By Ben Barker
Financial Advisor, California Municipal Finance Authority
If you’ve spent any time in the affordable housing world, you’ve heard about the 4% and 9% Low-Income Housing Tax Credit (LIHTC) programs. These two financing tools are the backbone of affordable housing development in California and across the country. But what’s the difference between them—and why are tax-exempt bonds and bond recycling so critical to making these projects happen?
Let’s break it down.
4% vs. 9% LIHTC—What does it mean and Who Invests in It
Both the 4% and 9% LIHTC programs are designed to incentivize private investment in affordable rental housing by offering federal tax credits to developers. But they work in very different ways
9% LIHTC is a competitive program. Developers apply through the California Tax Credit Allocation Committee (CTCAC), and only a limited number of projects are awarded credits each year. These credits can cover roughly 70% of a project’s eligible costs over 10 years, making it a powerful funding source. Because it’s so competitive, 9% credits typically go to projects that are able to show they meet the criteria set out by CTCAC and have can demonstrate the ability to close without the need for extension or additional funding.
4% LIHTC, on the other hand, is non-competitive—but only if the project is financed with tax-exempt private activity bonds. These credits can cover about 30% of eligible costs over 10 years. While less generous than 9% credits, 4% credits are automatically designated when 25% of the total project costs are financed with private activity bonds.
So, who actually uses these tax credits why would they want them?
The answer is investors, typically large banks or corporations. These investors purchase the tax credits from developers in exchange for an equity share in the project. This equity reduces the amount of debt the developer needs to take on, making the project financially feasible while keeping rents affordable. Tax credits are attractive to investors because they can use them to reduce their federal tax liability—dollar for dollar. In addition, financial institutions may receive Community Reinvestment Act (CRA) credit for investing in affordable housing, which helps them meet regulatory requirements.
In short, LIHTC is a public-private partnership. The government provides the credits, developers build the housing, and private investors provide the capital. It’s one of the most successful affordable housing programs in U.S. history.
For more on how these programs work, visit the CTCAC website and explore their Tax Credit Programs.
So, What About Those Bonds and What Exactly Is Bond Recycling?
To qualify for 4% LIHTC, a project must be financed with tax-exempt private activity bonds issued by a government agency or authority. These bonds are not backed by the state—they’re repaid by the developer—but they allow the project to access lower interest rates and unlock the 4% credits.
In California, the California Debt Limit Allocation Committee (CDLAC) manages the state’s annual volume cap. State volume cap allocation is determined yearly by population multiplied by a multiple which is determined by the IRS and and creates a finite resource. Once it’s gone, no more 4% LIHTC deals can be approved for the year.
Tax-exempt bonds are essential because they make affordable housing financially feasible. They reduce borrowing costs, attract private investment, and allow developers to build more units for lower-income households. You can learn more about how CDLAC allocates bond authority here. Because bond volume is limited, recycling bonds is one of the most important strategies we have to stretch this resource further.
When a project transitions from construction to permanent financing, the original bond allocation may be preserved and recycled into a new project. Preservation of previously issued bond allocation that is recycled allows developments to additional tax-exempt dollars which lowers the overall cost of capital.
Recycling bonds:
- Reduces financing costs for developers
- Maximizes the impact of our limited bond cap
- Accelerates the development timeline for new projects
- Expands access to affordable housing across the state
Bond recycling is permitted under federal law (specifically 26 U.S.C. § 146(i)(6)) and is increasingly recognized as a best practice in California. CDLAC has issued guidance on how to structure bond documents to allow for recycling, including requirements for notice and documentation. You can read more in their Bond Recycling and Noticing regulations.
At CCAH and at the California Municipal Finance authority, we’re advocating for policies that support bond recycling and ensure that every dollar of public subsidy goes as far as possible. We encourage our members to structure deals that allow for recycling.