(1)Existing law establishes a low-income housing tax credit program pursuant to which the California Tax Credit Allocation Committee provides procedures and requirements for the allocation, in modified conformity with federal law, of state insurance, personal income, and corporation tax credit amounts to qualified low-income housing projects that have been allocated, or qualify for, a federal low-income housing tax credit, and farmworker housing. Existing law limits the total annual amount of the state low-income housing credit for which a federal low-income housing credit is required to the sum of $70,000,000, as increased by any percentage increase in the Consumer Price Index for the preceding calendar year, any unused credit for the preceding calendar years, and the amount of housing credit ceiling returned in the calendar year. Existing law additionally allows a state credit, which is not dependent on receiving a federal low-income housing credit, of $500,000 per calendar year for projects to provide farmworker housing. For purposes of determining the credit amount, existing law defines the term applicable percentage depending on, among other things, whether the qualified low-income building is a new building that is not federally subsidized, a new building that is federally subsidized, or is an existing building that is at risk of conversion.

This bill, under the law governing the taxation of insurers, the Personal Income Tax Law, and the Corporation Tax Law, for calendar years beginning in 2020, would increase the aggregate housing credit dollar amount that may be allocated among low-income housing projects by an additional $500,000,000, as specified, and would allocate to farmworker housing projects $25,000,000 per year of that amount. The bill, under those laws, would modify the definition of applicable percentage relating to qualified low-income buildings to depend on whether the building is a new or existing building and federally subsidized, or a building that is, among other things, at least 15 years old, serving households of very low income or extremely low income, and will complete substantial rehabilitation, as specified.

(2)Existing law requires the committee to allocate the housing credit on a regular basis, as provided, in accordance with a qualified allocation plan that includes specified provisions, including a requirement that all housing sponsors, as defined, demonstrate at the time the application is filed that the project meets specified threshold requirements.

This bill, with respect to the allocation of a credit pursuant to the Personal Income Tax Law, on or after January 1, 2020, would require that the housing sponsor demonstrate that it will invest an amount in the project at least equal to the amount of credit allocated to it.

(3)The Personal Income Tax Law and the Corporation Tax Law, in modified conformity with federal law, generally disallow passive activity loss and passive activity credits for any taxable year in computing taxable income, but, in the case of a natural person, allow an offset in the case of the low-income housing tax credit of up to $75,000 for any taxable year for all rental real estate activities in which the individual actively participated in the taxable year, as provided.

This bill, for each taxable year beginning on or after January 1, 2020, would provide that the dollar limitation for the offset for rental real estate activities does not apply to the low-income housing tax credit program.

(4)This bill would take effect immediately as a tax levy.

SENATE COMMITTEE ON APPROPRIATIONS

Senator Anthony Portantino, Chair

2019 - 2020 Regular Session

AB 10 (Chiu) - Income taxes: credits low-income housing: farmworker housing

Bill Summary:

AB 10 would remove two requirements that limit the California Tax Credit Allocation Committee’s authority to allocate increased amounts of low-income housing tax credits.

Fiscal Impact:

As discussed below, this bill would remove the requirement that additional low-income housing tax credit allocations (provided by a 2019-20 budget trailer bill) must be funded in future years’ budget actions. Consequently, it is likely that more tax credits would be allocated than would have been the case absent the bill. This increase in allocated credits would, in turn, eventually lead to a General Fund revenue loss once these allocated credits are claimed. The amount is unknown, but potentially in the millions of dollars annually (General Fund).

Both the Franchise Tax Board (FTB) and the California Tax Credit Allocation Committee (CTCAC) indicate that the bill would not significantly impact their administrative costs.

Background:

Current federal law allows tax credits for investors who provide project capital to low-income housing projects. Taxpayers claim Low-Income Housing Tax Credits (LIHTCs) equal to either 9 percent or 4 percent of the project’s basis over 10 years, and start claiming the credit in the taxable year in which the project is placed in service. Projects must remain affordable to residents for 15 years.

CTCAC awards 9 percent federal credits up to a limit set in federal law using a competitive process. Total awards were $97 million in federal credits for 64 projects in 2017. While federal law caps CTCAC’s authority to allocate federal 9 percent and state tax credits, CTCAC can allocate 4 percent credits with few limits.

CTCAC can allocate state tax credits only when federal credits do not provide sufficient subsidy, up to a specified cap. Taxpaying investors can only claim state credits in the first four taxable years after a project is placed in service. State law generally excludes acquisition costs from basis for the purposes of state LIHTCs, except for previously subsidized projects that qualify as "at-risk" of being converted to market rate. CTCAC awarded state credits of $102 million to 24 projects in 2017.

Housing developers design projects and apply to CTCAC for credits. CTCAC then reviews the application in a competitive process; if CTCAC grants credits, it then enters a regulatory agreement with the housing developer setting forth income and rent restrictions. CTCAC then reserves the amount of credit for that application, and then the housing developer forms partnership agreements with investors that provide project capital for the housing in exchange for the credits at a discount. The developer then returns to CTCAC for a final credit allocation. Investors claim the credit until exhausted, then walk away from the partnership, and deduct the amount paid to the partnership in exchange for the tax credits as a capital loss.

Federal law includes specified limits on the initial incomes of households in tax credit units. The Internal Revenue Service (IRS) ensures compliance with affordability and other restrictions set in federal law for the 15-year federal compliance period. CTCAC enforces the regulatory agreement up to 30 years for older projects, or 55 years for newer ones, which includes physical inspections. If either IRS or CTCAC detects violations, credits can be recaptured.

The enacted 2019-20 budget package includes AB 101 (Committee on Budget), which made several changes to the LIHTC intended to entice construction of additional units for low-income residents of the State. Specifically, among other things, the measure increases CTCAC’s authority to allocate credits to $500 million for new construction projects that receive the federal 4 percent tax credit. However, this increase is only explicitly effective in the 2020 calendar year. For subsequent years, the increase is only effective if the Budget Act or another related measure specifies an amount available for allocation. Additionally, CTCAC must also adopt regulatory reforms aimed at increasing production and containing costs for the increase to be effective.

Proposed Law:

This bill would remove the requirement that the additional LIHTC allocations provided by AB 101 are only available if the Budget Act or other measure providing for appropriations related to the Budget Act specifies an amount available for allocation that calendar year. The measure also would delete the requirement for CTCAC to adopt regulatory reforms aimed at increasing production and containing costs for the increase to be effective.

Staff Comments:

Tax expenditure programs (TEPs), including tax credits such as the LIHTC, are special tax provisions that reduce the amount of revenues the “basic” tax system would otherwise generate in order to provide, among other things, inducements to encourage certain types of behavior and activities. Specifically, the LIHTC incentivizes investment in affordable housing by providing a tax shelter for investors who allocate capital to low-income housing, a type of asset with a historically lower rate of return than alternative options. By providing this tax shelter, the State’s supply of housing is higher than it otherwise would have been.

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SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Mike McGuire, Chair

2019 - 2020 Regular

Income taxes: credits low-income housing: farmworker housing

Removes two requirements that limit the authority of the California Tax Credit Allocation Committee’s authority to allocate increased amounts of low-income housing tax credits.

Background

Low-Income Housing Tax Credits. Current state law allows credits against the Personal Income Tax, Corporation Tax, and Gross Premiums Tax to subsidize investors who provide project capital to affordable rental housing projects. State Low-Income Housing Tax Credits (LIHTCs) are calculated in partial conformity with federal LIHTCs, and complement federal credits in the hopes of providing capital necessary to pay costs to construct affordable housing.

Federal tax credits can equal either 70% of the qualified basis – generally equal to the costs of construction - for projects that are not federally subsidized (known as 9% credits), or 30% for federally subsidized (known as 4% credits), and are claimed over a period after the building is placed in service. Tax-exempt bonds are generally the source of any qualifying federal subsidy. Under federal law, projects must remain affordable for 15 years.

The California Tax Credit Allocation Committee (CTCAC), comprised of the State Treasurer, the State Controller, the Director of Finance, and three non-voting members, allocates state and federal LIHTCs. CTCAC awards 9% federal credits up to a dollar threshold set in federal law using a competitive process, totaling $97.1 million in federal credits for 64 projects in 2017, inducing almost one billion dollars in equity financing, and developing 3,844 affordable rental units. While federal law caps CTCAC’s authority to allocate federal 9% and state tax credits, CTCAC can allocate 4% credits with few limits. CTCAC allocated $124.9 million in federal credits for 105 subsidized projects in 2017, generating $1.2 billion in equity investment, constructing or rehabilitating 4,220 units.

CTCAC can only allocate state tax credits when federal credits do not provide sufficient subsidy, up to a cap set in state law, plus any unused credits from previous years. Taxpaying investors can only claim state credits in the first four taxable years after a project is placed in service. State law generally excludes acquisition costs from basis for the purposes of state LIHTCs, except for previously subsidized projects that qualify as "at-risk" of being converted to market rate. CTCAC awarded state credits of $102.2 million to 24 projects in 2017.

Housing developers design projects and apply to CTCAC for credits. CTCAC then reviews the application in a competitive process; if CTCAC grants credits, it then enters a regulatory agreement with the housing developer setting forth income and rent restrictions. CTCAC then reserves the amount of credit for that application, and then the housing developer forms partnership agreements with investors that provide project capital for the housing in exchange for the credits at a discount. The developer then returns to CTCAC for a final credit allocation. Investors claim the credit until exhausted, then walk away from the partnership, and deduct the amount paid to the partnership in exchange for the tax credits as a capital loss.

Federal law limits the initial incomes of households in tax credit units. When a project developer or sponsor applies for tax credits, he or she irrevocably chooses one of the following minimum federal set-aside requirements:

• A minimum of 40% of the units must be both rent-restricted and occupied by households whose incomes are 60% or less of the area median gross income, adjusted for family size;
• A minimum of 20% of the units must be both rent-restricted and occupied by households whose incomes are 50% or less of the area median gross income, adjusted for family size; or
• A minimum of 40% of the units must be both rent-restricted and occupied by households whose incomes are 80% or less of the area median gross income, adjusted for family size, and the average income and rent limitation must not exceed 60% of the area median income.

The Internal Revenue Service (IRS) ensures compliance with affordability and other restrictions set in federal law for the 15-year federal compliance period. CTCAC enforces the regulatory agreement up to 30 years for older projects, or 55 years for newer ones, which includes physical inspections. If either IRS or CTCAC detects violations, investors can have credits recaptured.

California’s housing challenges. California faces a severe housing shortage. In its most recent statewide housing assessment, HCD estimated that California needs to build an additional 100,000 units per year over recent averages of 80,000 units per year to meet the projected need for housing in the state. A variety of causes have contributed to the lack of housing production. Recent reports by the Legislative Analyst’s Office (LAO) and others point to local approval processes as a major factor. They argue that local governments control most of the decisions about where, when, and how to build new housing, and those governments are quick to respond to vocal community members who may not want new neighbors. The building industry also points to CEQA review, and housing advocates note a lack of a dedicated source of funds for affordable housing.

AB 101. On July 31, Governor Newsom signed AB 101 (Committee on Budget), which made several changes to the LIHTC as part of the agreement to enact the 2019-20 Budget Act, including to:

• Increase CTCAC’s authority to allocate credits to $500 million for new construction projects that receive the federal 4% tax credit, and increases the eligible basis for these projects to 30%.
• Direct $300 million of the additional $500 million to new construction projects receiving the federal 4% tax credit.
• Increase LIHTC percentages to a cumulative 95% of the qualified basis over four years for rehabilitating existing buildings at least 15 years old if it meets all of the following requirements:
  • The project serves households of very-low and extremely-low income such that its average maximum household income is not more than 45% of the area median gross income, or is financed under Section 514 (loans to farm owners or associations to construct housing for farmworkers) or 521 (interest subsidy or rental assistance) of the National Housing Act of 1949.
  • The project would have insufficient credits under current categories to complete substantial rehabilitation, and
  • CTCAC finds that the credit allocation results in the completion of the project.
• Allow up to $200 million to be available to projects receiving assistance from the California Housing Finance Agency Mixed Income Program.
• Eliminate the current $75,000 passive loss limitation on income derived from projects funded with LIHTCs.
• Make permanent the ability of developers to sell the credits to an unrelated investor, rather than requiring the investor to be a partner in the development, and sell state credits to investors who are not also buying federal tax credits.

However, AB 101’s increase in CTCAC’s authority to allocate up to $500 million in 4% credits is only explicitly effective in the 2020 calendar year. For subsequent calendar years, AB 101 provides that this increase is only effective if the Budget Act or other measure providing for appropriations related to the Budget Act specifies an amount available for allocation that calendar year. Additionally, the California Tax Credit Allocation Committee must also adopt regulatory reforms aimed at increasing production and containing costs for the increase to be effective. The author wants to remove these limitations, thereby making AB 101’s allocation authority increase permanent.

Proposed Law

Assembly Bill 10 removes the requirement that the additional LIHTC allocations provided by AB 101 are only available if the Budget Act or other measure providing for appropriations related to the Budget Act specifies an amount available for allocation that calendar year. The measure also deletes the requirement for the California Tax Credit Allocation Committee to adopt regulatory reforms aimed at increasing production and containing costs for the increase to be effective. The bill applies its changes to LIHTC provisions under the Gross Premiums, Personal Income, and Corporation Taxes.

State Revenue Impact

Pending.

Comments

1. Purpose of the bill. According to the author, “California continues to struggle with an affordable housing crisis, the low income housing tax credit (LIHTC) is the backbone of affordable housing development in the state. AB 10 would build upon the 2019-20 budget by making the $500 million to the LIHTC permanent rather than subject to appropriation each year.

Affordable housing developers line up their funding sources years in advance. The tax credits are typically purchased by major banks and corporations who need certainty because they do their tax planning over a long time horizon. From 2016 to 2018, California lost about a $1B in LIHTC investor equity due to federal tax law changes, having a state tax credit that may or may not be funded in a given year will make it very difficult to attract investors at the level of volume needed to ensure that all of the credits are successfully sold at good prices.”

