LIHTC Eligible Basis: Qualifying Costs, 130% Boost, and Recapture

In a Low-Income Housing Tax Credit deal, LIHTC eligible basis is the adjusted basis of the depreciable residential rental property, measured at the end of the first year of the credit period. It’s the dollar figure that drives every downstream number in the deal. Take the total cost of building or rehabilitating the project, strip out land and anything else that can’t be depreciated, and what remains is the starting point for the credit calculation.

If a project costs $12 million to develop and $1.5 million of that is land, eligible basis starts at $10.5 million before further adjustments.

When Eligible Basis Is Measured

Eligible basis is fixed as of the close of the first year of the credit period. The credit period runs 10 taxable years and begins either in the year the building is placed in service or, if the taxpayer elects, the following year. That election is irrevocable. Developers often use it because a building placed in service partway through a year yields a partial first year of credits; deferring the start to January 1 of the next year captures a full first year.¹

How Eligible Basis Turns Into Credits

Eligible basis is the starting point, not the credit. Two more steps stand between it and the annual credit amount.

First, multiply eligible basis by the applicable fraction. The applicable fraction is the smaller of two ratios: the percentage of units set aside for low-income tenants, or the percentage of total floor space those units occupy. A 100% affordable project has an applicable fraction of 100%. An 80/20 mixed-income project has an applicable fraction of 80%. The product is the qualified basis.¹

Second, multiply qualified basis by the applicable percentage. There are two, commonly called the 9% credit and the 4% credit, though those are minimum floors rather than exact figures. The 9% floor applies to new construction and substantial rehabilitation that is not federally subsidized; Congress made that floor permanent in the Protecting Americans from Tax Hikes Act of 2015. The 4% floor applies to acquisition of existing buildings and to any federally subsidized project (most often tax-exempt bond deals) and was made permanent in December 2020.¹

The result is the annual credit, claimed each year for 10 years. Qualified basis of $8 million at the 9% rate yields roughly $720,000 per year, or about $7.2 million over the credit period.

Costs That Count

Hard construction costs make up most of eligible basis: labor, materials, and site work tied to the building itself.

Soft costs also qualify. Architectural and engineering fees, construction-period loan interest, environmental assessments, and building permits are all includable. Developer fees count too, subject to caps imposed by state housing agencies, generally in the range of 15% to 18% of total development costs depending on state and project size. If a state agency finds any cost unreasonable, it can reduce or exclude that amount from the eligible basis it approves.

Common areas count when they serve residents without a separate charge. Community rooms, laundry facilities, fitness centers, management offices, and parking qualify if they are functionally related to the residential use of the building and available to all tenants without extra fees.¹

Costs That Don’t Count

Land is out. Because it can’t be depreciated, its cost never enters eligible basis, regardless of purchase price or how it was acquired.

Federally funded grants are out. Treasury Regulation 1.42-16 provides that if any portion of a grant is federally funded, eligible basis is reduced by that amount for the current year and all succeeding years of the compliance period.¹²

Costs allocable to non-residential commercial space in a mixed-use building are out. If the ground floor houses retail, the construction costs tied to that space don’t belong in eligible basis. In mixed-income projects, costs attributable to market-rate units must also be carved out.

Syndication costs are out. Legal fees for structuring the limited partnership, offering documents, and expenses of finding and securing investor equity are financial structuring costs, not building costs.¹

When a developer claims both LIHTC and the federal historic rehabilitation credit on the same building, eligible basis must be reduced by the amount of the historic credit attributable to residential rental property. This prevents double-dipping and can meaningfully reduce the LIHTC benefit on historic projects.

The 130% Basis Boost

Projects in certain high-cost or low-income areas can increase eligible basis to 130% of what it would otherwise be. The boost exists because building affordable housing in expensive markets or deeply impoverished neighborhoods often costs more than the standard calculation can support.

