How LIHTC Developers Can Utilize Section 45L Tax Credits

Understanding the program can help you market your site.

The Section 45L tax credit is a federal tax credit intended to foster the development of energy-efficient homes and buildings. The credit was first introduced as a tax deduction under the Energy Policy Act of 2005. At the time, it allowed developers of energy-efficient residential properties to claim a deduction of up to $2,000 per unit for eligible construction or rehabilitation projects meeting specific energy-efficiency criteria.

The deduction approach to incentivize energy-efficient construction, however, was limiting for affordable housing projects with tight budgets. In response, federal legislators converted the Section 45L deduction into a tax credit with the Consolidated Appropriations Act of 2021. This change significantly enhanced the attractiveness of the credit, as tax credits provide a dollar-for-dollar reduction in tax liability, unlike deductions, which reduce taxable income.

The change from a deduction to a credit has been beneficial to affordable housing developers and has had a particular impact on LIHTC developments. LIHTC development projects involve complex financing structures, and the availability of the 45L credit as a dollar-for-dollar reduction in tax liability provides LIHTC developers with an additional source of financing.

As a LIHTC manager, you may be tasked to manage a LIHTC site partially financed with Section 45L tax credits. Although a developer taking advantage of these tax benefits doesn’t add additional compliance concerns when maintaining a LIHTC site, knowing some details about the program may help you in marketing the site to prospective tenants and in being aware of how affordable housing development is evolving. We’ll go over the advantages offered by linking Section 45L credits and LIHTCs. We’ll also discuss the eligibility requirements and credit amounts for developers claiming Section 45L credits.

Financing Impact on LIHTC Developments

The LIHTC has been the most used federal incentive to create affordable housing across the country. To meet LIHTC requirements, developers and owners have to meet criteria based rent values, occupancy metrics, and tenant incomes. The tax credit itself is determined by the total basis of the qualified units that meet these requirements.

The credit can be either the “4-Percent Credit” for rehab projects or projects funded by non-taxable bonds, or the “9-Percent Credit” for new construction or substantial rehabs. The credits are paid out over a 10-year period so long as all requirements are met.

The LIHTC credits are transferable, but non-refundable. And many LIHTC projects are syndicated, where the credits are transferred to third-party investors in exchange for project funding. This factor plays into Section 45L’s usefulness with these efforts.

When Section 45L was first introduced into the Internal Revenue Code, qualifying buildings had to be three stories or fewer, and units had to be modeled, showing a 50 percent reduction in heating and cooling loads. This reduction percentage was compared against a reference home based on the 2006 International Energy Conservation Codes (IECC), with at least 10 percent of the reduction coming from the building envelope.

In 2023, as a result of the Inflation Reduction Act (IRA), the qualifications for the Section 45L tax credit were updated to make the tax credits easier to utilize. The IRA removed the height limitations for multifamily buildings to qualify but added prevailing wage requirements to receive the full credit amounts for multifamily buildings.

With the changes to Section 45L, there’s been a great financial benefit to obtaining energy-efficiency certifications like ENERGY STAR and Zero Energy Ready Homes programs in LIHTC developments. Investors can capture the 45L credit of up to $5,000 per unit.  

And as a result of the Inflation Reduction Act, Section 45L no longer reduces the basis for LIHTC projects. This means sites are able to earn Section 45L credits without a corresponding reduction in LIHTC eligible basis. This allows developers to receive full credit amounts for both LIHTC and Section 45L. Although LIHTC sites take 10 years to fully pay out their LIHTCs, the Section 45L credit is usable as soon as the project is completed.

In addition to taking advantage of LIHTCs and Section 45L credits, development sites can gain more through the use of HUD loans. Since 2016, HUD loans offer lower mortgage insurance premiums for getting certain Green Building Certifications. And since many HUD-assisted projects also require prevailing wages to be paid on the project, this means an affordable housing developer can receive full Section 45L credit amounts as well as lower mortgage insurance premiums and LIHTCs.