2. Another bite? AB 101 made several changes to the LIHTC in the hopes of spurring construction of additional units for low-income, rent-burdened, Californians. The Legislature enacted the bill as part of the Budget Act as part of an agreement between the Governor and the Legislature. AB 10 removes requirements added by AB 101, thereby altering the terms of that agreement. The Committee may wish to consider the merits of changing part of an agreement made by the Legislature and the Governor.

3. A different kind of credit. The LIHTC induces investment in affordable housing by providing a tax shelter for investors who allocate capital to an asset class with a relatively poor rate of return. In return for providing the tax shelter, the state gets more housing than it otherwise would have. Housing faces many barriers in California: high costs of land, labor, and capital; resistance from local residents and state and local laws, and policies protecting the environment; among others. Because the credit is capped and allocated, CTCAC awards 9% credits to projects on a competitive process based on an evaluation of the most effective use of the tax credits. This program differs from other tax credits, where any individual or businesses can qualify for a credit by virtue of incurring specific costs, such as research and development or hiring specific individuals.

4. Bigger and better. Federal law allows CTCAC to allocate 9% credit for projects that are not “federally subsidized,” but 4% for ones that are. Developers that obtain federal 9% credits and combine them with state credits generally have a sufficient subsidy to construct a low-income housing project; however, CTCAC can only allocated these credits up to a cap set by federal law. While the 4% credits are not subject to a similar cap, they often do not have the value necessary to generate sufficient project capital for a project to pencil out. AB 10 seeks to fill this gap by extending CTCAC’s increased authorization to allocate 4% credits projects. Another vital component is the federal subsidy, which is not a direct monetary subsidy, but instead the issuance of mortgage revenue bonds, where the subsidy is the federal and state income tax exclusion for interest payments. Local housing authorities apply to the California Debt Limit Allocation Committee (CDLAC) for an allocation of tax-exempt private activity bond ceiling. If approved, the local housing authority sells the bonds, loans the proceeds to housing developers, who combine these funds with capital raised from state and federal LIHTCs to construct the project, and then repay the bonds out of rents.

5. Gut and amend. When approved by the Assembly and the Senate Committee on Housing, AB 10 made several changes to the LIHTC, many of which were incorporated into AB 101. On August 12^th, the author amended AB 10 to insert its current change, and to update the measure to reflect AB 101’s changes to LIHTC statutes.

Assembly Actions

Not relevant to this version of the bill.

Support and Opposition

(8/11/19)

Support: None received.

Opposition: None received.

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SENATE COMMITTEE ON HOUSING

Senator Scott Wiener, Chair

2019 - 2020 Regular

Bill No: AB 10 Hearing Date: 7/2/2019

SUBJECT: Income taxes: credits low-income housing: farmworker housing

DIGEST: This bill increases the amount of state tax credits the California Tax Credit Allocation Committee (TCAC) can allocate for low-income housing and makes other changes to the state low-income housing tax credit (LIHTC) program.

ANALYSIS:

Existing law:

1. Allows a state tax credit for costs related to construction, rehabilitation, or acquisition of low-income housing. This credit, which mirrors a federal LIHTC, may be used by taxpayers to offset the tax under the Personal Income Tax, the Corporation Tax, and the Insurance Tax laws.
2. Requires the TCAC to annually allocate the California LIHTC based upon qualifications of the applicant and proposed project. The California LIHTC is available only to projects that receive an allocation of the federal LIHTC.
3. Limits the annual aggregate amount of the state LIHTC to $70 million, as adjusted for an increase in the California consumer price index, plus any unused LIHTC from the preceding calendar year and any LIHTC returned in the calendar year. The state LIHTC awarded may be claimed as a credit over a four-year period.
4. Requires that $500,000 of the LIHTC be set aside for farmworker housing developments and provides that the farmworker tax credit awards are not dependent on receiving a federal LIHTC.
5. Allows TCAC to award state LIHTCs to developments in a qualified census tract (QCT) or a difficult to development area (DDA) if the project is also receiving federal LIHTC, under the following conditions:
6. Developments restrict at least 50% of the units to special needs households; and
7. The state credits do not exceed 130% of the eligible basis of the building.
8. Allows TCAC to replace federal LIHTC with state LIHTC of up to 130% of a project’s eligible basis if the federal LIHTC is reduced in an equivalent amount.
9. Defines a QCT as any census tract designated by the U.S. Department of Housing and Urban Development (HUD) in which either 50% or more of the households have an income that is less than 60% of the area median gross income or that has a poverty rate of at least 25%.
10. Defines a DDA as an area designated by HUD on an annual basis that has high construction, land, and utility costs relative to area median income.

This bill:

1. Increases, for 2020 through 2024, the annual aggregate amount of state LIHTC by an additional $500 million, as adjusted for inflation beginning in 2021. The additional $500 million is not available to a new qualified low-income housing building that receives a federal 9% credit.
2. Increases, for 2020 through 2024, the annual aggregate amount of LIHTCs set-aside for farmworker housing from $500,000 to $25 million. Amounts that are unallocated or returned shall be added back to the $500 million increase that may be allocated by TCAC to projects that do not receive a 9% credit.
3. Eliminates, on or after January 1, 2020, and before January 1, 2025, the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
4. Requires, for purposes of the Personal Income Tax (PIT) Law, the housing sponsor to demonstrate that it will invest an amount in the project at least equal to the amount of credit allocated to it with respect to the allocation of a credit on or after January 1, 2020.
5. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets all of the following requirements:
   1. The building is at least 15 years old;
   2. The building is serving households of very low-income or extremely low-income such that the average maximum household income is not more than 45% of the area median gross income adjusted for household size, and the tax credit regulatory agreement is entered into for a period of not less than 55 years;
   3. It would have insufficient LIHTC due to the building's low appraised value, to complete substantial rehabilitation; and,
   4. The substantial rehabilitation will be complete with this 95% state LIHTC of the qualified basis.
6. Modifies the allocation of state LIHTCs that may be awarded to a federally subsidized low-income housing project receiving a federal 4% LIHTC as follows:
   1. A qualified low-income building is eligible for a cumulative state LIHTC over four years of 50% of the qualified basis of the building; and,
   2. An existing qualified low-income housing building is eligible for a cumulative state LIHTC over four years of 13% of the qualified basis.
7. Includes members of a limited liability company within the definition of "taxpayer" and "housing sponsor."

COMMENTS

1. Purpose of the bill. According to the author, “Changes made to the corporate tax law at the federal level will undercut the efforts we have made to address the affordable housing crisis facing our state. As a result of the Trump tax plan California will lose 48,870 affordable rental homes, 55,230 jobs, $4.6 billion in business income, and $1.7 billion in local, state, and federal taxes. Low-income families will suffer the greatest from this loss. In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units. We need more resources at our disposal to increase the number of rental units for lower-income families. Lack of affordability is fueling the rising number of people experiencing homelessness as more and more people pay over 50% of their household income on rent. It's simply not sustainable. AB 10 proposes a $500M increase to the state's affordable housing tax credit, an extremely successful program that in turn leverages another $1B in federal tax credits, local, and private sector investments. AB 10 also revises state law exempting state LIHTCs from the passive activity loss rules, which could significantly increase the state LIHTC equity pricing. This bill would expand the ability of individual tax payers to claim the LIHTC by eliminating the $75,000 cap on an individual tax payer's offset for passive rental real estate activities in computing taxable income.”
2. Background of the federal LIHTC program. The LIHTC is an indirect federal subsidy developed in 1986 to incentivize the private development of affordable rental housing for low-income households. The federal LIHTC program enables low-income housing sponsors and developers to raise project equity through the allocation of tax benefits to investors. TCAC administers the program and awards credits to qualified developers who can then sell those credits to private investors who use the credits to reduce their federal tax liability. The developer in turn invests the capital into the affordable housing project.

Two types of federal tax credits are available: the 9% and 4% credits. These terms refer to the approximate percentage of a project’s “eligible basis” a taxpayer may deduct from his/her annual federal tax liability in each of 10 years. “Eligible basis” means the cost of development excluding land, transaction costs, and costs incurred for work outside the property boundary. For projects that are not financed with a federal subsidy, the applicable rate is 9%. For projects that are federally subsidized (including projects financed more than 50% with tax-exempt bonds), the applicable rate is 4%. Although the credits are known as the “9% and 4% credits,” the actual tax rates fluctuate every month, based on the determination made by the Internal Revenue Service on a monthly basis. Generally, the 9% tax credit amounts to 70% of a taxpayer’s eligible basis and the 4% tax credit amounts to 30% of a taxpayer’s eligible basis, spread over a 10-year period.

Each year, the federal government allocates funding to the states for LIHTC on the basis of a per-resident formula. In California, TCAC is the entity that reviews proposals submitted by developers and selects projects based on a variety of prescribed criteria. Only rental housing buildings, which are either undergoing rehabilitation or newly constructed, are eligible for the LIHTC. In addition, the qualified low-income housing projects must comply with both rent and income restrictions.

Each state receives an annual ceiling of 9% federal tax credits and they are oversubscribed by a 2:1 ratio. Unlike 9% LIHTC, federal 4% tax credits are not capped; however, they must be used in conjunction with tax-exempt private activity mortgage revenue bonds which are capped and are administered by the California Debt Limit Allocation Committee. In 2019, the state ceiling for private activity bonds is set at $4.15 billion.

The value of the 4% tax credits is less than half of the 9% tax credits and, as a result, 4% federal credits are generally used in conjunction with another funding source, like state housing bonds or local funding sources.

1. Background of the state LIHTC program. In 1987, the Legislature authorized a state LIHTC program to augment the federal tax credit program. State tax credits can only be awarded to projects that have also received, or are concurrently receiving, an allocation of the federal LIHTCs. The amount of state LIHTC that may be annually allocated by the TCAC is limited to $70 million, adjusted for inflation. In 2014, the total credit amount available for allocation was $99.4 million plus any unused or returned credit allocations from previous years. Current state tax law generally conforms to federal law with respect to the LIHTC, except that it is limited to projects located in California.

While the state LIHTC program is patterned after the federal LIHTC program, there are several differences. First, investors may claim the state LIHTC over four years rather than the 10-year federal allocation period. Second, the rates used to determine the total amount of the state tax credit (representing all four years of allocation) are 30% of the eligible basis of a project that is not federally subsidized and 13% of the eligible basis of a project that is federally subsidized, in contrast to 70% and 30% (representing all 10 years of allocation on a present-value basis), respectively, for purposes of the federal LIHTCs. Furthermore, state tax credits are not available for acquisition costs, except for previously subsidized projects that qualify as “at-risk” of being converted to market rate.

Combining federal 9% credits (which amounts to roughly 70%) with state credits (which amounts to 30%) generally equals 100% of a project’s eligible basis. Combining federal 4% credits (which amounts to roughly 30%) with state credits (which amounts to 13%), only results in 43% of a project’s eligible basis.

1. Background of state credits in DDAs and QCTs. Federal law also allows credits equal to 130% of eligible basis if the project is located in a QCT or a DDA, a so-called “basis boost” of 30%. QCTs are designated by the Secretary of HUD, in which either 50% or more of the households have an income that is less than 60% of the area median gross income or have a poverty rate of 25%. The Secretary of HUD also draws DDAs using a ratio of construction, land, and utility costs to area median income.

State law prohibits TCAC from allocating state credits in QCTs or DDAs unless TCAC swaps out federal credits willing to forgo the “basis boost,” so that the combined credit amount doesn’t exceed 130% of basis. The rationale for this prohibition is that projects in these areas can qualify for more federal tax credits through a basis boost and therefore are already advantaged.

State law was recently amended to authorize TCAC, in limited cases, to award state LIHTCs for use in DDAs or QCTs, in addition to the federal credits. To qualify, a development must restrict at least 50% of the units to special-needs households. The change allows these projects to receive state credits of 30% of basis in addition to federal ones generated on 130% of basis.

This bill would also allow state 4% tax credits to be awarded to projects without regard to DDA or QCT status, with the main purpose of providing enough state tax credits to match the value of a 9% federal tax credit.

1. Increasing amount of state credits. This bill would increase the state LIHTC allocation by $500 million per year, in addition to the existing $70 million cap, as adjusted for inflation, between 2020 and 2024. It also includes a set-aside from the $500 million increase to the LIHTC program of $25 million for farmworker housing. There is currently a $500,000 set-aside of low-income housing tax credits for farmworker housing developments serving farmworkers and their families. This bill would require any unused credits from the $25 million set-aside to go to qualified non-farmworker housing projects that don't receive funding under the main program.
2. Filling the gap. This bill also increases the amount of state 4% tax credits awarded to each qualified new low-income housing project from 13% to 50% of the eligible basis, provided the project is also receiving a 4% federal tax credit. Developers that receive federal 9% credits can combine them with a sufficient subsidy to construct a low-income housing project, but TCAC can only allocate those credits up to a federal cap. While the 4% credits are not subject to a cap, they do not have the same value because developers cannot generate sufficient capital needed to cover the cost of the project.

This increase would apply to new construction and would more than triple the amount of equity that an investor in the project would receive, which would bring the return on 4% credits in line with 9% credits and would likely result in greater affordability for the project. The costs of acquiring an existing low-income building would also be eligible for the state LIHTC allocated from the new additional funding of $500 million, but the applicable percentage used to calculate the amount of that credit would be limited to 13% of the project’s eligible basis.

1. Rehabilitating existing housing stock. Many low-income housing developments in the state are older and need significant rehabilitation. These projects, therefore, require more investment due to their age and level of repairs, combined with low rents. This bill will significantly increase an amount of state LIHTC — 95% of the eligible basis — that may be awarded to a qualified low-income housing building that houses very low-income or extremely low-income tenants and meets all specified requirements, including the building’s location, age, and value.

8) Impact of Federal Tax Package on LIHTC. As a result of the H.R. 1, the Tax Cuts and Jobs Act that passed in 2017, the federal reduction in the corporate tax rate from 35% to 21% is having a significant effect on the price of federal LIHTC. Novogradac & Company, LLC (Novogradac), a certified public accountant, estimates the price of the federal LIHTC has dropped from $1.03 in March of 2016 to $0.89 in December of 2017.

