President Biden signed the $700 million Inflation Reduction Act of 2022 (IRA) in August 2022. Although the IRA does not allocate funds to increase affordable housing stock, many of the provisions will impact low-income housing by reducing energy costs.
The housing crisis is well documented. Almost half of all American renters spend more than 30% of their income on housing, making them “cost-burdened.” Median rent is generally too high for households making the median income, and housing costs have risen much faster than the rate of inflation for the last five years.
Commercial and residential buildings are responsible for 13% of carbon emissions without even considering electricity use or construction emissions. The IRA addresses these concerns to meet the Biden Administration’s carbon emissions targets through a series of taxes, subsidies, and regulatory changes. These changes will affect affordable housing and reduce the long-term energy needs of housing.
Higher Corporate Taxation, More Affordable Housing
Several changes to the tax regime included in the IRA may increase the demand for low-income housing tax credits (LIHTCs), the linchpin of affordable housing finance. By extension, these changes will reshape the affordable housing landscape in the U.S.
The first is the book tax. Beginning in 2023, corporations that take in more than $1 billion in stated income over three years will pay a minimum of 15% of that income in federal taxes. The purpose of this measure is to increase the rate of corporate taxation. Under the previous tax regime, corporations paid taxes on their reported taxable income, which included a series of deductions and end-arounds not available under a book tax system. The second change is a 1% excise tax on stock buybacks, which is thought to also increase the rate of taxation.
These changes should increase the demand for the LIHTC in different ways. The book tax limits the viability of many tax deductions that would lower a corporation’s taxable income. LIHTCs, however, are an exception and can even lessen the tax burden of corporations paying on their book income. Since LIHTCs offset tax liability in all cases, there will likely be greater capital allocation to affordable housing. Greater buy-in from corporations and nonprofits also paves the way for more spending, especially since the LIHTC program already enjoys bipartisan support.
Environmental Subsidies Help Developers
The IRA’s changes to the U.S. tax regime are intended to pay for the bill’s subsidies, many of which seek to reduce the impact of climate change and better protect the built environment from rising sea levels, higher temperatures and other unpredictable weather. These changes make it easier to build environmentally friendly affordable housing.
The biggest change of interest to affordable housing developers are the investment tax credit (ITC) rules for renewable energy. The ITC, which provides credits for adopting renewable energy sources, was scheduled to decrease in 2023. However, under the IRA, the credit has been increased to 30%, making it more profitable to add solar panels to one’s buildings. Additionally, solar expenditures previously reduced LIHTC basis. Under the IRA, that is no longer the case. The result is that it is now more lucrative for developers to install, improve, and expand their solar technology. Given that the 9% credit is competitive, it is unlikely that states will allocate meaningful amounts of 9% credits for solar panels, but 4% bond deals are particularly likely to benefit from the change. As industry expert Michael Novogradac stated in a late summer podcast, it basically makes no business sense for new LIHTC properties to exclude solar panels. The expansion of the investment tax credit and change in basis rules will thus increase the sustainability of LIHTC projects.
The IRA also allocates $837.5 million for grants or loans to owners and sponsors of HUD-subsidized Section 202, 811, project-based Section 8 and Section 236 properties, according to the National Housing Trust. These grants and loans are allocated for developments that improve energy or water efficiency, air quality, clean electricity generation, energy storage or climate resilience. Since many states already insist in certain green building criteria for affordable housing communities, the additional funding in the IRA will help cover those associated costs.
In addition to the expansion of the investment tax credit, the IRA also changes Section 179D (the energy efficient commercial property deduction) to encourage the installation of renewable energy technology. Section 179D was already written into the tax code. Broadly construed, it allowed developers to write off improvements to renewable technologies. The IRA loosened those rules, which should result in further renewable energy investments in existing buildings.
Finally, the bill is particularly favorable to affordable housing communities through the energy efficient home credit extension. The energy efficient home credit is a tax credit awarded to developers whose residential buildings meet one of four levels of energy performance. At the most efficient level, a building that meets the Department of Energy’s requirements for zero energy ready homes receives $5,000 per unit; awards are also available at $500, $1,000, and $2,500 depending on the energy efficiency and wage considerations. Before the IRA, such tax credits reduced the eligible basis for the building, leaving developers with little incentive to build energy-efficient and affordable projects. The IRA makes these two components additive: LIHTC financed buildings do not have a lower eligible basis, so developers are rewarded jointly for affordability and sustainability.
Housing costs have risen dramatically over the past five years and have squeezed many American families, causing some to make very difficult choices between housing, food, and medical treatment. In some cases, those choices force them onto the street. The Inflation Reduction Act will not solve these problems. But the changes that it makes to the tax code and the spending it promises can help developers build more (and cleaner) affordable housing. Dollars that had been diverted from building additional units to make the units built greener can now be spent on the construction of units, while additional funding will handle some of the costs associated with green building.