The Tax Credit That Builds Most of America's New Affordable Rentals

On October 22, 1986, Ronald Reagan sat at a desk on the South Lawn of the White House and signed the Tax Reform Act of 1986, the most sweeping rewrite of the tax code in a generation. The law lowered top rates and wiped out a forest of tax shelters, including generous write-offs that had made apartment buildings attractive to wealthy investors whether or not anyone needed them. Tucked into the hundreds of pages, almost as a consolation prize for the real estate industry, was a new provision: Section 42 of the Internal Revenue Code, the Low-Income Housing Tax Credit. Few people at the signing would have guessed that this small, technical item would outlive almost everything else in the bill and become the country's main engine for building affordable apartments. If you have walked past a tidy new building with a modest sign naming a nonprofit developer and a list of funders, there is a very good chance it exists because of Section 42.

In short: The Low-Income Housing Tax Credit gives states a yearly allocation of tax credits, which developers sell to investors, usually banks, to raise the money to build or rehab apartments with capped rents. It has financed millions of homes with support from both parties, but it is complicated, expensive per unit and slow, and it does not reach the poorest renters on its own.

A shelter closed, a credit opened

Before 1986, the tax code subsidized rental housing mostly by accident. Investors could take accelerated depreciation and pile up paper losses on buildings, then use those losses to cut taxes on other income. Plenty of apartments got built that way, but the subsidy flowed to whoever had the biggest tax bill, and it did not care whether the apartments were affordable.

Tax reformers in both parties wanted that machinery gone. The compromise was to replace a broad, wasteful subsidy with a narrow, targeted one. Instead of rewarding any rental building, the new credit would reward only buildings that set aside apartments for lower-income households at restricted rents. It was a temporary program at first. Congress made it permanent in the 1993 budget law, and it has been expanded several times since, most recently in the 2025 tax and spending law, which raised states' allocations and made it easier for bond-financed projects to qualify.

That bipartisan staying power is worth noticing. The credit is a creature of Reagan's tax reform and has been championed by Republicans and Democrats on the tax-writing committees for decades. It is one of the few housing programs that has grown rather than shrunk across administrations of both parties.

How the money actually moves

The basic mechanics are simpler than the paperwork suggests. Follow one project from start to finish.

1. Washington sets a budget for each state. Every year, each state gets a cap on the credits it can award, based mostly on population, with a minimum for small states.
2. The state picks winners. A state housing finance agency publishes a plan, called a Qualified Allocation Plan, that scores applications. States reward things they care about: deeper affordability, homes near transit, housing for seniors or people leaving homelessness, rural projects, energy efficiency. Competition for the most valuable credits is fierce, and many good applications lose.
3. The developer sells the credits. A developer who wins an allocation cannot use the credits itself in most cases, so it sells them, usually through a middleman called a syndicator, to investors who owe federal taxes. The investor pays cash up front, typically somewhat less than a dollar for each dollar of future credits, and in return gets the credits spread over ten years, plus some tax losses from depreciation.
4. The cash becomes equity. That investor money goes into the project as equity, which means the building needs a smaller mortgage. A smaller mortgage means lower debt payments, which is what makes lower rents possible.
5. The rules last for decades. The building must keep its income and rent limits for a compliance period of fifteen years, and federal law since 1989 has required a longer commitment, generally thirty years in total. Many states require even longer.

There are two flavors. The more valuable credit, often called the 9 percent credit, is designed to cover roughly 70 percent of the cost of building the affordable units in present-value terms, and it is the one states ration through competition. The less valuable 4 percent credit covers about 30 percent and comes almost automatically with a project financed by tax-exempt private activity bonds, which are themselves capped by state. Big urban projects often use the 4 percent route because it is not competitive in the same way, but they need to fill a larger gap with other money.

Who lives there and what they pay

To qualify, a project has to meet an income test. The classic choices are to set aside at least 20 percent of the units for households earning no more than 50 percent of the area median income, or at least 40 percent of the units for households at no more than 60 percent. Since 2018, developers can also use income averaging, which lets some units serve households up to 80 percent of median as long as the average across the restricted units stays at 60 percent or below. That option can help mix in deeply affordable units.

Rents are capped at 30 percent of the income limit for the unit, not 30 percent of the tenant's actual income. That distinction matters a great deal. A family earning far less than the 60 percent limit still pays the rent set for the 60 percent level, which can eat half its paycheck. That is why many residents of tax credit buildings also hold a housing choice voucher, and why the credit alone does not solve the needs of the lowest-income renters. The two programs work best together, and when voucher funding is squeezed, tax credit buildings feel it.

Most residents are what housing advocates sometimes call the working poor: home health aides, cooks, retail workers, retirees on Social Security and people with disabilities. They are a cross-section of the country, rural and urban. A tax credit building in a small town in Iowa and one in the Bronx are financed by the same section of the code.

Who profits, and is that a scandal?

Progressives are right to ask where the money goes. A tax credit is spending through the tax code; the Treasury forgoes revenue just as surely as if it wrote a check. The Joint Committee on Taxation estimates the cost in the billions of dollars each year. And the money passes through many hands before it becomes an apartment.