Although the price of the federal credit has been reduced, the decrease in the federal corporate tax rate could result in an increase in value to the state LIHTC. In general the state LIHTC equity pricing for allocated credits is strongly inversely correlated to the investor's federal income tax rate. According to Novogradac, "there is an inverse correlation because the state credit that reduces the investor’s federal deduction for state income taxes, such that the higher the federal tax rate, the less valuable the state credit. When the corporate federal rate was 35%, state LIHTC equity prices were generally in the range of, but slightly greater than, 65 cents. Now that the federal rate has been reduced to 21%, equity pricing for allocated state credits is expected to increase, possibly in the range of 20 percent." An increase in the state LIHTC could help mitigate the loss resulting from the federal tax change.

In addition to increasing the total amount of the credit, California can make changes to tax law to increase the value of the state LIHTC. California uses "modified conformity" to federal income tax law, meaning it mirrors federal law, with certain exceptions. California’s modified conformity to the federal passive activity loss rules restricts the ability of individual investors to use state LIHTCs. California caps the amount of passive activity for rental real estate activities an individual can offset with a state tax credit. According to Novogradac, "a revision to state tax law exempting state LIHTCs from the passive activity loss rules could significantly increase the state LIHTC equity pricing, even more so since tax reform limits individual taxpayers’ federal deductions for state and local income taxes to $10,000 and subjects individuals to federal tax rates that are significantly higher than corporate rates." The new federal tax law also establishes an individual tax rate of 37%, compared to a corporate rate of 21%. This will provide individuals with a greater incentive to invest in state tax credits.

This bill would expand the ability of individual tax payers to claim the LIHTC by eliminate the $75,000 cap on an individual tax payer’s offset for passive rental real estate activities in computing taxable income.

1. Costs and effects. The increase in state LIHTCs is a tax credit, which means this is tax liability that would have otherwise gone to the general fund from corporations, which instead choose to invest in low-income housing tax credits. While it’s possible that it could take $500 million from the general fund, the idea is that investors would likely be seeking tax credits elsewhere and might, with the enactment of this bill, now build affordable housing. Further, there are positive economic impacts from the construction, job creation, and local tax benefits of building multifamily homes. The estimated one-year impacts of building 100 rental apartments in a typical local area include $11.7 million in local income, $2.2 million in taxes and other revenue for local governments, and 161 local jobs (1.62 jobs per apartment). The additional, annually recurring impacts of building 100 rental apartments in a typical local area include $2.6 million in local income, $503,000 in taxes and other revenue for local governments, and 44 local jobs (.44 jobs per apartment).

9) Opposition. Writing as a coalition, the California Coalition for Adequate School Housing, California Retired Teachers Association, California State PTA, and California Teachers Association oppose AB 10. They are asking the State to pause the creation of any additional tax credits until a comprehensive evaluation, including broader transparency and accountability can be created for all existing tax credits. Forty percent of every dollar shifted from the General Fund to a tax credit is money that would have gone to fund Proposition 98 and California’s schools.

10) Double-referral. This bill is also referred to the Governance and Finance Committee.

Related Legislation:

SB 9 (Beall, 2019) — allows a taxpayer who receives an allocation of state LIHTC from TCAC to sell all or any portion of the credit to one or more unrelated parties for each taxable year in which the credit is allowed for not less than 80% of the amount of the credit. This bill is pending in the Assembly Housing and Community Development Committee.

AB 71 (Chiu, 2017) — would have increased the amount of state tax credits the California Tax Credit Allocation Committee (TCAC) can allocate for low-income housing and makes other changes to the state low-income housing tax credit (LIHTC) program. This bill was placed on the Inactive File on the Assembly Floor.

AB 2817 (Chiu, 2016) — would have increased the amount of state tax credits the California Tax Credit Allocation Committee (TCAC) can allocate for low-income housing and makes other changes to the state low-income housing tax credit (LIHTC) program. This bill was held in the Assembly Appropriations Committee.

AB 35 (Chiu, 2015) — would have increased the amount of state tax credits the California Tax Credit Allocation Committee (TCAC) can allocate for low-income housing and makes other changes to the state low-income housing tax credit (LIHTC) program. This bill was vetoed by Governor Brown. The veto message read:

“Despite strong revenue performance over the past few years, the state's budget has remained precariously balanced due to unexpected costs and the provision of new services. Now, without the extension of the managed care organization tax that I called for in special session, next year's budget faces the prospect of over $1 billion in cuts. 

“Given these financial uncertainties, I cannot support providing additional tax credits that will make balancing the state's budget even more difficult. Tax credits, like new spending on programs, need to be considered comprehensively as part of the budget deliberations.”

FISCAL EFFECT: Appropriation: Fiscal Com.: Local:

POSITIONS: (Communicated to the committee before noon on Wednesday,

June 26, 2019.)

SUPPORT:

California Housing Consortium (Co-Sponsor)
California Housing Partnership (Co-Sponsor)
Housing California (Co-Sponsor)
Non-Profit Housing Association Of Northern California (Co-Sponsor)
Abode Communities
Affirmed Housing Group 
Bay Area Housing Advocacy Coalition 
Bay Area Regional Health Inequities Initiative
Burbank Housing Development Corporation
C & C Development
CalAsian Chamber Of Commerce
California Apartment Association
California Association Of Housing Authorities
California Association Of Local Housing Finance Agencies (Cal-Alhpfa)
California Coalition For Rural Housing
California State Association Of Counties
California YIMBY
Corporation For Supportive Housing
County Of Santa Clara
EAH Housing
East Bay Asian Local Development Corp
Eden Housing
First Community Housing
Housing Authority Of The City Of Alameda
Housing Trust Silicon Valley
John Stewart Company
LeadingAge California
League Of California Cities
League Of Women Voters Of California
Los Angeles Homeless Services Authority
Many Mansions
Midpen Housing Corporation
Mono; County Of
National Association Of Social Workers, California Chapter
Pacific Companies, The
Palm Communities
Paulett Taggart Architects
Sacramento Area Council Of Governments
San Diego Housing Federation
San Francisco Housing Action Coalition
Southern California Association Of Governments
Southern California Association Of Nonprofit Housing
TELACU
The Coalition Of Homeless Services Providers
Ventura Council Of Governments
Ventura; County Of
Wakeland Housing And Development Corporation
Walnut Creek; City Of

1 Individual

OPPOSITION:

California Coalition for Adequate School Housing
California Retired Teachers Association
California State PTA
California Teachers Association

-- END –

ASSEMBLY THIRD READING

ATR Bill Id:AB 10

Author:(Chiu, et al.)

As Amended Ver:April 30, 2019

Majority vote. Tax Levy

SUMMARY:

Increases the state Low-Income Housing Tax Credit (LIHTC) by $500 million, increases the set aside for the farmworker housing tax credit from $500,000 to $25 million, and modifies the LIHTC, as specified.

Major Provisions

1. Increases, for calendar years 2020 through 2024, the amount of state LIHTC by an additional $500 million, as adjusted for inflation beginning in 2021. The additional $500 million is not available to a new qualified low-income housing building that receives a federal 9% credit.
2. Increases, for calendar years 2020 through 2024, the amount of LIHTCs set aside for farmworker housing from $500,000 to $25 million. Amounts that are unallocated or returned shall be added back to the $500 million increase that may be allocated by the Tax Credit Allocation Committee (TCAC) to projects that do not receive a 9% credit.
3. Eliminates, beginning on or after January 1, 2020, and before January 1, 2025, the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
4. Requires, for purposes of the Personal Income Tax (PIT) Law, the housing sponsor to demonstrate that it will invest an amount in the project at least equal to the amount of credit allocated to it with respect to the allocation of a credit on or after January 1, 2020.
5. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets all of the following requirements:
   1. The building is at least 15 years old;
   2. The building is serving households of very low-income or extremely low-income such that the average maximum household income is not more than 45% of the area median gross income adjusted for household size, and the tax credit regulatory agreement is entered into for a period of not less than 55 years;
   3. It would have insufficient LIHTCs due to the building's low appraised value to complete substantial rehabilitation; and,
   4. The substantial rehabilitation will be complete with this 95% state LIHTC of the qualified basis.
6. Modifies the allocation of state LIHTCs that may be awarded to a federally subsidized low-income housing project receiving a federal 4% LIHTC as follows:
   1. A new qualified low-income building is eligible for a cumulative state LIHTC over four years of 50% of the qualified basis of the building; and,
   2. An existing qualified low-income housing building is eligible for a cumulative state LIHTC over four years of 13% of the qualified basis.
7. Makes technical changes to the definition of "at risk of conversion."
8. Defines "extremely low income households" as having the same meaning as in Health and Safety Code (H&SC) Section 50053.
9. Defines "very low income households" as having the same meaning as in H&SC Section 50053.
10. Includes members of a limited liability company within the definition of "taxpayer" and "housing sponsor."
11. Makes findings and declarations in compliance with Revenue and Taxation Code (R&TC) Section 41
12. Takes effect immediately as a tax levy.

COMMENTS:

Affordable housing shortage: According to the Legislative Analyst, California needs to produce approximately 180,000 units of housing per year to keep up with population growth – we produce less than half that amount. The lack of affordable housing has the most significant impact on low-income renter households. In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units. Of the 6 million renter households in the state, 1.7 million are paying more than 50% of their income toward rent. The National Low Income Housing Coalition estimates that the state needs an additional 1.5 million housing units that very-low income Californians can afford.

Low-Income Housing Tax Credit Program: In 1987, the legislature authorized a state LIHTC program to augment the federal tax credit program. State tax credits can only be awarded to projects that also receive federal LIHTCs, except for farmworker housing projects, which can receive state credits without federal credits. Investors can claim the state credit over four years. Projects that receive either state or federal tax credits are required to maintain the housing at affordable levels for 55 years.

Changes to the LIHTC: AB10 would increase the state LIHTC allocation by an additional $500 million. In addition to increasing the total amount of state LIHTC, AB 10 proposes to increase the amount of state tax credits awarded to a project that is also receiving 4% federal tax credits from 13% to 50% of the qualified basis. This would more than triple the amount of equity that an investor purchasing a state tax credit would receive, which would bring the return on 4% credits in line with 9% credits and result in greater affordability for the project.

Federal LIHTC can be used anywhere in the state, but projects are given an additional 30% boost on their eligible basis if the project is located in a DDA or a QCT. Because these areas by definition have a higher poverty level and there is a higher concentration of extremely low-income or homeless individuals and families, housing needs deep subsidy to make it affordable. Existing state law does not allow state tax credits to be awarded in DDAs and QCTs with one exception: housing developments where 50% of the units are for special needs populations. The rationale for this prohibition is projects in these areas can qualify for more federal tax credits and therefore are already advantaged. AB 10 would also allow state tax credits to be awarded to projects without regard to DDA or QCT status, with the main purpose of providing enough state tax credits to match the value of a 9% federal tax credit.

AB 10 includes a set-aside from the $500 million increase to the LIHTC program of $25 million for farmworker housing. There is currently a $500,000 set-aside of low-income housing tax credits for farmworker housing developments serving farmworkers and their families. AB 10 would require any unused credits from the $25 million set-aside to go to qualified non-farmworker housing projects that don't receive funding under the main program.

Many low-income housing developments in the state are older and in need of rehabilitation. These projects need higher levels of equity investments because of their age, level of repairs needed, and the low rents. It is hard for these projects to compete for state tax credits because the assessed value is low and therefore the eligible basis upon which the amount of tax credits the project can qualify for is also low. To assist these older projects, AB 10 would allow them to receive state tax credits of 95% over four years. To qualify, projects would need to be at least 15 years old, serve low and extremely low-income households, be a single room occupancy, in a rural area, and have insufficient state credits to complete substantial rehabilitation due to a low appraised value.

This bill would expand the ability of individual tax payers to claim the LIHTC by eliminate the $75,000 cap on an individual tax payer’s offset for passive rental real estate activities in computing taxable income.

According to the Author:

According to the author, Changes made to the corporate tax law at the federal level will undercut the efforts we have made to address the affordable housing crisis facing our state.  As a result of the Trump tax plan California will lose 48,870 affordable rental homes, 55,230 jobs, $4.6 billion in business income, and $1.7 billion in local, state, and federal taxes.  Low income families will suffer the greatest from this loss.  In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units.  We need more resources at our disposal to increase the number of rental units for lower-income families.  Lack of affordability is fueling the rising number of people experiencing homelessness as more and more people pay over 50% of their household income on rent.  It's simply not sustainable.

AB 10 proposes a $500M increase to the state's affordable housing tax credit, an extremely successful program that in turn leverages another $1B in federal tax credits, local and private sector investments. AB 10 also revises state law exempting state LIHTCs from the passive activity loss rules which could significantly increase the state LIHTC equity pricing. This bill would expand the ability of individual tax payers to claim the LIHTC by eliminating the $75,000 cap on an individual tax payer's offset for passive rental real estate activities in computing taxable income.

Arguments in Support:

According to the California Housing Partnership Corporation, AB 10 builds on the successful track record of the LIHTC programs in California, which have produced or preserved more than 350,000 homes, created 400,000 jobs, and generated $35 billion in local income and $14 billion in tax revenues in California since 1986. AB 10 would expand the successful state LIHTC by $500 million annually, leveraging an additional $1 billion in federal funds to build more than 5,000 affordable homes each year.

Arguments in Opposition:

The California Association of Teachers (CTA) is opposing all new tax credits this year and is part of an education tax coalition asking the state to pause the creation of any additional tax credits until a comprehensive evaluation, including broader transparency and accountability can be created for all existing tax credits.

FISCAL COMMENTS:

According to the Assembly Committee on Appropriation, annual General Fund revenue loss of $14 million in 2019-20, $39 million in 2020-21 and $70 million in 2021-22.

