Qualified Basis in LIHTC: Formula, 130% Boost, and Recapture

Qualified basis in LIHTC is the dollar figure that drives every Low-Income Housing Tax Credit calculation: it equals a building’s eligible depreciable cost multiplied by the fraction of the property devoted to qualifying low-income use. That product is then multiplied by the applicable credit rate — 9% or 4% — to produce the annual credit an owner claims for ten years.¹ Get the qualified basis wrong and the error rides along for a decade, so every input deserves scrutiny.

The Formula in One Line

Qualified Basis = Eligible Basis × Applicable Fraction

A building with $10 million in eligible basis and a 90% applicable fraction has a qualified basis of $9 million. At the 9% credit rate, that yields $810,000 in credits per year, or $8.1 million over the full ten-year credit period. At the 4% rate, the same qualified basis would produce $360,000 annually. A building where every residential unit qualifies as low-income has a qualified basis equal to its full eligible basis.

Both inputs are measured as of the close of the first tax year of the credit period, and they are tested again at the close of each taxable year during the compliance period.² In practice, the numbers lock in at the end of year one and stay stable unless something changes — a unit falls out of compliance, a federal grant hits the project, or occupancy standards slip.

What Goes Into Eligible Basis

Eligible basis is the total depreciable cost of the residential rental building. For new construction, that means hard costs like foundation, framing, and finishes, plus soft costs properly capitalized to the building, such as architectural and engineering fees. Common areas that serve all tenants — laundry rooms, community spaces, on-site management offices — are included as long as they are not commercial space.

Acquisition and rehabilitation projects split into two separate eligible bases. The acquisition cost forms one, and the rehabilitation expenditures form a second that is treated as a new building.¹ The distinction matters because the acquisition piece qualifies only for the 4% rate, while the rehabilitation piece can qualify for the 9% rate. Blending the two inflates projected credits early in underwriting and creates a painful reckoning at cost certification.

Costs That Fall Outside

Land is the biggest exclusion. It is not depreciable, so it never counts. Several soft costs are also outside eligible basis:

Syndication costs — fees to package and sell the tax credit investment to limited partners.
Permanent financing fees, including lender points and commitment fees.
Marketing and lease-up expenses.
Partnership organization costs, such as legal and accounting fees to form the ownership entity.
Operating reserves, generally treated as a cost of securing financing rather than a capitalized building cost.³
Any portion of the building used as commercial space.

Federal grants that fund construction or operation of the building also reduce eligible basis dollar-for-dollar, and the reduction persists for every year afterward. HOME funds and CDBG money in a project will trigger this. Tenant-based rental assistance like Section 8 vouchers does not — it is not treated as a grant to the building.⁴

The Applicable Fraction

The applicable fraction is the smaller of two ratios calculated for each building:¹

The unit fraction: low-income units divided by total residential rental units, whether or not occupied.
The floor space fraction: square footage of low-income units divided by square footage of all residential rental units, whether or not occupied.

Using the lesser figure blocks a developer from designating many small units as low-income while keeping the large units at market rate. If 80 of a building’s 100 units are low-income but those 80 units cover only 60% of the floor space, the applicable fraction is 60%, not 80%.

A unit counts as low-income only if it is both rent-restricted and occupied by a household whose income fits the project’s elected set-aside. The traditional elections are the 20/50 test (at least 20% of units at 50% of area median gross income or below) and the 40/60 test (at least 40% of units at 60% AMGI or below). Since 2018, projects can instead elect income averaging: each low-income unit is designated at a specific tier in 10% increments between 20% and 80% of AMGI, and the average of those designations across the building cannot exceed 60%.¹ At least 40% of units must still be rent-restricted and occupied by qualifying tenants. Rent for each designated unit is capped at 30% of that unit’s designated income level. The election is made on Form 8609 and cannot be reversed, and projects already placed in service cannot switch to income averaging retroactively.

The Full-Time Student Rule

A unit occupied entirely by full-time students does not count as low-income, which reduces the applicable fraction. The statute provides narrow exceptions where the unit still qualifies:⁵

All adult occupants are single parents living with their minor children, and none are dependents of someone outside the household.
All adult occupants are married and entitled to file a joint return.
At least one household member receives Title IV Social Security Act assistance, such as TANF.
At least one household member was previously in foster care under a state agency.
At least one household member is enrolled in a job training program that receives federal, state, or local government assistance.

Student status must be verified annually. If a household becomes entirely full-time students mid-year without qualifying for an exception, the unit drops out of the numerator.

