitment was actually in place at the start of a year, that discovery does not undo credit already allowed for earlier periods, and the current year's credit can still be allowed if the problem is fixed within a year of being found. Other allocation rules: an agency can only allocate its ceiling to buildings within its own jurisdiction. If an agency allocates more than its ceiling allows, the excess is trimmed starting with its most recent allocations. If the amount actually allocated to a building is less than the amount the credit formula would otherwise produce, the credit is scaled down proportionally to match the allocation (measured against a "full" credit amount computed by ignoring certain proration and two-thirds-reduction rules in (f)). Whenever an agency allocates a dollar amount to a building, it must specify both the applicable percentage and the maximum qualified basis it is recognizing, and neither figure can exceed what the statute would otherwise allow. Finally, "housing credit agency" means any agency authorized to run this program, and "State" includes U.S. possessions. (i) Definitions and special rules The "compliance period" is the 15 taxable years starting with credit-period year 1. A new building counts as "federally subsidized" for a year if a tax-exempt bond was outstanding at any point that year or earlier and its proceeds were used for the building — unless the taxpayer elects to exclude those bond proceeds from eligible basis, or the bonds were short-term construction financing that (when issued) named this building and were redeemed before the building went into service. A "low-income unit" is one that is rent-restricted and occupied by an income-qualifying tenant, but only if it is suitable for occupancy under local health, safety, and building codes and is not used on a transient basis. Two things are not treated as "transient": units in a building used exclusively to move homeless individuals into independent living within 24 months, where a government or qualifying nonprofit provides temporary housing and support services; and single-room-occupancy units rented month to month. In a building with four or fewer residential units, no unit counts as low-income if it is owned by someone who lives in the building (or a relative of theirs) — unless the building is being acquired or rehabbed under a government- or nonprofit-sponsored development plan, in which case the applicable fraction is capped at 80% of the unit fraction, and any unit vacant for 90 days or more is treated as occupied by the owner. A unit does not lose its low-income status just because it is occupied by certain students: those getting Title IV Social Security Act assistance, former foster youth, or job-training-program participants; or, for a fully student household, single parents (not someone else's dependent) with their children, or a married couple filing jointly. A "new building" is one whose original use begins with the taxpayer; an "existing building" is any other building. For an estate or trust, the credit (and any recapture tax under (j)) is split between the estate/trust and its beneficiaries based on how the underlying income is allocated. A tenant's, resident corporation's, qualifying nonprofit's, or government agency's right of first refusal to buy the property after the compliance period does not cost the taxpayer any federal tax benefit, as long as the purchase price is at least the outstanding secured debt (excluding debt from the last five years) plus taxes owed because of the sale (with tax-on-tax excluded, except for federal income tax itself). For rural projects (as defined in Housing Act section 520), income limits are measured against the higher of area median income or the national non-metro median income — unless the ceiling rules in (h) do not apply to the credit because of the bond-financing exception in (h)(4). And for the 2009 stimulus year, a state's ceiling components are reduced by whatever was already counted toward that state's 2009 low-income housing grant under the Recovery Act, and a building's basis is not reduced on account of that grant either. (j) Recapture of credit If a building's qualified basis at the end of a year is lower than it was at the end of the prior year, the taxpayer's tax for that year goes up by a "credit recapture amount." That amount is worked out in two steps. First, figure the "accelerated portion" of the credit already claimed on the lost basis — the difference between what was actually claimed in prior years and what would have been claimed if the whole compliance-period credit had instead been spread out evenly (ratably) over all 15 years. Second, add interest on that accelerated amount, at the IRS overpayment rate, running from the due date of the return for each earlier year. No deduction is allowed for that interest. Several limits apply: tax only goes up for credit that actually reduced the taxpayer's tax bill (unused carryforward or carryback amounts get adjusted instead); only basis that was actually used to figure a prior credit counts toward a "decrease"; a basis decrease does not trigger recapture to the extent it just undoes an earlier basis increase that got the reduced two-thirds credit rate under (f)(3); the extra recapture tax itself cannot be offset by any other credit; a basis drop from a casualty loss does not trigger recapture if the property is repaired or replaced within a reasonable time the Secretary sets; and the Secretary can excuse recapture for a small, de minimis change in floor space, as long as the building still qualifies afterward. A partnership with 35 or more partners (unless it elects out) is itself treated as "the taxpayer" for recapture purposes: it is treated as having received the original credit, and the extra recapture tax is split among the partners the same way the partnership's taxable income is split. A married couple counts as a single partner for the 35-partner count, and the election out, once made, cannot be changed. Selling a building (or an interest in it) does not by itself trigger recapture, as long as it is reasonably expected to keep operating as qualifying low-income housing for the rest