VOTES:

ASM HOUSING AND COMMUNITY DEVELOPMENT: 8-0-0

YES: Chiu, Diep, Gabriel, Gloria, Kiley, Limón, Maienschein, Quirk-Silva

ASM REVENUE AND TAXATION: 11-0-0

YES: Burke, Brough, Chu, Gray, Mayes, Melendez, Mullin, Petrie-Norris, Quirk, Luz Rivas, Ting

ASM APPROPRIATIONS: 18-0-0

YES: Gonzalez, Bigelow, Bloom, Bonta, Brough, Calderon, Carrillo, Chau, Diep, Eggman, Fong, Gabriel, Eduardo Garcia, Maienschein, Obernolte, Petrie-Norris, Quirk, Robert Rivas

UPDATED:

VERSION: April 30, 2019

CONSULTANT: Lisa Engel / H. & C.D. / (916) 319-2085 FN: 0000711

Date of Hearing: May 16, 2019

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez, Chair

ABPCA Bill Id:AB 10

Author:(Chiu) – As Amended Ver:April 30, 2019

Urgency: No State Mandated Local Program: No Reimbursable: No

SUMMARY:

This bill increases the amount of state Low-Income Housing Tax Credit (LIHTC) available and makes assorted modifications to the LIHTC program. Specifically, this bill:

1. Increases the amount to LIHTC by an additional $500 million in 2019 and then adjusts that amount for inflation in years 2020 through 2024 and increases, for years 2020 through 2024, the amount of LIHTC set aside for farmworker housing, from $500,000 to $25 million. These new LIHTC amounts may not be used for projects receiving the federal 9% LIHTC.
2. Eliminates, for years 2020 through 2024, the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
3. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets certain requirements.

FISCAL EFFECT:

Annual GF revenue loss of $14 million in 2019-20, $39 million in 2020-21 and $70 million in 2021-21.

COMMENTS:

1. Federal LIHTC Program. The LIHTC is an indirect federal subsidy developed in 1986 to incentivize the private development of affordable rental housing for low-income households. The federal LIHTC program replaced traditional housing tax incentives, such as accelerated depreciation, with a tax credit that enables low-income housing sponsors and developers to raise project equity through the allocation of tax benefits to investors.

Two types of federal tax credits are available: the 9% credit and 4% credit. These terms refer to the approximate percentage of a project's "qualified basis" a taxpayer may deduct from their annual federal tax liability in each of 10 years. For projects not financed with a federal subsidy, the applicable rate is 9%. For federally subsidized projects (including projects financed with more than 50% in tax-exempt bonds), the applicable rate is 4%.

1. State LIHTC Program. In 1987, the Legislature authorized a state LIHTC program to augment the federal program. While the state LIHTC program is patterned after the federal program, there are several differences, including a provision allowing investors to claim the state LIHTC over a four-year, rather than the federal 10-year, allocation period. Furthermore, unlike the federal LIHTC program, the California law requires project developers or housing sponsors to agree to a minimum of 55 years of rent and income restrictions.

State tax credits can only be awarded to projects that have also received, or are concurrently receiving, an allocation of the federal LIHTC. The state LIHTC percentages are roughly 30% for projects that are not federally subsidized and 14% for projects that are federally subsidized. The amount of state LIHTC that may be annually allocated by the state is limited to $70 million, adjusted for inflation, plus any unallocated or unused credits from previous years.

1. Passive activity losses. Federal and state laws provide that passive activity losses are generally deductible only from passive activity income. Passive activity includes any rental activity, whether or not the taxpayer materially participates. Federal law provides an exception to losses from rental real estate activities that do not exceed $25,000. California modifies this provision to allow passive activity losses from rental real estate relating to low-income housing to a maximum of $75,000.
2. Purpose. According to the author, AB 10 will build on a successful program by proposing additional credits and by expanding the ability of individual taxpayers to claim the LIHTC by eliminating the $75,000 cap on an individual taxpayer’s offset for passive rental real estate activities.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: May 16, 2019

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez, Chair

ABPCA Bill Id:AB 10

Author:(Chiu) – As Amended Ver:April 30, 2019

Urgency: No State Mandated Local Program: No Reimbursable: No

SUMMARY:

This bill increases the amount of state Low-Income Housing Tax Credit (LIHTC) available and makes assorted modifications to the LIHTC program. Specifically, this bill:

1. Increases the amount to LIHTC by an additional $300 million in 2019 and then adjusts that amount for inflation in years 2020 through 2024 and increases, for years 2020 through 2024, the amount of LIHTC set aside for farmworker housing, from $500,000 to $25 million. These new LIHTC amounts may not be used for projects receiving the federal 9% LIHTC.
2. Eliminates, for years 2020 through 2024, the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
3. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets certain requirements.

FISCAL EFFECT:

Annual GF revenue loss of $14 million in 2019-20, $39 million in 2020-21 and $70 million in 2021-21.

COMMENTS:

1. Federal LIHTC Program. The LIHTC is an indirect federal subsidy developed in 1986 to incentivize the private development of affordable rental housing for low-income households. The federal LIHTC program replaced traditional housing tax incentives, such as accelerated depreciation, with a tax credit that enables low-income housing sponsors and developers to raise project equity through the allocation of tax benefits to investors.

Two types of federal tax credits are available: the 9% credit and 4% credit. These terms refer to the approximate percentage of a project's "qualified basis" a taxpayer may deduct from their annual federal tax liability in each of 10 years. For projects not financed with a federal subsidy, the applicable rate is 9%. For federally subsidized projects (including projects financed with more than 50% in tax-exempt bonds), the applicable rate is 4%.

1. State LIHTC Program. In 1987, the Legislature authorized a state LIHTC program to augment the federal program. While the state LIHTC program is patterned after the federal program, there are several differences, including a provision allowing investors to claim the state LIHTC over a four-year, rather than the federal 10-year, allocation period. Furthermore, unlike the federal LIHTC program, the California law requires project developers or housing sponsors to agree to a minimum of 55 years of rent and income restrictions.

State tax credits can only be awarded to projects that have also received, or are concurrently receiving, an allocation of the federal LIHTC. The state LIHTC percentages are roughly 30% for projects that are not federally subsidized and 14% for projects that are federally subsidized. The amount of state LIHTC that may be annually allocated by the state is limited to $70 million, adjusted for inflation, plus any unallocated or unused credits from previous years.

1. Passive activity losses. Federal and state laws provide that passive activity losses are generally deductible only from passive activity income. Passive activity includes any rental activity, whether or not the taxpayer materially participates. Federal law provides an exception to losses from rental real estate activities that do not exceed $25,000. California modifies this provision to allow passive activity losses from rental real estate relating to low-income housing to a maximum of $75,000.
2. Purpose. According to the author, AB 10 will build on a successful program by proposing additional credits and by expanding the ability of individual taxpayers to claim the LIHTC by eliminating the $75,000 cap on an individual taxpayer’s offset for passive rental real estate activities.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: May 6, 2019

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Autumn R. Burke, Chairwoman

ABPCA Bill Id:AB 10 (

Author:Chiu) – As Amended Ver:April 30, 2019

FOR VOTE ONLY

Majority vote. Tax levy. Fiscal committee.

SUBJECT: Income taxes: credits low-income housing: farmworker housing

SUMMARY: Increases the state Low-Income Housing Tax Credit (LIHTC) by $500 million, increases the set aside for the farmworker housing tax credit from $500,000 to $25 million, and modifies the LIHTC, as specified. Specifically, this bill:

1. Increases, for calendar years 2020 through 2024, the amount of state LIHTC by an additional $500 million, as adjusted for inflation beginning in 2021. The additional $500 million is not available to a new qualified low-income housing building that receives a federal 9% credit.
2. Increases, for calendar years 2020 through 2024, the amount of LIHTCs set aside for farmworker housing from $500,000 to $25 million. Amounts that are unallocated or returned shall be added back to the $500 million increase that may be allocated by the Tax Credit Allocation Committee (TCAC) to projects that do not receive a 9% credit.
3. Eliminates, beginning on or after January 1, 2020, and before January 1, 2025, the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
4. Requires, for purposes of the Personal Income Tax (PIT) Law, the housing sponsor to demonstrate that it will invest an amount in the project at least equal to the amount of credit allocated to it with respect to the allocation of a credit on or after January 1, 2020.
5. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets all of the following requirements:
   1. The building is at least 15 years old;
   2. The building is serving households of very low-income or extremely low-income such that the average maximum household income is not more than 45% of the area median gross income adjusted for household size, and the tax credit regulatory agreement is entered into for a period of not less than 55 years;
   3. It would have insufficient LIHTCs due to the building's low appraised value to complete substantial rehabilitation; and,
   4. The substantial rehabilitation will be complete with this 95% state LIHTC of the qualified basis.
6. Modifies the allocation of state LIHTCs that may be awarded to a federally subsidized low-income housing project receiving a federal 4% LIHTC as follows:
   1. A new qualified low-income building is eligible for a cumulative state LIHTC over four years of 50% of the qualified basis of the building; and,
   2. An existing qualified low-income housing building is eligible for a cumulative state LIHTC over four years of 13% of the qualified basis.
7. Makes technical changes to the definition of "at risk of conversion."
8. Defines "extremely low income households" as having the same meaning as in Health and Safety Code (H&SC) Section 50053.
9. Defines "very low income households" as having the same meaning as in H&SC Section 50053.
10. Includes members of a limited liability company within the definition of "taxpayer" and "housing sponsor."
11. Makes findings and declarations in compliance with Revenue and Taxation Code (R&TC) Section 41
12. Takes effect immediately as a tax levy.

EXISTING LAW:

1. Disallows, generally, losses from passive activities that exceed the income from passive activities for the current year. A taxpayer can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities.
2. Limits passive losses that an individual can take against nonpassive income for the LIHTC to $75,000.
3. Allows a state tax credit for costs related to construction, rehabilitation, or acquisition of low-income housing. This credit, which mirrors a federal LIHTC, may be used by taxpayers to offset the tax under the Personal Income Tax, the Corporation Tax, and the Insurance Tax laws.
4. Requires the TCAC to allocate each year the California LIHTC based upon qualifications of the applicant and proposed project. The California LIHTC is available only to projects that receive an allocation of the federal LIHTC.
5. Limits the annual aggregate amount of the state LIHTC to $70 million, as adjusted for an increase in the California consumer price index from 2002, plus any unused LIHTC for the preceding calendar year and any LIHTC returned in the calendar year. The state LIHTC awarded may be claimed as a credit against tax over a four-year period.
6. Requires that $500,000 of the LIHTC be set aside for farmworker housing developments and provides that the farmworker tax credit awards are not dependent on receiving a federal LIHTC.
7. Defines "farmworker housing" as housing in which at least 50% of the units are available to, and occupied by, farmworkers and their households. TCAC may permit an owner to temporarily house non-farmworkers in vacant units in the event of a disaster or other critical occurrence. However, such emergency shelter shall only be permitted if there are no pending qualified farmworker household applications for residency.
8. Allows federally-subsidized farmworker housing projects to receive a state LIHTC equal to 75% the qualified basis of the project. Additionally, farmworker housing projects that are built in high cost areas are allowed to receive a state LIHTC in excess of 100% of the qualified basis of the building.
9. Allows TCAC to award state LIHTCs to developments in a Qualified Census Tract (QCT) or a Difficult to Develop Area (DDA), if the project is also receiving a federal LIHTC, under the following conditions:
   1. The amount of state credit is computed on 100% of the qualified basis of the building; or,
   2. If the usage of at least 50% of the units in a low-income housing building is restricted to special needs households, the amount of an allowable state LIHTC may not exceed 30% of the eligible basis of the building.

FISCAL EFFECT: The Franchise Tax Board estimates that this bill will result in a General Fund revenue loss of $14 million in fiscal year (FY) 2019-20, $39 million in FY 2020-21, and $70 million in FY 2021-22.

COMMENTS:

1. The author has provided the following statement in support of this bill:

Changes made to the corporate tax law at the federal level will undercut the efforts we have made to address the affordable housing crisis facing our state.  As a result of the Trump tax plan California will lose 48,870 affordable rental homes, 55,230 jobs, $4.6 billion in business income, and $1.7 billion in local, state, and federal taxes.  Low income families will suffer the greatest from this loss.  In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units.  We need more resources at our disposal to increase the number of rental units for lower-income families.  Lack of affordability is fueling the rising number of people experiencing homelessness as more and more people pay over 50% of their household income on rent.  It's simply not sustainable.

AB 10 proposes a $500M increase to the state's affordable housing tax credit, an extremely successful program that in turn leverages another $1B in federal tax credits, local and private sector investments.  AB 10 also revises state law exempting state LIHTCs from the passive activity loss rules which could significantly increase the state LIHTC equity pricing.  This bill would expand the ability of individual tax payers to claim the LIHTC by eliminating the $75,000 cap on an individual tax payer's offset for passive rental real estate activities in computing taxable income.

1. Committee Staff Comments:
   1. LIHTC program: The LIHTC is an indirect federal subsidy developed in 1986 to incentivize the private development of affordable rental housing for low-income households. The federal LIHTC program replaced traditional housing tax incentives, such as accelerated depreciation, with a tax credit that enables low-income housing sponsors and developers to raise project equity through the allocation of tax benefits to investors. Each year, the Federal Government allocates funding to the states for LIHTCs on the basis of a per-resident formula. State or local housing authorities review proposals submitted by developers and select projects based on a variety of prescribed criteria. Only rental housing buildings, which are either undergoing rehabilitation or newly constructed, are eligible for the LIHTC programs. The federal law specifies that each state must designate a "housing credit agency" to administer the federal LIHTC program. In California, responsibility for administering the federal program is assigned to the California TCAC.

In 1987, the Legislature authorized a state LIHTC Program to augment the federal tax credit program. State tax credits can only be awarded to projects that have also received, or are concurrently receiving, an allocation of the federal LIHTCs. The amount of state LIHTC that may be annually allocated by TCAC is limited to $70 million, adjusted for inflation.