Banks are the biggest buyers of the credits. Part of their motivation is the tax savings, and part comes from the Community Reinvestment Act, which presses banks to invest in the communities where they take deposits. Tax credit equity counts toward that obligation. Syndicators take fees for packaging deals. Developers, both nonprofit and for-profit, collect developer fees, which can be substantial and are counted as part of the project's cost. Lawyers, accountants and consultants earn fees for the paperwork that every deal requires.

Critics, including some on the right, argue that all these intermediaries make each apartment far more expensive than it needs to be, and that a direct grant would build more homes per dollar. There is evidence for parts of this. Studies have found that tax credit projects often cost more per unit than comparable market-rate buildings, partly because of fees and partly because of the extra requirements states attach.

Here is the fair answer. Some of the cost is waste, and reformers should go after it. But some of it buys things we want: permanence, inspections, quality standards, accessible units, energy efficiency and decades of income limits that a market-rate building never promises. The private investors also bring discipline. Because they lose their credits if a building falls out of compliance, they watch the property closely, and the program's record on foreclosures has been notably strong. That track record is one reason the credit has kept bipartisan support while other housing programs were cut.

Why it builds so slowly

The deepest complaint about the credit is not cost; it is speed and scale. A single project can take years to assemble. The credit almost never covers the whole cost, so developers stack sources: a state housing trust fund, a city loan, federal HOME funds, a private mortgage, perhaps a grant from a foundation or the local housing authority. Each source has its own application cycle, its own rules and its own lawyers. Advocates call the result a capital stack, and some projects have more than a dozen layers.

Meanwhile the land has to be found and rezoned. In many places a building with capped rents still faces the same neighborhood opposition, parking requirements and design reviews as any other apartment building, and sometimes more. Every month of delay adds interest and construction costs, which require more subsidy, which means another application cycle.

And the supply of credits is fixed. States can only award what Washington allocates, so even a perfectly efficient system would build only as many homes as the cap allows. The program produces many tens of thousands of affordable units a year and has financed more than three million since 1987, by most counts. Researchers estimate the country is short millions of homes affordable to the lowest-income renters. The credit was never designed to close that gap by itself.

There is a hard lesson here for progressive cities. Some of the slowest, most expensive tax credit deals are in places with the friendliest politics and the most layered local requirements. Each requirement may be defensible on its own. Together they can mean fewer homes. Getting serious about affordability means asking which rules are worth what they cost in units that never get built.

The time bomb at year fifteen

One more piece of the mechanism deserves attention. When the first fifteen years end, the investors usually exit. In older deals, and in some states still, there is a provision known as the qualified contract, which can allow an owner to ask the state to find a buyer at a set price and, if none appears, to leave the program early after a wind-down period. Some owners have used it to convert affordable buildings to market rents.

Many states now require developers to waive that option to win credits, and advocates have pushed Congress to close it altogether. Nonprofit owners have also used the right of first refusal built into many deals to buy out investors and keep buildings affordable. But the first big wave of tax credit buildings is now reaching the end of its required period, and whether those homes stay affordable depends on state rules and on who owns them.

What a better version would look like

The case for the credit is that it works, it survives elections and it builds decent housing that lasts. The case against the status quo is that it is too small, too slow and too complicated. Both are true. Housing advocates of very different stripes have converged on a set of fixes:

• Expand the allocation further, as Congress has begun to do.
• Make it easier to combine the credit with vouchers or other rental help, so the poorest families can actually afford the units.
• Close the qualified contract loophole nationwide so affordability does not expire early.
• Cut duplicative local requirements and speed up approvals for affordable projects, as several states have begun to do with by-right approval laws.
• Give extra weight to rural areas and to Native communities, where projects are small and costs per unit are high.

None of these require choosing between markets and government. The credit is already a hybrid: public dollars, private capital, nonprofit and for-profit builders and state priorities. The question is whether we are willing to fund it at the scale the problem demands.

The small-town version

Most coverage of the credit focuses on big cities, but some of its most important work happens in rural America. In small towns, there may be no other new rental housing at all; a single tax credit building of a few dozen units can house the town's teachers, retirees and young families. Those projects face their own problems: higher costs per unit, fewer local contractors and investors who prefer big deals in big markets. Many states set aside a share of their credits for rural projects for exactly that reason, and that set-aside is one of the quieter ways the program serves voters of every party.

What you can do

• Read your state's allocation plan. Your state housing finance agency publishes its Qualified Allocation Plan and usually takes public comment on it each year. That plan decides whether credits go to deep affordability, family housing or homes near jobs. Follow the larger debate on the affordability and cost of living page.
• Tell Congress what the credit needs. Expansion bills and fixes like closing the qualified contract loophole move through the tax committees. Find your representative and senators, see their latest votes and call their offices.
• Look for bipartisan housing bills. Tax credit expansions have often passed with votes from both parties. The common ground page tracks bills both parties passed together, which is a good place to spot the next opening.
• Support the nonprofit builders in your area. Community development corporations and housing nonprofits do much of the patient work of assembling these deals. The organizations directory lists housing groups by state.
• Say yes at the hearing. When a tax credit building comes before your zoning board, the most valuable thing a neighbor can do is show up in support. Ten supportive residents can change the tone of a meeting that would otherwise be dominated by opposition.