What Is LIHTC Equity and How Does It Work?

LIHTC equity is the cash a private investor pays into an affordable housing partnership in exchange for ten years of federal Low-Income Housing Tax Credits under Section 42 of the Internal Revenue Code. On most deals it covers 40% to 70% of total development costs, filling the space between what the project can support in debt and what it actually costs to build. Because the investor is paid back through tax credits rather than interest, the project carries far less debt than a conventional apartment building would, and that is what makes the restricted rents work.

The Partnership That Raises the Equity

To bring in equity, a developer forms a limited partnership or LLC and admits the investor as the equity partner. The investor typically takes a 99.99% ownership interest as the limited partner; the developer keeps 0.01% as the general partner.¹ The split looks lopsided, and it is, but it reflects the economics. The investor needs almost all of the tax credits and depreciation losses. The developer needs day-to-day control over construction and operations.

Investors are almost always large commercial banks motivated by Community Reinvestment Act obligations, or corporate syndicators pooling capital from multiple institutions. They are passive. The developer hires the contractors, leases to tenants, and keeps the building in federal compliance. Because equity carries no interest payments, operating costs stay lean enough to charge rents low-income tenants can afford.

How Much Equity a Project Raises

The annual credit a building generates equals its applicable percentage multiplied by its qualified basis.² Multiply that annual credit by ten years, then by the investor’s price per credit dollar, and you have the equity contribution.

Eligible Basis

Eligible basis is the adjusted basis of the building at the close of the first year of the credit period. It includes hard construction costs, architectural and engineering fees, and other costs that become part of the building’s depreciable value. Land is excluded because it is not depreciable.² Common areas and amenities available to all tenants do count, which is why community rooms and shared laundry facilities show up in LIHTC projects.

Qualified Basis

Qualified basis is eligible basis multiplied by the applicable fraction, defined as the smaller of two ratios: low-income units divided by total units, or low-income floor space divided by total floor space.² A 100% affordable project has a fraction of 1.0, so all of its eligible basis counts. A mixed-income project with 80% low-income units generates fewer credits.

The Ten-Year Credit Period

Credits are claimed each year over a ten-year credit period that starts either when the building is placed in service or, at the developer’s irrevocable election, the following year.² A project generating $500,000 in annual credits, sold to an investor at 84 cents per credit dollar, raises $4.2 million in equity. That is the number a developer builds the rest of the capital stack around.

9% Credits and 4% Credits

The two credit types differ in rate, in how they are awarded, and in what kind of project they suit. The distinction shapes every financial assumption in the deal.

The 9% credit is used for new construction and substantial rehabilitation that is not federally subsidized. Congress permanently fixed the applicable percentage at no less than 9%.² These credits are competitively awarded by state housing finance agencies under a qualified allocation plan, and demand runs well above the supply capped by each state’s per capita ceiling. For 2026, the ceiling is $3.416 per capita, up from $3.00 in 2025.

The 4% credit applies to acquisition of existing buildings and to projects financed primarily with tax-exempt bonds. The applicable percentage cannot fall below 4% for buildings placed in service after December 31, 2020.² Unlike the 9% credit, it is not competitively allocated. A project qualifies as long as at least 50% of its aggregate basis (including land) is financed with tax-exempt bonds. 4% deals produce most LIHTC units by count, though each project generates roughly half the credit subsidy of a 9% deal.

Basis Boosts

Section 42 lets certain projects increase eligible basis by up to 30%, which flows directly through to more credits and more equity. A project automatically qualifies for the 130% basis boost if it sits in a Qualified Census Tract or a Difficult Development Area, both designated by HUD. Outside those zones, a state housing agency can discretionarily designate a building as needing the boost for financial feasibility under Section 42(d)(5)(B)(v), treating it as if it were in a DDA. Agencies are expected to publish their standards in the qualified allocation plan and to limit the boost to what the project actually needs to work. One limit worth flagging: the agency-designated boost is not available for tax-exempt bond deals unless the project sits in a federally designated QCT or DDA.

What Investors Pay Per Credit Dollar

Pricing moves with market conditions. In the fourth quarter of 2025, the average price for 9% credits was roughly 84 cents per dollar, down from about 87 cents a year earlier. Most syndicators heading into 2026 expected pricing to hold steady or drift down modestly, with firmer numbers in markets where banks have strong CRA obligations and softer numbers in secondary and tertiary markets.

The corporate tax rate is the biggest single driver: when the rate is higher, a dollar of credit is worth more, and pricing rises. Tax code changes that cut the corporate rate or introduce competing tax benefits push LIHTC pricing down. Deal-specific factors matter too. Investors look at the developer’s track record, the strength of the local rental market, the project’s ability to stay compliant for the full 15-year period, and the quality of property management. A strong sponsor in a strong market can price several cents above the national average; an untested sponsor on a rural deal can price well below it.