• 1. Credit percentages: Two types of federal tax credits are available: the 9% and 4% credits. These terms refer to the approximate percentage of a project's "qualified basis" a taxpayer may claim from his/her annual federal tax liability in each of the 10 years.
     1. 9% credit (70% subsidy): For projects that are not financed with a federal subsidy, the applicable rate is 9%. The 9% credit is generally reserved for new construction. Each year, a credit equal to roughly 9% of the project's qualified basis (cost of construction) may be claimed. Even though the credit is designated as the "9%" credit, it varies so that the value of the 10-year stream of credit is equal to a 70% subsidy of the qualified basis^[1]. Over time, the 9% credit has ranged between 7.89% and 9.27%.
     2. 4% credit (30% subsidy): The 4% credit is generally claimed for rehabilitation and new construction that is federally subsidized (including projects financed by more than 50% with tax-exempt bonds). Like the 9% credit, the actual credit rate of the 4% credit fluctuates over the 10-year period to deliver a present value subsidy equal to 30% of the project's qualified basis.
     3. 30% "basis boost": An additional subsidy is provided to incentivize investors to develop in DDAs and QCTs by providing a "basis boost" of 30% to help offset the higher cost of building affordable units in these difficult to develop areas. As such, a developer can claim the LIHTC for up to 130% of the project's total basis instead of 100%.
  2. California's augmentation: The California LIHTC can be claimed over four years instead of a 10-year federal allocation period, and the total amount of the state tax subsidy is roughly 30% of the qualified basis of a project that is not federally subsidized and 13% of the qualified basis of a project that is federally subsidized. Combining the federal 9% credit (70% subsidy) with a state credit (30% subsidy) generally provides a 100% subsidy of a project's eligible basis. Combining the federal 4% credit (30% subsidy) with a state credit (13% subsidy) only results in a subsidy of 43% of a project's eligible basis. As such, obtaining a 9% credit is extremely competitive.
  3. Farmworker Housing Assistance (FHA) Program: In 1996, the Legislature created the FHA Tax Credit Program and set aside $500,000 per year from the LIHTC allocation for farmworker housing projects. In an effort to streamline administration and make the farmworker program more user-friendly, SB 1247 (Lowenthal), Chapter 521, Statutes of 2008, eliminated the FHA Tax Credit Program as a separate program, consolidated it into the state LIHTC program, and established an annual set-aside of state LIHTCs for farmworker housing developments (Farmworker State Credits). TCAC receives a $500,000 farmworker state tax credit allocation each year, available for projects dedicating 50% of their affordable units to agricultural workers and their families. Beginning in 2016, TCAC regulations permitted applicants to request farmworker state credits through a non-competitive "over the counter" process. Recently enacted legislation has made the farmworker housing credits more attractive. Projects will be allowed to receive both the 130% federal basis boost and state credits, and the state credit percentage was increased.
  4. Is there a problem with the farmworker housing credit? According to the TCAC annual report, the total amount of state LIHTC available in 2017 was $76,285,716, plus $5,547,118 in Farmworker State Credits available for agricultural worker housing. Beginning in 2016, TCAC regulations permitted applicants to request Farmworker State Credits through a non-competitive, over-the-counter process. In 2017, two awards were made totaling nearly $3.4 million in farmworker state tax credits. Most recently, in 2018, $2.7 million in farmworker state tax credits were available, and one award for farmworker housing was made totaling nearly $2.6 million to a project located in Solano Beach, San Diego County. According to TCAC, recently enacted legislation, AB 571 (Garcia), makes the farmworker housing credit much more attractive. Going forward, projects only need to reserve 50% of units for farmworker families, projects will be allowed to receive both the 130% federal basis boost and state credits if built in high-cost areas, and the state credit percentage is increased to 75% of the qualified basis over four years.
  5. Housing shortage: According to a recent LAO report, California's home prices and rental prices are higher than just about anywhere else in the country^[2]. The average home price in California is $440,000 or about 2.5 times more expensive than the national average and the average monthly rent in California is about $1,240 or about 50% higher than the national average. Though several factors have led to California's high housing costs, the main driving force is a lack of new housing^[3]. In general, cities across the state, and particularly along the coast, are building fewer homes than people want. In order to mitigate the state's problem with housing affordability, the LAO estimates that California will have to at least double the number of units currently being built to prevent home prices from growing at a rate faster than the rest of the country. If California home and rental prices continue on this trend, those at the margin (i.e., those who currently earn just enough to purchase a home or rent an apartment within a desired location) will likely be pushed out of the market.
  6. Working against each other:  As noted above, the main driving force of high housing costs is a lack of new construction; why are new homes not being built?  Clearly, many families are willing to spend a large share of their income on housing so it seems odd that developers are seemingly not responding to economic signals by producing a greater number of housing units.  However, the inability to create new housing units may not necessarily be due to a developer's inability to assess consumer demand, but local governments' unwillingness to allow for new development.  According to the LAO, the main factor that inhibits developers from building new housing units is community resistance. In fact, more often than not, voters in California's coastal communities vote to limit housing development when given the option.  On average, coastal communities approve about five measures per year either limiting housing growth or rejecting new growth. Other factors that inhibit growth include the use of the California Environmental Quality Act as a tool to stop development and fiscal incentives to push local governments toward nonresidential development^[4].  Each of these decisions, which are made for the most part by local governments and individual residents, has the effect of preventing new construction.  Critics may therefore question the propriety of having the state provide funding, through a LIHTC, to reduce the cost of affordable housing that is directly made more expensive by the aggregate decisions of local governments.
  7. Funds for homeownership programs: Two years ago, the Legislature passed a package of bills to address the housing affordability crisis, which includes SB 3 (Beall), Chapter 365, Statutes of 2017, and the Veterans and Affordable Housing Bond Act of 2018, which was passed by the voters in November 2018. The bond includes a total of $450 million for homeownership programs. $150 million will go to the California Housing Finance Agency (CalHFA) for down-payment assistance for first-time homebuyers and $300 million for the CalHOME program to fund homeownership programs, including self-help mortgage assistance. SB 2 (Atkins), Chapter 364, Statutes of 2017, which creates a permanent funding source for affordable housing programs through a $75 recording fee on real estate documents (excluding those at the time of sale of a property), directs 70% of the funding in year two and beyond to locals to address affordable housing needs, including homeownership.
  8. Proposed solution: This bill increases state LIHTCs by $500 million; increases the set aside for the Farmworker Housing Tax credit to $25 million; and modifies the state credit percentages augmenting the federal 4% credit. This bill would effectively create two pots of money: the existing $70 million allocation that is adjusted for inflation and made available to both 4% and 9% credits, and this new $500 million fund that is only made available for 4% credit applications. If this bill were enacted, many projects receiving a federal 4% credit would apply to the new $500 million pot, which should free up additional funds in the current $70 million pot for 9% projects.

The changes will encourage greater utilization of the 4% credit. TCAC, in partnership with the California Debt Limit Allocation Committee, adopted a number of changes in the fall of 2015 intended to reduce costs and increase the amount of tax credits available to 4% projects. According to TCAC's 2016 annual report, "[c]oupled with positive market conditions, these changes have resulted in a historic increase in 4% tax credit projects and units newly constructed or rehabilitated. Whereas TCAC awarded 4% tax credits to 9,213 total units in 2014, TCAC provided 4% tax credits to 20,847 total units in 2016, an increase of 126% over two years." According to the most recent annual report, "in 2017, 4% credit awards decreased to 105 projects totaling $124.9 million from a record high in 2016 of 187 projects totaling $229.6 million." The trend reversed in 2018, and 135 projects received $214,395,831 that will produce 14,619 low-income units. Of the 135 projects awarded 4% federal tax credits in 2018, 6 received allocations of state credits totaling $17,122,027.

• 1. Value of federal LIHTC: A recent article by Novogradac & Company found that the Tax Cuts and Jobs Act will reduce California's affordable rental units by 48,870; lose 55,230 jobs; lose $4.6 billion in business income; and $1.7 billion in local, state, and federal taxes due to the reduction in the federal corporate tax rate^[5]. The federal reduction in the corporate tax rate from 35% to 21% has caused, according to Novogradac, the price of the federal LIHTC to drop from $1.03 in March 2016 to $0.89 in December of 2017^[6]. In general, it might seem odd to have taxpayers pay more than $1 for $1 in tax credit, but the benefit is actually greater than what the taxpayer pays because the taxpayer, in addition to utilizing the credit, is also allowed to take a loss for their investment once they exit the project. However, the price of the federal LIHTC is likely to stay below the $1 value since corporations no longer have the same need to offset tax liability due to the corporate tax rate going down from 35% to 21%.
  2. Value of state LIHTC: Unlike the federal LIHTC, the value of the state LIHTC will likely increase. In general, the state LIHTC equity pricing for allocated credits is inversely correlated to the investor's federal income tax rate because a reduction in state tax liability reduces the amount of the deduction a taxpayer can take at the federal level. As an example, assume a corporation pays $100,000 in state taxes. The cost of the $100,000 state liability will be offset by a deduction at the federal level. The value of the deduction is equal to the corporation's federal tax rate. Prior to the Tax Cuts and Jobs Act, the federal tax rate was set at 35%, allowing a corporation to save $35,000 at the federal level for their $100,000 state tax liability. As such, for every state LIHTC dollar, the taxpayer loses $1 in deduction at the federal level equal to their highest marginal tax rate. Now that the federal tax rate has decreased, the value of the state LIHTC will increase since the value of the lost federal deduction has been minimized.
  3. Eliminating the passive loss limit: Existing law generally disallows losses from passive activities that exceed the income from passive activities for the current year. A taxpayer can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities. As such, passive losses cannot be used to reduce active income. An exception to this general rule applies to individuals who actively participate in a passive rental real estate activity. These individuals can deduct up to $25,000 of losses from their nonpassive income at the federal level. For state purposes, the $25,000 limitation is increased to $75,000 for the state LIHTC. Because the limit functions as a deduction, a $75,000 deduction would be equal to about $7,500 worth of state LIHTC depending on the taxpayer's marginal tax rate. The $75,000 cap, according to supporters, has effectively limited the utilization of the LIHTC to corporations.

By removing the cap, supporters argue that the price of the state LIHTC will increase for a few reasons. First, opening up the LIHTC market to individual taxpayers creates new demand for state LIHTCs, pushing the price higher. Second, and more importantly, individuals are likely to pay a much higher price for state LIHTCs than corporations. As noted above, the delta between the value of the state LIHTC and the price currently paid by corporations will probably narrow because of the new lower federal tax rate. The value may still remain less than $1 since utilizing the state LIHTC still reduces the corporation's federal deduction. However, the game has changed under the PIT since the loss in federal deduction, especially for wealthy individuals, has effectively been eliminated because of the $10,000 cap on the state and local tax (SALT) deduction.

The $10,000 cap applies to state income tax. The federal tax liability paid by very wealthy individuals would therefore not be affected by the utilization of a state LIHTC since a reduction in the state tax liability would not impact their federal deduction, at least not until it falls below $10,000. As such, individual taxpayers may be willing to pay at least $1 for a state LIHTC and, in some cases, more than $1 because of the federal loss taken once an investor exits the partnership. In fact, supporters of this bill state that because individuals are no longer impacted by the federal deduction, and because investors can also take a federal loss after utilizing the state LIHTC, it is likely that individual investors will pay upwards of $1.20 for a state LIHTC, in part, because the price is now being subsidized by the federal government.

• 1. Will we ever get more than $1? In 2016, the Legislature provided authority for TCAC to "certificate" state low-income housing tax credits for reservations made between 2017 and 2019. With "certificated" state credits, the investor takes no ownership interest in the project partnership but rather buys the credits outright. Breaking the ownership link changes the federal tax treatment of the state credit. According to TCAC, because traditional credits reduce an investor's federal deductions and therefor increase the investor's federal tax liability, traditional credits had been worth only $0.74 to the investor. TCAC expects the price to increase to about $0.79 based on the new 21% federal corporate rate. Certificated credits do not reduce an investor's federal deductions. As a result, certificated credits are worth much closer to $1 to the investor. Unfortunately, the average price for a certificated credit, according to TCAC, is about $0.89, which is far lower than originally expected. According to TCAC, the lower price may be due to market turbulence and uncertainty related to the federal tax reform. Irrespective of why the certificated credits sold for less than expected, certificated credits brought in an additional $7 million in equity over the traditional credit in 2017, and an additional $2 million in 2018. Despite being worth more than the normal credit, a smaller percentage of projects elected to have their credits certificated in 2018 than they did in 2017. In 2018, 5 of 24 projects receiving state tax credit awards elected to certificate their credits versus 11 of 22 projects in 2017. As such, the benefits from certificated credits have not been as successful as expected.

Proponents of this bill hope that the elimination of the $75,000 will finally increase the price of a tax credit to at least equal a dollar, if not more. Like many of the prior changes made to the state's LIHTC program, expectations of meeting or exceeding the $1 threshold may not come to fruition. This bill, however, requires a housing sponsor to demonstrate that it will invest an amount in the project that is at least equal to the amount of the credit allocated to the housing sponsor under the PIT Law. This is meant to ensure that the amount received by the housing sponsor is not less than $1 for each credit.