of the compliance period. But if a sale is later followed by a basis drop that does trigger recapture, the IRS gets three extra years (from the date it is notified of the drop) to assess the resulting tax, regardless of any other statute of limitations. (k) At-risk rules Qualified basis is generally figured using rules like the general "at-risk" rules for the investment credit (parts of section 49(a)(1), all of section 49(a)(2), and section 49(b)(1)), with two narrow carve-outs from section 49 not applying. Financing borrowed from a qualifying nonprofit organization can still count, even if the nonprofit is not in the regular business of lending money, as long as several conditions are met: the loan is secured by the building itself (with an exception for a federally assisted building whose federal mortgage insurer will not allow a security interest, as long as the loan proceeds went to buy or improve the building); no more than 60% of the building's eligible basis, at the end of any compliance-period year, traces back to that financing (after subtracting any wraparound government financing); and the loan is fully repaid by the earliest of its maturity date, the 90th day after the compliance period ends, or the date it is refinanced or the building is sold. For loans from a nonprofit not otherwise closely tied to the housing program, that 90-day deadline instead runs from whichever is earlier: the building losing its low-income status, or 15 years after the compliance period ends. If such a loan's interest rate is more than one point below the applicable federal rate, the basis attributable to that loan is scaled down to its present value, discounted at that federal rate (treating any government-subsidized interest as if it were not actually payable). If a loan is not fully repaid on time, the taxpayer's tax for that year goes up by the credit tied to the unrepaid portion of basis, plus interest (at the underpayment rate) running from the due date of the return for the first year the credit was claimed through the due date for the year of the failure. Rules like the tax-benefit and no-credit-against-recapture-tax rules in (j)(4) apply here too. (l) Certifications and reports to the Secretary After the first year of a building's credit period, the taxpayer must certify to the Secretary: the year (tax year and calendar year) the building was placed in service; its adjusted and eligible basis at the end of year 1; the maximum percentage and basis the state agency approved under (h); which election under (g) the project made; and anything else the Secretary asks for. If this certification is filed late without reasonable cause, no credit is allowed for any year before it is finally filed. The Secretary may also require taxpayers to file annual information returns reporting each building's qualified basis for the year and the same (h)-related figures; missing this triggers the penalty in section 6652(j). Housing credit agencies must likewise file annual reports identifying every building they allocated credit to, the taxpayer, and the dollar amount allocated — with the same penalty for missing the deadline. (m) Responsibilities of housing credit agencies An allocation to a building counts for nothing (is treated as zero) unless it comes from a "qualified allocation plan" that the relevant local government has approved (using a process like the one for private-activity bonds), the agency has notified the local chief executive and given them a chance to comment, an independent party has done a market study of local low-income housing need at the developer's expense before the allocation, and the agency makes public a written explanation whenever it allocates outside its own established priorities. A "qualified allocation plan" must lay out the agency's local selection priorities; must give preference to projects serving the lowest-income tenants, projects committing to serve tenants the longest, and projects in a qualified census tract that support a broader community revitalization plan; and must spell out how the agency (or its contractor) will monitor for noncompliance — including regular site visits to check habitability — and notify the IRS of any noncompliance it finds. The plan's selection criteria must specifically cover: location, local housing needs, project characteristics (including whether it reuses existing housing as part of revitalization), sponsor qualifications, tenant populations with special needs, public housing waiting lists, households with children, projects planned for eventual tenant ownership, energy efficiency, and historic character. A bond-financed project only skips the state ceiling under (h)(4) if it also meets the qualified allocation plan's requirements for its area. The dollar amount allocated to a project cannot exceed what the agency determines the project actually needs to be financially workable and to stay viable as qualifying housing for the whole credit period. In deciding that, the agency must weigh the project's full funding sources and uses, any proceeds expected from tax benefits, how much of the credit amount goes to costs other than intermediaries (though this should not be used to block hard-to-develop-area projects), and whether the developmental and operating costs are reasonable — but this determination is not a guarantee that the project will actually be feasible. The agency must make this determination three separate times: at application, at allocation, and when the building is placed in service; before each check, the taxpayer must disclose every other federal, state, and local subsidy involved. A bond-financed project needs an equivalent determination from the government that issued the bonds. (n) Regulations The Secretary must write regulations to carry out this section, including rules covering projects with more than one building or only part of a building; buildings placed in service in stages; how this section applies to short tax years; preventing taxpayers from using the section to dodge its own limits; and giving housing agencies a reasonable window to fix administrative mistakes in allocations and recordkeeping after they are discovered.