The 130% Basis Boost

Buildings in certain high-cost or high-poverty areas receive an automatic increase in eligible basis to 130% of what it would otherwise be. This 30% boost applies to projects in Qualified Census Tracts or Difficult Development Areas designated for it.¹ For existing buildings, the boost applies to rehabilitation expenditures rather than the full basis.

A Qualified Census Tract is one where at least 50% of households earn below 60% of AMGI, or the poverty rate is 25% or higher. Difficult Development Areas are HUD-designated regions where construction, land, and utility costs run high relative to local incomes. HUD updates both lists annually.⁶ State housing finance agencies can also award the 130% boost to buildings outside these areas when the extra subsidy is needed to make the deal work. A developer whose building cost $8 million to construct can claim credits on $10.4 million of eligible basis, closing the gap between project costs and what restricted rents can support.

Buildings in Qualified Census Tracts get an additional benefit: the cost of a community service facility can be folded into eligible basis, capped at 25% of the first $15 million of eligible basis plus 10% of any eligible basis above that. A community service facility is space primarily serving people at 60% of AMGI or below, such as a health clinic, after-school program, or workforce training center inside the project. All community service facilities within one project count as a single facility for the cap. Outside Qualified Census Tracts, these costs generally cannot be included.

Turning Qualified Basis Into Annual Credits

Qualified basis produces credits only when multiplied by the applicable percentage. Two rates apply:¹

The 9% credit applies to new construction and substantial rehabilitation that is not federally subsidized (that is, not financed with tax-exempt bonds). The PATH Act of 2015 set a permanent 9% floor.⁷
The 4% credit applies to the acquisition cost of existing buildings and to projects financed with tax-exempt bonds. The Consolidated Appropriations Act of 2021 established a permanent 4% floor for buildings placed in service after December 31, 2020.⁷

Treasury still calculates a floating rate each month, but the effective rate cannot dip below either floor. Before the floors were enacted, floating rates ran well below 9% and 4%, making deals hard to underwrite with certainty.

Keeping Qualified Basis Intact

The credit period is ten years, but the compliance period runs fifteen. Throughout those fifteen years, if qualified basis drops, the IRS can recapture credits previously claimed.⁸ Federal law also requires most projects to remain affordable for an additional fifteen-year extended use period, though recapture risk no longer applies during that second stretch. Owners report compliance annually to the IRS and to their state housing finance agency throughout the initial fifteen years.

What Triggers a Drop

Qualified basis falls whenever the applicable fraction shrinks: fewer qualifying units, less qualifying square footage, or both. Common causes include renting a vacant low-income unit to a market-rate tenant, failing to re-certify a tenant’s income, and losing units to the full-time student rule. A household whose income rises above 140% of the applicable income limit creates an “over-income unit” that can eventually pull the fraction down.⁹

The Next Available Unit Rule

An over-income unit does not immediately lose its low-income status. It keeps that status as long as the next comparable unit that becomes available in the building (a unit of similar or smaller size in the same building) is rented to a qualifying low-income tenant at a restricted rent.⁹ Rent the next available comparable unit to a market-rate tenant instead, and every over-income unit for which it was a comparable unit loses low-income status immediately. Many compliance failures start here, when a property manager focused on filling vacancies rents to the first qualified applicant without checking whether the next-available-unit obligation applies.

Vacancies

A vacant unit last occupied by a qualifying tenant continues to count toward the applicable fraction as long as it stays available for rent at a restricted rent. A unit that has never been occupied by a qualifying tenant, however, cannot go into the numerator; it sits only in the denominator and lowers the fraction until someone qualifies and moves in.

How Recapture Is Calculated

When qualified basis at year-end is lower than it was at the end of the prior year, the owner owes a recapture amount. This is not a straight payback of the lost credits. The IRS calculates the “accelerated portion” of credits previously claimed, which is the difference between what was actually claimed under the ten-year credit period and what would have been claimed if the same total credits had been spread ratably over fifteen years. The owner pays back that accelerated portion plus interest at the federal overpayment rate, and the interest is not deductible.¹ The math is more forgiving than outright repayment, but the interest compounds across every prior year affected, so the financial hit is real.

1
Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit
2
Internal Revenue Service. Instructions for Form 8609 – Low-Income Housing Credit Allocation and Certification
3
Internal Revenue Service. IRC 42, Low-Income Housing Credit – Part III Eligible Basis
4
eCFR. 26 CFR 1.42-16 – Eligible Basis Reduced by Federal Grants
5
Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit
6
HUD User. Qualified Census Tracts and Difficult Development Areas
7
Congress.gov. An Introduction to the Low-Income Housing Tax Credit
8
HUD User. What Happens to Low-Income Housing Tax Credit Properties at Year 15 and Beyond
9
eCFR. 26 CFR 1.42-15 – Available Unit Rule