Energy-Saving Requirements

To qualify, developers must construct or substantially reconstruct a qualified new energy-efficient home or unit. Qualifying LIHTC sites must be in the specific category of multifamily homes under ENERGY STAR programs, be located in the United States, and meet applicable energy-saving requirements based on unit type and acquisition date.

For units developed in 2023 through 2032, the credit amount ranges from $500 to $5,000, depending on the standards met, which include ENERGY STAR program requirements; zero-energy ready-home program requirements; and prevailing wage requirements.

According to IRS Notice 2023-65, for a unit to meet the energy-saving requirements under the ENERGY STAR Multifamily New Construction Program it must be ENERGY STAR certified. There are three paths to earning the ENERGY STAR certification for multifamily new construction projects. Developers may choose:

• Energy Rating Index (ERI) Path: Use an approved rating tool software to determine unit-by-unit energy savings based on the ERI target (or savings above Title 24 in California) and follow a prescriptive package of energy-efficient measures developed by the Environmental Protection Agency (EPA) in common spaces; or
• ASHRAE Path: Use an energy-modeling software approved to determine energy cost savings of the building’s energy-efficient design compared to American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) baseline (or Title 24 in California); or
• Prescriptive Path: Use a prescriptive package of energy-efficient measures developed by the EPA. This path is not available in California.

Regardless of which path is chosen, each building must meet certain minimum mandatory requirements, and these are verified in the field by an approved rater. Energy-rating companies must have at least one individual on staff who is a certified rater or approved inspector as determined by a Home Certification Organization (HCO) or Multifamily Review Organization (MRO) and has completed the required training through a HCO-accredited training provider.

Section 45L Credit Amounts

Multifamily dwelling units that meet the requirements of the ENERGY STAR Multifamily New Construction Program receive a credit of either $500 or $1,000. The $500 credit is for dwelling units that meet the most recent ENERGY STAR Multifamily New Construction National Program Requirements in effect on Jan. 1, 2023. The $1,000 credit is for dwelling units that meet the Zero Energy Ready Home Program of the Department of Energy in effect on Jan. 1, 2023.

The multifamily credits increase to $2,500 and $5,000, respectively, if contractors meet prevailing-wage requirements. If the prevailing-wage requirement isn’t met, the impacted workers can be paid the difference between the wage paid and the prevailing wage in wages plus interest and the developer can pay a $5,000 per worker penalty to meet the requirements.

According to the IRS, developers that are seeking an increased credit amount must ensure that laborers employed by the developer, contractor, or subcontractor in the construction of the site are paid prevailing wages (wages at rates that are not less than the prevailing rates determined by the Department of Labor (DOL) in accordance with the Davis-Bacon Act). General wage determinations are published by the Wage and Hour Division of DOL and available online at the system for award management website (https://sam.gov/content/home) under the “Wage Determinations” tab. Additional information on the prevailing wage and the Inflation Reduction Act can be found on DOL’s website at www.dol.gov/agencies/whd/IRA.

Claiming the Credit

The Inflation Reduction Act granted a decade-long extension to the Section 45L credits. This extension gives affordable housing developers a more extended period to strategize and incorporate these credits alongside LIHTC. The expansion of the 45L tax credits with the increased per-unit credit, broadened eligibility criteria, and extended time frame offers a great financial opportunity for investors and developers of affordable housing.

According to the IRS, developers must meet the general recordkeeping requirements under IRC Section 6001 to substantiate that they have met the IRC Section 45L credit requirements. They must maintain certifications, records with details about the qualified units, and prevailing wage records (if applicable).

LIHTC developers must meet all requirements under IRC Code Section 45L prior to claiming the credit. And developers can’t claim these credits retroactively from 2023 onwards, which emphasizes the need for proactive planning. Being forward-thinking in the preconstruction stages will allow developers to maximize the increased value and flexibility offered by these revised Section 45L tax credits. IRS Form 8908 is used to quantify and report the credits with the developer’s federal tax return filing.