How the Equity Actually Comes In

The investor does not wire the equity at closing in a single check. It flows in through scheduled installments, called pay-ins, tied to project milestones. The staged approach protects the investor: money moves only when the project hits real benchmarks.

The first installment typically arrives at construction loan closing, giving the developer the liquidity to break ground. A second installment follows when the building receives its certificates of occupancy. The final major installment is triggered by stabilized occupancy, meaning the building has been leased to qualified tenants at restricted rents for a specified period. Some deals hold back a small amount released after the state agency completes cost certification and IRS Form 8609 is filed.

The exact split is negotiated. A common structure releases 30% at closing, 40% at completion, and 30% at stabilization, but investors adjust those percentages based on how they read the risk. Developers with strong track records can push for more capital up front.

Recapture: The Main Risk Behind the Equity

If a project’s qualified basis drops during the 15-year compliance period, the IRS claws back a portion of the credits already claimed. Recapture under Section 42(j) is the single biggest financial risk investors face in a LIHTC deal.²

Common triggers include dropping below the minimum set-aside, disposing of a building, failing to comply with the extended use agreement, and casualty losses that reduce the building’s value.³ Recapture is not a simple return of the extra credits. The statute adds interest at the IRS overpayment rate on the recaptured amount, running from the due date of each affected prior-year return.² On a project where credits have been flowing for years, the interest alone can be substantial.

Recapture is reported on IRS Form 8611.⁴ The statute recaptures what it calls the “accelerated portion” of the credit: the difference between what was actually claimed over the ten-year period and what would have been allowable if the total credits had been spread ratably over 15 years. That structure means recapture bites hardest in the early years, when the gap between the ten-year stream and a hypothetical 15-year stream is widest.

Year 15: How the Investor Gets Out

By year 10 the investor has claimed all the tax credits. By year 15 the compliance period ends and recapture risk falls away. Most investors want to exit at that point, and the partnership agreement is written with that in mind.⁵

Section 42(i)(7) permits a nonprofit general partner, a government agency, or the tenants themselves to hold a right of first refusal to purchase the property after the compliance period. The purchase price is set by statute: the outstanding debt secured by the building (excluding debt taken on in the five years before the sale) plus all federal, state, and local taxes attributable to the transaction.² That formula price sits well below fair market value, which is the point. Mission-driven owners can acquire the property affordably and keep it in the affordable stock.

Exit taxes are the other year 15 issue. The investor’s capital account in the partnership goes negative over the life of the deal, because tax losses and credits push it below zero. When the investor exits, the negative balance generates taxable gain. A negative capital account of $500,000 at a 21% federal rate produces a base tax liability of $105,000. Because paying the tax itself creates additional taxable income, the amount is usually “grossed up” to cover the tax on the tax, so the total sits higher. In many deals, the general partner or a right-of-first-refusal buyer pays these exit taxes as part of the purchase price.

Affordability Doesn’t End at Year 15

The compliance period is 15 years. The affordability restrictions are not. Every LIHTC project signs an extended use agreement with the state housing agency, and the extended use period runs from the first day of the compliance period and ends no earlier than 15 years after the compliance period closes. That is a minimum 30-year affordability commitment.² Many state agencies require longer.

Only two things end the extended use period early. One is foreclosure or deed in lieu of foreclosure, provided the IRS does not find the foreclosure was arranged to lift the restriction. The other is the qualified contract process: the owner requests one, and if the state agency cannot produce a buyer willing to pay the formula price for the low-income portion within a year, the extended use restrictions lift.² Even then, existing tenants are protected for three years: no eviction without good cause, and no rent increases beyond what Section 42 allows during the wind-down.

For anyone underwriting a LIHTC deal, this is where the equity math meets a long horizon. A 30-year affordability restriction shapes residual value, construction quality decisions, and the developer’s willingness to invest in durable materials. Treating the 15-year compliance period as the full obligation is a mistake that catches first-time developers off guard.

1
U.S. Department of Housing and Urban Development. 2015 Rental Assistance Demonstration LIHTC Slides
2
Office of the Law Revision Counsel. 26 USC 42 Low-Income Housing Credit
3
Internal Revenue Service. IRC 42, Low-Income Housing Credit – Part VII Computing Adjustments
4
Internal Revenue Service. About Form 8611, Recapture of Low-Income Housing Credit
5
U.S. Department of Housing and Urban Development. What Happens to Low-Income Housing Tax Credit Properties at Year 15 and Beyond