• 1. Prioritize certificated credits: Despite the additional equity generated by certificated credits, a smaller percentage of projects in 2018 chose to have their credits certificated versus projects in 2017. The reduction in a company's federal tax liability means little since the investor can simply modify the price paid for either a normal credit or certificated credit. However, having the credits certificated means a lot to the project sponsor since it provides a larger sum money for development over traditional credits. As such, TCAC should prioritize projects that choose to have their credits certificated over projects that do not. Committee staff has been told that projects can be prioritized by TCAC without the need for legislation, but it is unclear how long such a change in regulation will take. According to TCAC's 2018 annual report, the average traditional credit sold for an average of $0.78 while the certificated credit sold for an average of $0.89 per dollar of credit. Assuming TCAC can prioritize projects that choose to have their credits certificated without legislation, this would bring in an additional $0.11 for every dollar of credit, which can translate into millions more for affordable housing.
  2. Financing structure: To raise funds for construction or rehabilitation of low-income housing buildings, the project developers or housing sponsors usually enter into various financing transactions with private entities. Investment partnerships are a primary source of equity financing for LIHTC projects. A typical arrangement is to match a corporate tax credit investor with a project developer or sponsor, creating a partnership (such as a general partnership or a LLC) where the investor is allocated the LIHTC in exchange for cash and the developer acts as a general partner (or managing member). The money that investors pay for the partnership interest is paid into the low-income housing project as equity financing. Although investors are buying an interest in a rental housing partnership, this process is commonly referred to as "buying" tax credits because they receive tax credits in return for their investment.
  3. Cost of financing LIHTC akin to credit card rates: As noted above, complicated structures are created whereby private investors buy LIHTCs. The price that investors are willing to pay for a credit, according to the most recent TCAC report, ranges anywhere between $0.78^[7] and $0.90. Over the years, the Legislature has repeatedly attempted to modify the state LIHTC program in an effort to make the program more efficient. Most recently, the state LIHTC was allowed to be certificated in an attempt to raise additional revenue. Despite efforts, the best price that sponsors are able to get in exchange for a LIHTC is $0.90 for a dollar of credit. This means that the state is paying a finance charge of anywhere between 10% and 22%, and in some cases more. In order to ensure that the entire credit is utilized for the construction of affordable housing, the Committee may want to directly appropriate funds to the housing sponsor, either all at once, or a percentage each year for four years.

If the state were to directly appropriate funds instead of providing a tax credit, millions more would be available for affordable housing construction. This would not eliminate the middle man associated with the sale of federal LIHTCs but it would make the state LIHTC much more efficient, and it would finally accomplish what many of the previous changes hoped to do. Supporters of the LIHTC may not want to have the funds appropriated since the Legislature could choose to not appropriate funds for any specific year. However, opponents of the current version of this bill would likely remove their opposition since it would no longer impact school funding as calculated by Proposition 98. Another option would be to provide a refundable tax credit for housing sponsors. Again, this would provide the housing sponsor with 100% of the value of the credit, though a refundable credit would likely not remove opposition.

• 1. Tax shelters for good causes: A tax shelter is a partnership or other investment arrangement designed to assist the investor minimize federal income tax liability. An entity such as a limited partnership invests in a transaction expected to generate more than $1 in tax savings for every $1 invested. Tax credits, such as the LIHTC, generate savings by allowing investors to subtract the credit amount directly from their tax liability, and the tax savings can exceed the actual equity invested by the taxpayer. Tax incentive programs have been controversial. Many tax incentives created to increase social welfare have been abused by individuals seeking to shelter their own income and thereby reduce their tax liability. As one critic, Paul McDaniel, commented, "One problem is that every time Congress enacts a tax preference for a particular industry or economic activity, a highly skilled band of tax and financial advisors with a battery of computers is ready and able to convert that provision into a tax shelter for their high-bracket clients.^[8]" Tax shelters were so controversial that tax advocates of the 1986 tax reform made the elimination of the tax shelters a top priority, enacting new rules on passive losses and modifying depreciation schedules for real estate. This bill proposes to eliminate this longstanding rule of limiting the use of passive losses to offset nonpassive income so that individual investors can also take advantage of this tax shelter.
  2. What is a "Tax Expenditure"? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, United States Treasury officials began arguing that these features of the tax law should be referred to as "expenditures," since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each of them (in the form of forgone revenues). This bill would expand the existing LIHTC tax expenditure program.
  3. Committee’s Tax Expenditure Policy: SB 1335 (Leno), Chapter 845, Statutes of 2014, added R&TC Section 41, which recognized that the Legislature should apply the same level of review used for government spending programs to tax credits introduced on or after January 1, 2015. This Committee has recently adopted a new policy, requiring that all new tax expenditure proposals comply with the requirements of R&TC Section 41. A tax expenditure proposal must outline specific goals, purposes, and objectives that the tax expenditure will achieve, along with detailed performance indicators for the Legislature to use when measuring whether the tax expenditure meets those stated goals, purposes, and objectives. A tax expenditure bill will not be eligible for a Committee vote unless it has complied with these requirements. In addition to the R&TC Section 41 requirements, this Committee's policy also requires that all tax expenditure proposals contain an appropriate sunset provision to be eligible for a vote. According to the new policy, an "appropriate sunset provision" shall mean five years, except in the case of a tax expenditure measure providing relief to California veterans, in which case "appropriate sunset provision" shall mean ten years. This bill complies with all of these requirements.
  4. Double-referral: This bill was heard in the Assembly Committee on Housing and Community Development on March 27, 2019, and passed that Committee with a vote of 8 to 0.

REGISTERED SUPPORT / OPPOSITION:

Support

None on file

Opposition

None on file

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098

1. Assuming the credit is actually 9% per year, the developer will receive 90% of the total cost of the project's basis. The present value, however, will be roughly 70% of the eligible basis because money today is worth more than money in the future. ↑

2. California's High Housing Costs, March 17, 2015. ↑

3. Id at 10. ↑

4. Id at 15. ↑

5. Michael Novogradac, See How Many Jobs, Affordable Rental Homes Each State Would Lose under the Final Tax Reform Bill, December 20, 2017. ↑

6. Kevin Wilson, How Recent Tax Law Changes May Affect State LIHTCs, ↑

7. The annual report states that the average traditional state credit price was $0.78. A range for the price was not provided, but because this figure is an average, it can be assumed that some of the credits sold for less than $0.78. ↑

8. Janet Stearns, The Low-Income Housing Tax Credit: A Poor Solution to the Housing Crisis, Yale Law & Policy Review, 1988 ↑

Date of Hearing: April 29, 2019

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Autumn R. Burke, Chairwoman

ABPCA Bill Id:AB 10 (

Author:Chiu) – As Introduced Ver:December 3, 2018

FOR TESTIMONY ONLY

Majority vote. Tax levy. Fiscal committee.

SUBJECT: Income taxes: credits: low-income housing: farmworker housing

SUMMARY: Increases the state Low-Income Housing Tax Credit (LIHTC) by $500 million, increases the set aside for the farmworker housing tax credit from $500,000 to $25 million, and modifies the LIHTC, as specified. Specifically, this bill:

1. Beginning in 2020 and each calendar year thereafter, increases the amount of state LIHTC by an additional $500 million, as adjusted for inflation beginning in 2021. The additional $500 million is not available to a new qualified low-income housing building that receives a federal 9% credit.
2. Beginning in 2020, increases the amount of LIHTCs set aside for farmworker housing from $500,000 to $25 million. Amounts that are unallocated or returned shall be added back to the $500 million increase that may be allocated by the Tax Credit Allocation Committee (TCAC) to projects that do not receive a 9% credit.
3. Eliminates the dollar limitation of $75,000, related to the offset of passive activity losses for rental real estate activities, if the taxpayer actively participated in the real estate activities.
4. Requires, for purposes of the Personal Income Tax (PIT) Law, the housing sponsor to demonstrate that it will invest an amount in the project at least equal to the amount of credit allocated to it with respect to the allocation of a credit on or after January 1, 2020.
5. Allows a qualified low-income building to be eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets all of the following requirements:
   1. The building is at least 15 years old;
   2. The building is serving households of very low-income or extremely low-income such that the average maximum household income is not more than 45% of the area median gross income adjusted for household size, and the tax credit regulatory agreement is entered into for a period of not less than 55 years;
   3. It would have insufficient LIHTCs due to the building's low appraised value to complete substantial rehabilitation; and,
   4. The substantial rehabilitation will be complete with this 95% state LIHTC of the qualified basis.
6. Modifies the allocation of state LIHTCs that may be awarded to a federally subsidized low-income housing project receiving a federal 4% LIHTC as follows:
   1. A new qualified low-income building is eligible for a cumulative state LIHTC over four years of 50% of the qualified basis of the building; and,
   2. An existing qualified low-income housing building is eligible for a cumulative state LIHTC over four years of 13% of the qualified basis.
7. Makes technical changes to the definition of "at risk of conversion."
8. Defines "extremely low income households" as having the same meaning as in Health and Safety Code (H&SC) Section 50053.
9. Defines "very low income households" as having the same meaning as in H&SC Section 50053.
10. Includes members of a limited liability company within the definition of "taxpayer" and "housing sponsor."
11. Takes effect immediately as a tax levy.

EXISTING LAW:

1. Disallows, generally, losses from passive activities that exceed the income from passive activities for the current year. A taxpayer can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities.
2. Limits passive losses that an individual can take against nonpassive income for the LIHTC to $75,000.
3. Allows a state tax credit for costs related to construction, rehabilitation, or acquisition of low-income housing. This credit, which mirrors a federal LIHTC, may be used by taxpayers to offset the tax under the Personal Income Tax, the Corporation Tax, and the Insurance Tax laws.
4. Requires the TCAC to allocate each year the California LIHTC based upon qualifications of the applicant and proposed project. The California LIHTC is available only to projects that receive an allocation of the federal LIHTC.
5. Limits the annual aggregate amount of the state LIHTC to $70 million, as adjusted for an increase in the California consumer price index from 2002, plus any unused LIHTC for the preceding calendar year and any LIHTC returned in the calendar year. The state LIHTC awarded may be claimed as a credit against tax over a four-year period.
6. Requires that $500,000 of the LIHTC be set aside for farmworker housing developments and provides that the farmworker tax credit awards are not dependent on receiving a federal LIHTC.
7. Defines "farmworker housing" as housing in which at least 50% of the units are available to, and occupied by, farmworkers and their households. TCAC may permit an owner to temporarily house non-farmworkers in vacant units in the event of a disaster or other critical occurrence. However, such emergency shelter shall only be permitted if there are no pending qualified farmworker household applications for residency.
8. Allows federally-subsidized farmworker housing projects to receive a state LIHTC equal to 75% the qualified basis of the project. Additionally, farmworker housing projects that are built in high cost areas are allowed to receive a state LIHTC in excess of 100% of the qualified basis of the building.
9. Allows TCAC to award state LIHTCs to developments in a Qualified Census Tract (QCT) or a Difficult to Develop Area (DDA), if the project is also receiving a federal LIHTC, under the following conditions:
   1. The amount of state credit is computed on 100% of the qualified basis of the building; or,
   2. If the usage of at least 50% of the units in a low-income housing building is restricted to special needs households, the amount of an allowable state LIHTC may not exceed 30% of the eligible basis of the building.

FISCAL EFFECT: The Franchise Tax Board estimates that this bill will result in a General Fund revenue loss of $14 million in fiscal year (FY) 2019-20, $39 million in FY 2020-21, and $70 million in FY 2021-22.

COMMENTS:

1. The author has provided the following statement in support of this bill:

Changes made to the corporate tax law at the federal level will undercut the efforts we have made to address the affordable housing crisis facing our state.  As a result of the Trump tax plan California will lose 48,870 affordable rental homes, 55,230 jobs, $4.6 billion in business income, and $1.7 billion in local, state, and federal taxes.  Low income families will suffer the greatest from this loss.  In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units.  We need more resources at our disposal to increase the number of rental units for lower-income families.  Lack of affordability is fueling the rising number of people experiencing homelessness as more and more people pay over 50% of their household income on rent.  It's simply not sustainable.

AB 10 proposes a $500M increase to the state's affordable housing tax credit, an extremely successful program that in turn leverages another $1B in federal tax credits, local and private sector investments.  AB 10 also revises state law exempting state LIHTCs from the passive activity loss rules which could significantly increase the state LIHTC equity pricing.  This bill would expand the ability of individual tax payers to claim the LIHTC by eliminating the $75,000 cap on an individual tax payer's offset for passive rental real estate activities in computing taxable income.

1. Supporters state that this bill "will expand the successful state [LIHTC] Program by $500 million annually, leveraging an additional $2 billion in federal funds to build more than 5,000 affordable homes each year. Combined, the federal and state tax credit programs are powerful housing production programs because they incentivize private investment and generate the up-front dollars needed to get affordable housing developments off the ground. AB 10 builds on the successful track record of these programs in California, which have produced or preserved more than 300,000 homes, created 340,000 jobs, and generated $32.33 billion in local income and $12.73 billion in tax revenues in California since 1986."
2. Opponents of this bill in no way oppose the creation of farmworker housing but do not support diverting funding from public education for this purpose, particularly since 58.7% of California's students participate in the free and reduced lunch program due to their family's economic status. According to the California Teachers Association (CTA), "[d]uring the recession, California's schools lost $65 billion in funding due to budget cuts and the suspension of Proposition 98. Our schools have never recovered. Creating additional programs, despite a meritorious policy goal, would not be prudent without a comprehensive assessment of all existing tax credits to justify the continued reduction in school funding." Furthermore, "California schools are being severely underfunded for special education and transportation. They cannot provide adequate numbers of guidance counselors, librarians and nurses. They are 50th in the nation in the teacher to student ratio. All of these factors are reasons why CTA believes California must refrain from diverting additional funding from schools prior to a review and justification of the current tax credits, as well as a greater discussion of the impact new tax credits will have to education funding. This review will ensure all tax credits are fulfilling their purpose to provide economic benefit for California."
3. Committee Staff Comments:
   1. LIHTC program: The LIHTC is an indirect federal subsidy developed in 1986 to incentivize the private development of affordable rental housing for low-income households. The federal LIHTC program replaced traditional housing tax incentives, such as accelerated depreciation, with a tax credit that enables low-income housing sponsors and developers to raise project equity through the allocation of tax benefits to investors. Each year, the Federal Government allocates funding to the states for LIHTCs on the basis of a per-resident formula. State or local housing authorities review proposals submitted by developers and select projects based on a variety of prescribed criteria. Only rental housing buildings, which are either undergoing rehabilitation or newly constructed, are eligible for the LIHTC programs. The federal law specifies that each state must designate a "housing credit agency" to administer the federal LIHTC program. In California, responsibility for administering the federal program is assigned to the California TCAC.

In 1987, the Legislature authorized a state LIHTC Program to augment the federal tax credit program. State tax credits can only be awarded to projects that have also received, or are concurrently receiving, an allocation of the federal LIHTCs. The amount of state LIHTC that may be annually allocated by TCAC is limited to $70 million, adjusted for inflation.

