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Understanding Tax Credits

The basic premise behind using tax credits as subsidies in deals is simple: investing in a project generates a credit, which can be used by the investor to offset income tax liability. In most real estate transactions, however, the sponsor team / project will have no income for a number of years (as the project gets built and leased up), so structures have evolved to “sell” the credits generated by the investment to a third party (like a bank) that needs them.

We have summarized some of the key tax credit distinguishing points below to help you decide which credits might make sense for your pipeline:

● What Generates the Credit

Tax credits get generated by spending money; in some cases, those expenditures must be to restore a historic structure (Historic Tax Credits or HTCs), create low-income housing (Low Income Housing Tax Credits or LIHTCs), or support economic development in low-income communities (New Market Tax Credits or NMTCs) ; in other cases, it would be investing in a new solar facility (Investment Tax Credits), inclusive hiring (Work Opportunity Tax Credit), or paying employees (Jobs Tax Credits, common industrial incentives in many states).  In some cases, every dollar spent is eligible investment for the credit; in others, only a fraction of those dollars work.

● Who Provides Credit

Federal agencies and states typically “allocate” credits to projects (or, in some cases, like NMTC, to third party community development organizations who then allocate to projects).

● Amount of Credit

To figure out how much credit is generated, multiply the eligible spend (which will be different depending on the tax credit type) times the amount of the credit – see below for some examples of credit percentages. 

● Who Can Claim the Credit & How

This is the biggest question for every tax credit program because it dictates how “valuable” the credits are to the project on Day 1. There are two key aspects of every credit that play into this valuation:

  • Refundability: If a tax credit is “refundable,” it means it can be claimed as a refund if the project does not have income tax liability. For example – if a project has $5M in refundable tax credits, but $0 income tax liability (as is typical for real estate deals in Years 1-3), it would claim a $5M refund on its tax return in Year 1 – and that $5M would flow straight to the project. If a project (like a business) had $1M of tax liability in Year 1 and $5M in refundable credits, the refund would be $4M, etc. Refundable credits are effectively the same as cash subsidies to projects – which is exactly why most tax credits are NOT refundable.
  • Transferability: Most tax credits are non-refundable – meaning that a project with $0 in income for Years 1-3 would have $5M of unusable tax credits. But if a project sponsor could find someone with $5M of income tax liability, the sponsor could transfer the credits to that person in exchange for cash. The “purchaser” of those credits would probably buy them at a discount – in other words, they would provide the sponsor with, say, $4.5M for the $5M in credits (meaning they make $500K on the swap). To the sponsor, $4.5M in cash up front is far better than $5M in useless tax credits – so they’ll make the deal. This “discount” is called the credit’s “market value” – in this case, it would be 90%, but market values for credits can swing wildly from 50-60% for state tax credits to almost 100% for some popular federal tax credits.

So, as you look at credits, check for refundability first – but if that’s not an option, make sure the credits can be transferred/”sold.” Banks are frequent purchasers of tax credits, but any large company with recurring income tax liability could be a good purchaser. 

● Time Period / Compliance Period

Most tax credits can only be claimed over time – and the time over which they are claimed typically aligns with a “compliance period” (which ensures that the investment that earned you the credits actually does what you promised it will do). The length of this period, and how the credits come in over that period (e.g., all in Year 1 vs. spread between Years 1 and 5), is a huge factor in how transferable credits are priced or discounted. A 20% credit that comes in over 4 years (e.g., 5% a year) is less valuable than a 20% credit – or, arguably, even a lower credit amount – that comes in during Year 1.

We explore three popular federal tax credits below: 


How to Monetize Tax Credits

Historic Tax Credits

Basic Description

Administered jointly by the National Park Service (NPS) and the Internal Revenue Service, the Federal Historic Preservation Tax Incentives program helps to bring private capital into historic revitalization projects. Since its creation in 1976, this program has helped incentivize over $100 billion dollars in private capital investment and has preserved more than 45,000 historic properties across the county, including 260,000 renovated housing units. Once the NPS designates a property as a “certified historic structure”, the historic revitalization project is eligible for a 20% tax credit to be used for “qualified expenditures” over a five year period. This credit provides a reduction in tax liability calculated as a percentage of the eligible project expenses (referred to as “qualified rehabilitation expenditures”). These projects must be for income-producing properties, such as housing, commercial, office, and retail.

