How the Low-Income Housing Tax Credit Works

The Low-Income Housing Tax Credit was created under the Tax Reform Act of 1986. It was part of the federal government’s move away from developing affordable housing itself. Responsibility shifted to the private sector — nonprofit and for-profit developers — who got a tax incentive to build it instead.

The same law killed the tax shelters that had been pulling private money into apartment construction. So LIHTC did two things at once. It transferred the work, and it replaced the incentive Congress had just taken away.

The program generally has bipartisan support. Democrats are happy because it tackles a serious social issue. Republicans are happy because of the lessened impact to federal spending. It also runs through the tax code instead of annual appropriations, so it never has to survive a budget fight. That is a big part of why it has lasted forty years while public housing funding shrank.

How does LIHTC work?

Congress sets the size of the program

• Congress caps how many credits can be issued each year. The IRS splits that up among the states by population.
• In 2026 each state gets the greater of $3.416 per resident or $3,953,600. Small states get the floor.
• Each state’s housing finance agency hands out the credits.
• The agency writes a Qualified Allocation Plan, or QAP. The QAP is the scoring sheet. It decides what gets built and where. (Iowa’s current 9% and 4% plans: Housing Tax Credit QAPs and resources — the 2026–27 9% QAP is on its second amendment, so always pull the newest file.)

There are two credits

• The 9% credit is competitive. There is never enough of it. It covers about 70% of eligible development cost in present value. It is used for new construction and substantial rehab.
• The 4% credit is less competitive and in some states can be gained automatically if you finance the deal with tax-exempt private activity bonds. It covers about 30%. The bonds have their own annual cap.
• Bonds used to have to cover at least half the project’s basis. For bonds issued after December 31, 2025, that drops to 25%. This is a big deal. The same bond cap now stretches across twice as many deals.

In Iowa the 9% squeeze is measurable. Roughly one in three applications wins in a normal year:

How the credit amount is set

• Start with eligible basis. That is the depreciable cost of the building. Land does not count. Commercial space usually does not count.
• If the project sits in a Qualified Census Tract or a Difficult Development Area, eligible basis goes up 30%. States can award the boost on their own too.
• Multiply by the applicable fraction. That is the share of units that are income restricted.
• The result is qualified basis. Multiply that by the credit rate and you get the annual credit. You claim it every year for ten years.

That 30% boost is geographic, and in Iowa it is scarce. Only 85 census tracts carry a 2026 QCT boost, and just 28.6% of the state’s LIHTC projects sit in one — they cluster in the metros:

Vintage matters: HUD flags each project's QCT status against the map in force when it was placed in service. The map above shows the current 2026 QCTs — the map a new deal is sited against.

Where you apply matters as much as where you build. Across all 114 Iowa applications from 2022–2026, the set-aside you request moves your odds more than almost anything else:

The Innovation set-aside deserves its own explanation, because the raw numbers flatter it. It is not scored like the other pools — it is a pitch competition. You apply, IFA selects three or four projects, and those finalists pitch at the Iowa Housing Conference. One project wins. So the pool’s three-for-three record is three annual winners, not a 100% success rate: the applicants who never reach the pitch stage are not in that denominator. Treat it as the narrowest award in the QAP, not the easiest.

I have been through it. Our own project, The Townhall, won the first Innovation set-aside ever awarded.

The credits get sold

• Most developers cannot use the credits. They do not have the tax liability. So they sell them.
• An investor, usually a bank, buys 99.99% of the ownership entity. Banks want the credits partly to meet Community Reinvestment Act obligations.
• The investor pays cash up front, in installments tied to closing, construction, and lease-up. In exchange it takes ten years of credits and the losses.
• Price is quoted in cents per credit dollar. Ninety cents means the investor pays $0.90 today for $1.00 of future credit. That price moves with corporate tax rates, bank demand, and interest rates.
• This is the whole point of the program. Restricted rents mean less income. Less income supports less debt. The credit equity fills the hole.

Because the credit is the equity, construction-cost inflation shows up directly in how many credits a single unit consumes. In Iowa the median has climbed nearly 40% in four years:

What you give up

• You pick an income set-aside. Twenty percent of units at 50% AMI, 40% at 60% AMI, or income averaging, where units run from 20% to 80% AMI and average no more than 60%.
• Rents are capped at 30% of the income limit for that unit size. Not 30% of what the tenant actually earns.
• Fifteen-year compliance period. You certify tenant income every year. Fall out of compliance and the IRS takes the credits back.
• A recorded extended use agreement keeps the property affordable for at least 30 years. Most state QAPs award points for going longer, so in practice it is longer.

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