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State Tax Credit Background
What are Tax Credits?
Tax Credits are government incentives authorized under the Federal Internal Revenue Code and under certain state tax codes. They are issued to aid in the implementation of public policy. Congress, in an effort to encourage the private sector to provide a public benefit, allows participating taxpayer-investors tax credits, which reduce tax liabilities in exchange for their participation in housing properties.
——— Kenneth Baggett, President ———
Georgia Affordable Housing Coalition
Federal Tax Credits – Internal Revenue Code Section 42
In the 1986 Tax Act, the Federal Government created an incentive program for developers to build privately owned apartments in locations where market rate rents have exceeded the level many individuals could afford. Under this program the U.S. Treasury Department allocates tax credits to each state based on that state’s population. These credits are then awarded to real estate developers who develop and maintain apartments as affordable units. Developers, in turn, may resell these credits to investors to provide equity capital for property development.
- The cost to the government in lost tax revenue is far less than its cost if it were to develop these properties. By providing the tax credits, the government is able to cost-effectively support its policy to build much needed housing in markets where the gap between supply and demand continues to widen.
- Investors in tax credits enjoy the benefits of the predictability of the 10-year stream of credits and benefit from the tax reduction.
- Tenants benefit from clean, safe housing, which they otherwise could not afford.
According to the Office of Economic Affairs of the U.S. Department of Housing and Urban Development, the Federal housing tax credit program has provided approximately 90,000 new apartment units annually and approximately 1,300 development projects each year from 1995 to 2002, the last year for which updates to the HUD database are available. Nearly two-thirds of these are new construction, with most tax credits issued for developments in urban areas of the Southern U.S.
State Tax Credits
Fifteen states provide their own state housing tax credits. These credits were created as an added incentive to provide capital formation for housing within their states. Also, many states provide a variety of single year special benefit state tax credits that include: Brownsfield credits, Donation credits, Historic Preservation credits and others. The amount of credit, the term of credit and the cost of the credit differ from state to state.
Missouri, Georgia, Arkansas, North Carolina, Utah, Hawaii and Massachusetts permit the state housing credits to be bifurcated, or separated, from the Federal Credit. In most of these states participants can acquire a partnership interest solely in the stream of the state tax credits with no direct participation, real estate income. This creates a unique opportunity in that corporations or individuals can acquire as many tax credits from a particular partnership as necessary to satisfy their tax liability in that state without a direct investment in the underlying property.
A key component to the state credit is its flexibility. State housing tax credits can be used to reduce income tax, franchise tax and, in several cases, premium tax. Many insurance companies, particularly property/casualty companies find this very beneficial from a tax and economic perspective. Although a public market for the credits has yet to develop, they can be sold or transferred to others in private transactions.