• 1. Credit percentages: Two types of federal tax credits are available: the 9% and 4% credits. These terms refer to the approximate percentage of a project's "qualified basis" a taxpayer may claim from his/her annual federal tax liability in each of the 10 years.
     1. 9% credit (70% subsidy): For projects that are not financed with a federal subsidy, the applicable rate is 9%. The 9% credit is generally reserved for new construction. Each year, a credit equal to roughly 9% of the project's qualified basis (cost of construction) may be claimed. Even though the credit is designated as the "9%" credit, it varies so that the value of the 10-year stream of credit is equal to a 70% subsidy of the qualified basis^[1]. Over time, the 9% credit has ranged between 7.89% and 9.27%.
     2. 4% credit (30% subsidy): The 4% credit is generally claimed for rehabilitation and new construction that is federally subsidized (including projects financed by more than 50% with tax-exempt bonds). Like the 9% credit, the actual credit rate of the 4% credit fluctuates over the 10-year period to deliver a present value subsidy equal to 30% of the project's qualified basis.
     3. 30% "basis boost": An additional subsidy is provided to incentivize investors to develop in DDAs and QCTs by providing a "basis boost" of 30% to help offset the higher cost of building affordable units in these difficult to develop areas. As such, a developer can claim the LIHTC for up to 130% of the project's total basis instead of 100%.
  2. California's augmentation: The California LIHTC can be claimed over four years instead of a 10-year federal allocation period, and the total amount of the state tax subsidy is roughly 30% of the qualified basis of a project that is not federally subsidized and 13% of the qualified basis of a project that is federally subsidized. Combining the federal 9% credit (70% subsidy) with a state credit (30% subsidy) generally provides a 100% subsidy of a project's eligible basis. Combining the federal 4% credit (30% subsidy) with a state credit (13% subsidy) only results in a subsidy of 43% of a project's eligible basis. As such, obtaining a 9% credit is extremely competitive.
  3. Farmworker Housing Assistance (FHA) Program: In 1996, the Legislature created the FHA Tax Credit Program and set aside $500,000 per year from the LIHTC allocation for farmworker housing projects. In an effort to streamline administration and make the farmworker program more user-friendly, SB 1247 (Lowenthal), Chapter 521, Statutes of 2008, eliminated the FHA Tax Credit Program as a separate program, consolidated it into the state LIHTC program, and established an annual set-aside of state LIHTCs for farmworker housing developments (Farmworker State Credits). TCAC receives a $500,000 farmworker state tax credit allocation each year, available for projects dedicating 50% of their affordable units to agricultural workers and their families. Beginning in 2016, TCAC regulations permitted applicants to request farmworker state credits through a non-competitive "over the counter" process. Recently enacted legislation has made the farmworker housing credits more attractive. Projects will be allowed to receive both the 130% federal basis boost and state credits, and the state credit percentage was increased.
  4. Is there a problem with the farmworker housing credit? According to the TCAC annual report, the total amount of state LIHTC available in 2017 was $76,285,716, plus $5,547,118 in Farmworker State Credits available for agricultural worker housing. Beginning in 2016, TCAC regulations permitted applicants to request Farmworker State Credits through a non-competitive, over-the-counter process. In 2017, two awards were made totaling nearly $3.4 million in farmworker state tax credits. Most recently, in 2018, $2.7 million in farmworker state tax credits were available, and one award for farmworker housing was made totaling nearly $2.6 million to a project located in Solano Beach, San Diego County. According to TCAC, recently enacted legislation, AB 571 (Garcia), makes the farmworker housing credit much more attractive. Going forward, projects only need to reserve 50% of units for farmworker families, projects will be allowed to receive both the 130% federal basis boost and state credits if built in high-cost areas, and the state credit percentage is increased to 75% of the qualified basis over four years.
  5. Housing shortage: According to a recent LAO report, California's home prices and rental prices are higher than just about anywhere else in the country^[2]. The average home price in California is $440,000 or about 2.5 times more expensive than the national average and the average monthly rent in California is about $1,240 or about 50% higher than the national average. Though several factors have led to California's high housing costs, the main driving force is a lack of new housing^[3]. In general, cities across the state, and particularly along the coast, are building fewer homes than people want. In order to mitigate the state's problem with housing affordability, the LAO estimates that California will have to at least double the number of units currently being built to prevent home prices from growing at a rate faster than the rest of the country. If California home and rental prices continue on this trend, those at the margin (i.e., those who currently earn just enough to purchase a home or rent an apartment within a desired location) will likely be pushed out of the market.
  6. Working against each other:  As noted above, the main driving force of high housing costs is a lack of new construction; why are new homes not being built?  Clearly, many families are willing to spend a large share of their income on housing so it seems odd that developers are seemingly not responding to economic signals by producing a greater number of housing units.  However, the inability to create new housing units may not necessarily be due to a developer's inability to assess consumer demand, but local governments' unwillingness to allow for new development.  According to the LAO, the main factor that inhibits developers from building new housing units is community resistance. In fact, more often than not, voters in California's coastal communities vote to limit housing development when given the option.  On average, coastal communities approve about five measures per year either limiting housing growth or rejecting new growth. Other factors that inhibit growth include the use of the California Environmental Quality Act as a tool to stop development and fiscal incentives to push local governments toward nonresidential development^[4].  Each of these decisions, which are made for the most part by local governments and individual residents, has the effect of preventing new construction.  Critics may therefore question the propriety of having the state provide funding, through a LIHTC, to reduce the cost of affordable housing that is directly made more expensive by the aggregate decisions of local governments.
  7. Funds for homeownership programs: Two years ago, the Legislature passed a package of bills to address the housing affordability crisis, which includes SB 3 (Beall), Chapter 365, Statutes of 2017, and the Veterans and Affordable Housing Bond Act of 2018, which was passed by the voters in November 2018. The bond includes a total of $450 million for homeownership programs. $150 million will go to the California Housing Finance Agency (CalHFA) for down-payment assistance for first-time homebuyers and $300 million for the CalHOME program to fund homeownership programs, including self-help mortgage assistance. SB 2 (Atkins), Chapter 364, Statutes of 2017, which creates a permanent funding source for affordable housing programs through a $75 recording fee on real estate documents (excluding those at the time of sale of a property), directs 70% of the funding in year two and beyond to locals to address affordable housing needs, including homeownership.
  8. Proposed solution: This bill increases state LIHTCs by $500 million; increases the set aside for the Farmworker Housing Tax credit to $25 million; and modifies the state credit percentages augmenting the federal 4% credit. This bill would effectively create two pots of money: the existing $70 million allocation that is adjusted for inflation and made available to both 4% and 9% credits, and this new $500 million fund that is only made available for 4% credit applications. If this bill were enacted, many projects receiving a federal 4% credit would apply to the new $500 million pot, which should free up additional funds in the current $70 million pot for 9% projects.

The changes will encourage greater utilization of the 4% credit. TCAC, in partnership with the California Debt Limit Allocation Committee, adopted a number of changes in the fall of 2015 intended to reduce costs and increase the amount of tax credits available to 4% projects. According to TCAC's 2016 annual report, "[c]oupled with positive market conditions, these changes have resulted in a historic increase in 4% tax credit projects and units newly constructed or rehabilitated. Whereas TCAC awarded 4% tax credits to 9,213 total units in 2014, TCAC provided 4% tax credits to 20,847 total units in 2016, an increase of 126% over two years." According to the most recent annual report, "in 2017, 4% credit awards decreased to 105 projects totaling $124.9 million from a record high in 2016 of 187 projects totaling $229.6 million." The trend reversed in 2018, and 135 projects received $214,395,831 that will produce 14,619 low-income units. Of the 135 projects awarded 4% federal tax credits in 2018, 6 received allocations of state credits totaling $17,122,027.

• 1. Value of federal LIHTC: A recent article by Novogradac & Company found that the Tax Cuts and Jobs Act will reduce California's affordable rental units by 48,870; lose 55,230 jobs; lose $4.6 billion in business income; and $1.7 billion in local, state, and federal taxes due to the reduction in the federal corporate tax rate^[5]. The federal reduction in the corporate tax rate from 35% to 21% has caused, according to Novogradac, the price of the federal LIHTC to drop from $1.03 in March 2016 to $0.89 in December of 2017^[6]. In general, it might seem odd to have taxpayers pay more than $1 for $1 in tax credit, but the benefit is actually greater than what the taxpayer pays because the taxpayer, in addition to utilizing the credit, is also allowed to take a loss for their investment once they exit the project. However, the price of the federal LIHTC is likely to stay below the $1 value since corporations no longer have the same need to offset tax liability due to the corporate tax rate going down from 35% to 21%.
  2. Value of state LIHTC: Unlike the federal LIHTC, the value of the state LIHTC will likely increase. In general, the state LIHTC equity pricing for allocated credits is inversely correlated to the investor's federal income tax rate because a reduction in state tax liability reduces the amount of the deduction a taxpayer can take at the federal level. As an example, assume a corporation pays $100,000 in state taxes. The cost of the $100,000 state liability will be offset by a deduction at the federal level. The value of the deduction is equal to the corporation's federal tax rate. Prior to the Tax Cuts and Jobs Act, the federal tax rate was set at 35%, allowing a corporation to save $35,000 at the federal level for their $100,000 state tax liability. As such, for every state LIHTC dollar, the taxpayer loses $1 in deduction at the federal level equal to their highest marginal tax rate. Now that the federal tax rate has decreased, the value of the state LIHTC will increase since the value of the lost federal deduction has been minimized.
  3. Eliminating the passive loss limit: Existing law generally disallows losses from passive activities that exceed the income from passive activities for the current year. A taxpayer can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities. As such, passive losses cannot be used to reduce active income. An exception to this general rule applies to individuals who actively participate in a passive rental real estate activity. These individuals can deduct up to $25,000 of losses from their nonpassive income at the federal level. For state purposes, the $25,000 limitation is increased to $75,000 for the state LIHTC. Because the limit functions as a deduction, a $75,000 deduction would be equal to about $7,500 worth of state LIHTC depending on the taxpayer's marginal tax rate. The $75,000 cap, according to supporters, has effectively limited the utilization of the LIHTC to corporations.

By removing the cap, supporters argue that the price of the state LIHTC will increase for a few reasons. First, opening up the LIHTC market to individual taxpayers creates new demand for state LIHTCs, pushing the price higher. Second, and more importantly, individuals are likely to pay a much higher price for state LIHTCs than corporations. As noted above, the delta between the value of the state LIHTC and the price currently paid by corporations will probably narrow because of the new lower federal tax rate. The value may still remain less than $1 since utilizing the state LIHTC still reduces the corporation's federal deduction. However, the game has changed under the PIT since the loss in federal deduction, especially for wealthy individuals, has effectively been eliminated because of the $10,000 cap on the state and local tax (SALT) deduction.

The $10,000 cap applies to state income tax. The federal tax liability paid by very wealthy individuals would therefore not be affected by the utilization of a state LIHTC since a reduction in the state tax liability would not impact their federal deduction, at least not until it falls below $10,000. As such, individual taxpayers may be willing to pay at least $1 for a state LIHTC and, in some cases, more than $1 because of the federal loss taken once an investor exits the partnership. In fact, supporters of this bill state that because individuals are no longer impacted by the federal deduction, and because investors can also take a federal loss after utilizing the state LIHTC, it is likely that individual investors will pay upwards of $1.20 for a state LIHTC, in part, because the price is now being subsidized by the federal government.

• 1. Will we ever get more than $1? In 2016, the Legislature provided authority for TCAC to "certificate" state low-income housing tax credits for reservations made between 2017 and 2019. With "certificated" state credits, the investor takes no ownership interest in the project partnership but rather buys the credits outright. Breaking the ownership link changes the federal tax treatment of the state credit. According to TCAC, because traditional credits reduce an investor's federal deductions and therefor increase the investor's federal tax liability, traditional credits had been worth only $0.74 to the investor. TCAC expects the price to increase to about $0.79 based on the new 21% federal corporate rate. Certificated credits do not reduce an investor's federal deductions. As a result, certificated credits are worth much closer to $1 to the investor. Unfortunately, the average price for a certificated credit, according to TCAC, is about $0.89, which is far lower than originally expected. According to TCAC, the lower price may be due to market turbulence and uncertainty related to the federal tax reform. Irrespective of why the certificated credits sold for less than expected, certificated credits brought in an additional $7 million in equity over the traditional credit in 2017, and an additional $2 million in 2018. Despite being worth more than the normal credit, a smaller percentage of projects elected to have their credits certificated in 2018 than they did in 2017. In 2018, 5 of 24 projects receiving state tax credit awards elected to certificate their credits versus 11 of 22 projects in 2017. As such, the benefits from certificated credits have not been as successful as expected.

Proponents of this bill hope that the elimination of the $75,000 will finally increase the price of a tax credit to at least equal a dollar, if not more. Like many of the prior changes made to the state's LIHTC program, expectations of meeting or exceeding the $1 threshold may not come to fruition. This bill, however, requires a housing sponsor to demonstrate that it will invest an amount in the project that is at least equal to the amount of the credit allocated to the housing sponsor under the PIT Law. This is meant to ensure that the amount received by the housing sponsor is not less than $1 for each credit.