To be classified as a certified historic structure, a building must be listed individually on the National Register of Historic Places or be listed as a contributing building to a certified local historic district. The NPS approves a building’s application to be certified. For a map of current NPS-approved buildings and districts, click here.

Each year, nearly $6 billion dollars in private capital is invested for 1,200 projects.


What Generates It

Investment into buildings on the National Register of HIstoric Places or contributing structures within historic districts listed on the National Register. Only eligible expenditures are “qualified rehabilitation expenditures” (QREs) – generally, project costs that go towards preserving and rehabilitating the building. Your state historic preservation office can typically help you scope what expenditures count as QREs.

Who Provides It

National Park Service / IRS

Amount / Percent

20% of QREs

Claiming / Monetization

Like most federal credits, HTCs are non-refundable; but they are transferable through a master-tenant lease structure. 

Timing & Compliance

HTCs come in over a 5-year compliance period, 4% per year.

State Historic Tax Credits

Alabama is one of only a small handful of states in the U.S. that offers a refundable state historic tax credit equal to 25% of qualified rehabilitation expenditures. For why this refundable credit is so significant, see “Who Can Claim Credit and How” discussion above. Approval for the state credits follows the same basic pathway as approval for federal credits, and is summarized on the Alabama Historical Commission’s website. A significant percentage of the deals we work on at OPAL involve state historic tax credits, so if you have questions on the program, feel free to contact us.

New Markets Tax Credits

Basic Description

Administered by the US Treasury Department’s CDFI Fund, and approved by Congress as part of the Community Renewal Tax Relief Act of 2000, the New Markets Tax Credit Program is a place-based anti-poverty program designed to incentivize investment in distressed communities. 

Congress authorizes the credit amount which the Treasury (through the CDFI Fund) designates to certain Community Development Entities (CDEs). CDEs are organizational intermediaries (banks, developers, local governments, community development corporations, etc.) that can make financial loans or investments. 

Each allocation cycle, these entities apply for tax credit authority from the CDFI Fund. Using their tax credit authority, CDEs offer tax credits to private investors in exchange for equity shares in the CDE. They then use these funds to provide financing to qualified businesses operating in low-income communities across the country. Investors are able to claim a tax credit equal to 39% of cost of the NMTC project share over a seven-year time period. Investors are typically corporate entities, such as financial institutions. CDEs can also be their own investors and are encouraged to offer preferential rates and returns for NMTC deals. NMTCs often act as a catalyst for securing public subsidy and other private investment in order to make a project happen.

For a project to be eligible for NMTC investment, it must be a “qualified active low-income community business” (QALICB), and can be either for-profit or non-profit. Over the past 18 years, the NMTC program has distributed $26 billion dollars worth of credits and supported more than 5,300 projects in all 50 states, the District of Columbia, and Puerto Rico across a variety of asset classes including manufacturing, food, retail, housing, health, technology, energy, education, and childcare. 


What Generates It

Investment, through a community development entity (CDE), into a qualified active low-income community business. This can be either a real estate project or an operating business, but most NMTC deals are for real estate projects.

Who Provides It

CDFI Fund – via CDE allocations (see above).

Amount / Percent

39% of CDE investment (which typically equals project cost – see diagram).

Claiming / Monetization

Like most federal credits, NMTCs are non-refundable; but they are transferable through the “leverage loan” structure shown in the diagram.

  • Because of the complexity of a NMTC transaction, the typical project only gets about half (or less than half) of the actual credit value. On a $10M project, the credits are worth $3.9M – but the credit purchase discount, the fees charged by CDEs, and legal/accounting fees, eat up $2-2.5M, leaving only $1.5-2M in “free cash subsidy” for the project. 
  • This same complexity makes it very difficult to do deals smaller than $5M – so beware of counting on NMTCs for smaller projects.
Timing & Compliance

NMTCs come in over a 7-year compliance period, distributed roughly evenly over the course of that period.