Two categories qualify automatically. Difficult Development Areas are places where construction, land, and utility costs run high relative to area median income. Qualified Census Tracts are tracts where at least 50% of households earn below 60% of area median income, or where the poverty rate is 25% or higher. HUD designates both, subject to a population cap: the designated portions of any metropolitan area cannot exceed 20% of that area’s population.³

State housing credit agencies can also designate a building for the 130% boost when they determine the project needs the extra credit to be financially feasible, even outside a DDA or QCT. For existing buildings, the 130% increase applies to rehabilitation expenditures, not to the acquisition component.³

Acquisition and Rehabilitation of Existing Buildings

Buying and rehabbing an existing building produces two separate eligible basis calculations: one for the acquisition cost and one for the rehabilitation expenditures.

The 10-Year Rule

To claim credits on the purchase price of an existing building, the building must not have been placed in service by anyone within the 10 years before the current owner’s acquisition. Exceptions apply for buildings acquired from a governmental entity or certain nonprofits. Acquisition basis is eligible only for the 4% credit; there is no 9% path for the purchase price, regardless of how it’s financed.¹

Substantial Rehabilitation Thresholds

The rehab expenditures are treated as a separate new building, so they can qualify for the 9% credit if the project isn’t federally subsidized. To qualify, rehab spending over any 24-month period must exceed the greater of two thresholds: 20% of the building’s adjusted basis on the first day of that 24-month window, or a per-unit minimum indexed annually for inflation.¹

The base per-unit amount is $6,000. For 2026, Revenue Procedure 2025-32 sets the indexed minimum at $8,700. On a 100-unit building with $3 million of adjusted basis, the developer would need to spend more than $870,000 (the greater of $600,000 or $870,000) within a 24-month window to qualify.⁴

How Federal Funding Affects the Calculation

Federal money reaches LIHTC projects in different forms, and the form determines whether it cuts eligible basis or shifts the credit rate.

Federal Grants

Federal grants reduce eligible basis by the full grant amount, whether or not the grant is included in gross income. Community Development Block Grant funds structured as grants and HOME funds provided as grants both trigger the reduction. Federal funds structured as loans (including soft, deferred-payment, or forgivable loans) do not, which is why federal assistance is often structured as a loan rather than a grant in LIHTC deals.²

Tax-Exempt Bond Financing

A project using tax-exempt bond proceeds is generally treated as federally subsidized. Eligible basis isn’t reduced. Instead, the entire project moves from the 9% applicable percentage to the 4% rate, even for new construction and substantial rehabilitation costs that would otherwise qualify for the higher credit.¹

An election is available to exclude bond-financed costs from eligible basis, which removes the federally subsidized classification and preserves the 9% rate on the remaining basis. In practice, most bond-financed projects keep the 4% rate on the full basis because it typically produces more total credit than the 9% rate on a reduced basis. For deals where only a small share is bond-financed, the election is worth running the numbers on.¹

Why the Number Keeps Mattering: Recapture

Getting eligible basis right at the front end isn’t a one-time exercise. The IRS can claw back previously claimed credits if the project falls out of compliance during the 15-year compliance period that follows the first year of credits.

Recapture is triggered any time qualified basis decreases from one year to the next. Because qualified basis depends on both eligible basis and the applicable fraction, anything that reduces either component can cause a drop. Common triggers include units no longer occupied by income-qualified tenants, units rented above the allowable limits, units that become unsuitable for occupancy, and the project falling below its minimum set-aside (the 20-50 test, 40-60 test, or average income test).⁵

The recapture amount is the “accelerated portion”: the difference between what was actually claimed and what would have been claimed if the credit had been spread ratably over 15 years instead of 10. Interest at the federal overpayment rate is added. Recapture is reported on Form 8611. If a building drops below its minimum set-aside entirely, the full accelerated portion is recaptured. Recapture applies only during the initial 15-year compliance period; after that, rent and income restrictions continue under the extended use agreement, but credits are no longer subject to recapture.⁵

1
Office of the Law Revision Counsel. 26 USC 42 Low-Income Housing Credit
2
eCFR. 26 CFR 1.42-16 Eligible Basis Reduced by Federal Grants
3
Office of the Law Revision Counsel. 26 US Code 42 – Low-Income Housing Credit
4
IRS.gov. About the Rehabilitation Credit and Low-Income Housing Credit
5
IRS.gov. Form 8611 Recapture of Low-Income Housing Credit