$5mm Allocation Example

Key Takeaways
  1. Tax credit purchaser gets tax credits, lender gets interest.
  2. CDE fees subtracted from B-loan.
  3. Structure collapsed in Year 7 when Tax Credit Investor exists transaction.
  1. Interest payments include interest on leverage loan plus 1% QLCI annually for accounting / CDE fees.
  2. Assumed 85% purchase price.
  3. Assumed 8% CDE fees.
  4. Assumed an additional $360,000 in legal, accounting, and other fees.

For a list of CDEs with allocation, see the CDFI Fund NMTC homepage, and open the latest “QEI Issuance Report” (listed right underneath the NMTC program fact sheets).

Low Income Housing Tax Credits


The federal government’s primary mechanism for encouraging the development of affordable housing is through the Low Income Housing Tax Credit (LIHTC) program, which subsidizes the construction, acquisition, or rehabilitation of affordable rental housing. Rents must be affordable for low-income or middle-income tenants, relative to the local geography’s area median income (AMI).

The program awards developers federal tax credits to offset construction costs in exchange for agreeing to reserve a certain fraction of units that are rent-restricted and for lower-income households. The credits are claimed over a 10-year period. Developers need upfront financing to complete construction so they will usually sell their tax credits to outside investors (e.g., corporations, financial institutions) in exchange for equity financing. The equity reduces the financing developers would otherwise have to secure and allows tax credit properties to offer more affordable rents.


The U.S. federal government issues tax credits to both states and territorial governments, which are then awarded by local housing agencies to private affordable housing developers based on each state’s allocation plans. Since real estate developers need upfront financing for their projects, they typically will sell the credits upon acquisition to external investors and will use those funds as equity within their project’s capital stack. Equity reduces the amount of debt financing developers would have to secure, which makes it easier for the project to have affordable rents.

After the housing project is made available to tenants, those tax credit investors can claim the LIHTC over a 10-year period. Typical tax credit investors include corporations and other entities that have sufficient income tax liability, such as financial institutions. They are usually passive investors and not involved in the day-to-day management of the project. Each year, Congress sets a cap on the total amount of available LIHTC for eligible projects.

There are two types of LIHTCs available to developers: the 9% and 4% credit. The 9% credit is used for new construction and provides up to 70% subsidy, while the 4% credit is used for rehabilitation projects (that also utilize 50% in tax exempt bond financing) and provides up to 30% subsidy. This subsidy amount is calculated by taking the present value of the tax credits over a 10 year period.

For both credits, the project subsidy amount is determined by multiplying the present value of the credit over a 10-year period (70% or 30%) with the project’s “qualified basis”, which is basically the project’s development cost excluding the value of the land.

The following examples will help illustrate how this credit works in a real-world context.


New Apartment Complex

A new apartment complex has a qualified basis (or project cost excluding land) of $1 million. This project would qualify for the 9% tax credit since it is new construction and would generate $900,000 in tax credits (9% * $1 million * 10 years). Based on the interest rate, the present value of these tax credits would be $700,000, resulting in a 70% project subsidy.


Formerly Occupied Apartment Complex

A formerly occupied apartment building is being rehabilitated to use as affordable housing and has a qualified basis (or project cost excluding land) of $1 million. This project would qualify for the 4% tax credit since it is for rehabilitation and would generate $400,000 in tax credits (4% * $1 million * 10 years). Based on the interest rate, the present value of these tax credits would be $300,000, resulting in a 30% project subsidy.

Project Qualifications

In order to quality for LIHTC, a housing project must include rental units, not for-sale.  However, it can include a variety of properties including multifamily apartments, single-family houses, townhouses, duplexes, etc. All housing projects must pass an income and gross rent test for the first 15 years of the project’s lifetime. There is also usually a 30-year compliance period. There are three ways to meet this test:

  • At a minimum, 20% of the project’s units are occupied by tenants with an income of 50% or less of area median income adjusted for family size (AMI).
  • No fewer than 40% of the units are occupied by tenants with an income of 60% or less of AMI.
  • At least 40% of the units are occupied by tenants with income averaging no more than 60% of AMI, and no units are occupied by tenants with income greater than 80% of AMI.

Depending upon the proportion of LIHTC subsidized units in the projects, rents may not exceed 30% of either 50% or 60% AMI (Tenants paying above 30% of income are considered “rent-burdened”).

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