• 1. Prioritize certificated credits: Despite the additional equity generated by certificated credits, a smaller percentage of projects in 2018 chose to have their credits certificated versus projects in 2017. The reduction in a company's federal tax liability means little since the investor can simply modify the price paid for either a normal credit or certificated credit. However, having the credits certificated means a lot to the project sponsor since it provides a larger sum money for development over traditional credits. As such, TCAC should prioritize projects that choose to have their credits certificated over projects that do not. Committee staff has been told that projects can be prioritized by TCAC without the need for legislation, but it is unclear how long such a change in regulation will take. According to TCAC's 2018 annual report, the average traditional credit sold for an average of $0.78 while the certificated credit sold for an average of $0.89 per dollar of credit. Assuming TCAC can prioritize projects that choose to have their credits certificated without legislation, this would bring in an additional $0.11 for every dollar of credit, which can translate into millions more for affordable housing.
  2. Financing structure: To raise funds for construction or rehabilitation of low-income housing buildings, the project developers or housing sponsors usually enter into various financing transactions with private entities. Investment partnerships are a primary source of equity financing for LIHTC projects. A typical arrangement is to match a corporate tax credit investor with a project developer or sponsor, creating a partnership (such as a general partnership or a LLC) where the investor is allocated the LIHTC in exchange for cash and the developer acts as a general partner (or managing member). The money that investors pay for the partnership interest is paid into the low-income housing project as equity financing. Although investors are buying an interest in a rental housing partnership, this process is commonly referred to as "buying" tax credits because they receive tax credits in return for their investment.
  3. Cost of financing LIHTC akin to credit card rates: As noted above, complicated structures are created whereby private investors buy LIHTCs. The price that investors are willing to pay for a credit, according to the most recent TCAC report, ranges anywhere between $0.78^[7] and $0.90. Over the years, the Legislature has repeatedly attempted to modify the state LIHTC program in an effort to make the program more efficient. Most recently, the state LIHTC was allowed to be certificated in an attempt to raise additional revenue. Despite efforts, the best price that sponsors are able to get in exchange for a LIHTC is $0.90 for a dollar of credit. This means that the state is paying a finance charge of anywhere between 10% and 22%, and in some cases more. In order to ensure that the entire credit is utilized for the construction of affordable housing, the Committee may want to directly appropriate funds to the housing sponsor, either all at once, or a percentage each year for four years.

If the state were to directly appropriate funds instead of providing a tax credit, millions more would be available for affordable housing construction. This would not eliminate the middle man associated with the sale of federal LIHTCs but it would make the state LIHTC much more efficient, and it would finally accomplish what many of the previous changes hoped to do. Supporters of the LIHTC may not want to have the funds appropriated since the Legislature could choose to not appropriate funds for any specific year. However, opponents of the current version of this bill would likely remove their opposition since it would no longer impact school funding as calculated by Proposition 98. Another option would be to provide a refundable tax credit for housing sponsors. Again, this would provide the housing sponsor with 100% of the value of the credit, though a refundable credit would likely not remove opposition.

• 1. Tax shelters for good causes: A tax shelter is a partnership or other investment arrangement designed to assist the investor minimize federal income tax liability. An entity such as a limited partnership invests in a transaction expected to generate more than $1 in tax savings for every $1 invested. Tax credits, such as the LIHTC, generate savings by allowing investors to subtract the credit amount directly from their tax liability, and the tax savings can exceed the actual equity invested by the taxpayer. Tax incentive programs have been controversial. Many tax incentives created to increase social welfare have been abused by individuals seeking to shelter their own income and thereby reduce their tax liability. As one critic, Paul McDaniel, commented, "One problem is that every time Congress enacts a tax preference for a particular industry or economic activity, a highly skilled band of tax and financial advisors with a battery of computers is ready and able to convert that provision into a tax shelter for their high-bracket clients.^[8]" Tax shelters were so controversial that tax advocates of the 1986 tax reform made the elimination of the tax shelters a top priority, enacting new rules on passive losses and modifying depreciation schedules for real estate. This bill proposes to eliminate this longstanding rule of limiting the use of passive losses to offset nonpassive income so that individual investors can also take advantage of this tax shelter.
  2. What is a "Tax Expenditure"? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, United States Treasury officials began arguing that these features of the tax law should be referred to as "expenditures," since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each of them (in the form of forgone revenues). This bill would expand the existing LIHTC tax expenditure program.
  3. Committee’s Tax Expenditure Policy: SB 1335 (Leno), Chapter 845, Statutes of 2014, added Revenue and Taxation Code (R&TC) Section 41, which recognized that the Legislature should apply the same level of review used for government spending programs to tax credits introduced on or after January 1, 2015. This Committee has recently adopted a new policy, requiring that all new tax expenditure proposals comply with the requirements of R&TC Section 41. A tax expenditure proposal must outline specific goals, purposes, and objectives that the tax expenditure will achieve, along with detailed performance indicators for the Legislature to use when measuring whether the tax expenditure meets those stated goals, purposes, and objectives. A tax expenditure bill will not be eligible for a Committee vote unless it has complied with these requirements.

In addition to the R&TC Section 41 requirements, this Committee's policy also requires that all tax expenditure proposals contain an appropriate sunset provision to be eligible for a vote. According to the new policy, an "appropriate sunset provision" shall mean five years, except in the case of a tax expenditure measure providing relief to California veterans, in which case "appropriate sunset provision" shall mean ten years. This bill, as currently drafted, does not contain Section 41 requirements and does not contain an appropriate sunset provision.

• 1. Double-referral: This bill was heard in the Assembly Committee on Housing and Community Development on March 27, 2019, and passed that Committee with a vote of 8 to 0.

REGISTERED SUPPORT / OPPOSITION:

Support

California Asian Pacific Islander Chamber of Commerce

California Coalition for Rural Housing

California Housing Consortium

California Housing Partnership

California YIMBY

California State Association of Counties

California State Treasurer

Corporation for Supportive Housing

County of Santa Clara

East Bay Asian Local Development Corporation

LeadingAge California

League of California Community Foundations

The League of Women Voters of California

National Association of Social Workers, California Chapter

Southern California Association of Governments

Silicon Valley at Home

Opposition

California Teachers Association

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098

1. Assuming the credit is actually 9% per year, the developer will receive 90% of the total cost of the project's basis. The present value, however, will be roughly 70% of the eligible basis because money today is worth more than money in the future. ↑

2. California's High Housing Costs, March 17, 2015. ↑

3. Id at 10. ↑

4. Id at 15. ↑

5. Michael Novogradac, See How Many Jobs, Affordable Rental Homes Each State Would Lose under the Final Tax Reform Bill, December 20, 2017. ↑

6. Kevin Wilson, How Recent Tax Law Changes May Affect State LIHTCs, ↑

7. The annual report states that the average traditional state credit price was $0.78. A range for the price was not provided, but because this figure is an average, it can be assumed that some of the credits sold for less than $0.78. ↑

8. Janet Stearns, The Low-Income Housing Tax Credit: A Poor Solution to the Housing Crisis, Yale Law & Policy Review, 1988 ↑

Date of Hearing: March 27, 2019

ASSEMBLY COMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT

David Chiu, Chair

ABPCA Bill Id:AB 10 (

Author:Chiu) – As Introduced Ver:December 3, 2018

SUBJECT: Income taxes: credits low-income housing: farmworker housing

SUMMARY: Increases the state Low-Income Housing Tax Credit (LIHTC) Program by $500 million and eliminates the cap on the amount of LIHTC that individual tax payers claim in a taxable year. Specifically, this bill:

1. Provides that the dollar limitation of $75,000 for the offset for rental real estate activities for an individual tax payer in computing taxable income does not apply to the LIHTC.
2. Sets the price of the state LIHTC at $1 for individual investors utilizing passive losses above the $75,000 cap.
3. Beginning in 2019 and each calendar year thereafter, increases the amount of state LIHTC by an additional $500 million, as adjusted for inflation. The additional $500 million is not available to a new qualified low-income housing building that receives a federal 9% credit.
4. Beginning in 2019, increases the amount of LIHTCs set aside for farmworker housing from $500,000 to $25 million. Amounts that are unallocated or returned shall be added to the total aggregate amount that may be allocated by the Tax Credit Allocation Committee (TCAC).
5. Eliminates the provision allowing TCAC to swap state LIHTCs for federal LIHTCs for buildings located in a Difficult to Develop Area (DDA) or a Qualified Census Tract (QCT) provided that the amount of the credit is computed on 100% of the qualified basis.
6. Eliminates the provision allowing state LIHTCs to be provided to qualified low-income housing projects in a DDA or QCT that are restricted to having 50% of occupants be special needs households.
7. Modifies the allocation of state LIHTCs that may be awarded to a federally subsidized low-income housing project receiving a federal 4% LIHTC as follows:
   1. A new qualified low-income housing building is eligible for a cumulative state LIHTC over four years of 50% of the qualified basis of the building, provided that the building is not located in a DDA or a QCT.
   2. An existing qualified low-income housing building that is not located in a DDA or QCT is eligible for a cumulative state LIHTC over four years of 13% of the qualified basis.
8. Requires TCAC to ensure that an increase in the basis boost due to a project being located in a DDA or QCT does not cause the state LIHTC to exceed 50% of the qualified basis for a new low-income housing building and 13% for an existing low-income housing building.
   1. A qualified low-income housing building is eligible for a cumulative state LIHTC of 95% of the qualified basis over four years if it meets all of the following requirements:
      1. It is at least 15 years old;
      2. It is serving households of very low-income or extremely low-income such that the average maximum household income is not more than 45% of the area median gross income adjusted for household size;
      3. It would have insufficient LIHTCs due to the building's low appraised value to complete substantial rehabilitation; and,
      4. The substantial rehabilitation will be complete with this 95% state LIHTC of the qualified basis.
   2. A qualified low-income housing building that is eligible for a cumulative state LIHTC of 95% may not receive a cumulative state LIHTC over four years of 13% for an existing qualified low-income housing building that is not located in a DDA or QCT.
9. Defines "extremely low income households" as having the same meaning as in Health and Safety Code (H&SC) Section 50053.
10. Defines "very low income households" as having the same meaning as in H&SC Section 50053.

EXISTING LAW:

1. Allows a state tax credit for costs related to construction, rehabilitation, or acquisition of low-income housing. This credit, which mirrors a federal LIHTC, may be used by taxpayers to offset the tax under the Personal Income Tax, the Corporation Tax, and the Insurance Tax laws.
2. Requires TCAC to allocate each year the California LIHTC based upon qualifications of the applicant and proposed project. The California LIHTC is available only to projects that receive an allocation of the federal LIHTC.
3. Limits the annual aggregate amount of the state LIHTC to $70 million, as adjusted for an increase in the California consumer price index from 2002, plus any unused LIHTC for the preceding calendar year and any LIHTC returned in the calendar year. The state LIHTC awarded may be claimed as a credit against tax over a four-year period.
4. Allows a taxpayer to make an irrevocable election to sell all or any portion of the state LIHTC to an unrelated party, subject to both of the following conditions:
   1. The consideration received by the taxpayer from the sale of the LIHTC equals at least 80% of the credit amount; and,
   2. The purchaser of the credit is a taxpayer allowed a state or federal LIHTC in connection with a project in this state in the same taxable year as the credit purchased, or any previous taxable year.
5. Applies the sale of credits to projects that receive a preliminary reservation beginning on or after January 1, 2016, and before January 1, 2020. A LIHTC purchaser may resell the credit once, subject to all of the applicable requirements. The sale of a tax credit is disallowed if the taxpayer was allowed the credit on any of his/her tax returns.
6. Permanently allows the state LIHTC to be allocated within the partnership agreement differently than federal LIHTCs, or irrespective of whether the agreement has substantial economic effect.
7. Allows a taxpayer, with the approval of TCAC, to rescind the election to sell all or any portion of the LIHTC allowed if the consideration falls below 80% of the amount of the LIHTC.
8. Treats the sale of a credit for federal and state income tax purposes as a sale of property. Therefore, the seller is required to report gain from the sale. The gain from the sale of the credit is the excess of the total consideration received over the seller's basis in the credit. The total amount of consideration received is the sum of any money received plus the fair market value of the property (other than money) received. Since the seller’s basis in the credit is $0 (zero), the seller will recognize and report gain on the full amount of consideration received.
9. Requires that $500,000 of the LIHTC be set aside for farmworker housing developments and provides that the farmworker tax credit awards are not dependent on receiving a federal LIHTC.
10. Defines "farmworker housing” to mean housing in which at least 50% of the units are available to, and occupied by, farmworkers and their households.
11. Allows TCAC to permit an owner to temporarily house non-farmworkers in vacant units in the event of a disaster or other critical occurrence provided there are no pending qualified farmworker applications for residency.
12. Allows TCAC to award state LIHTCs to developments in a QCT or a DDA, if the project is also receiving a federal LIHTC, under the following conditions:
    1. The amount of state credit is computed on 100% of the qualified basis of the building; or,
    2. If the usage of at least 50% of the units in a low-income housing building is restricted to special needs households, the amount of an allowable state LIHTC may not exceed 30% of the eligible basis of the building.
13. Defines a "QCT" as any census tract designated by the federal Department of Housing and Urban Development (HUD) in which either 50% or more of the households have an income that is less than 60% of the area median gross income or that has a poverty rate of at least 25%.
14. Defines a "DDA" as an area designated by HUD on an annual basis that has high construction, land, and utility costs relative to area median gross income.

FISCAL EFFECT: Unknown.

COMMENTS:

Affordable housing shortage: According to the Legislative Analyst, California needs to produce approximately 180,000 units of housing per year to keep up with population growth – we produce less than half that amount. The lack of affordable housing has the most significant impact on low-income renter households. In the current market, 2.2 million extremely low-income and very low-income renter households are competing for 664,000 affordable rental units. Of the 6 million renter households in the state, 1.7 million are paying more than 50% of their income toward rent. The National Low Income Housing Coalition estimates that the state needs an additional 1.5 million housing units that very-low income Californians can afford.

Governor’s budget proposal: The Governor’s January 2019 budget includes an investment of close to $2 billion in various programs and proposals to support increasing the housing production and affordability. The proposal includes a $500 million increase to the LIHTC this year and recommends subsequent increases in outgoing years through the appropriation process.

Low-Income Housing Tax Credit Program: In 1986, the federal government authorized the LIHTC program to enable affordable housing developers to raise private capital through the sale of tax credits to investors. Two types of federal tax credits are available and are generally referred to as 9% and 4% credits. TCAC administers the program and awards credits to qualified developers who can then sell those credits to private investors who use the credits to reduce their federal tax liability. The developer in turn invests the capital into the affordable housing project.

Each state receives an annual ceiling of 9% federal tax credits. In 2017 it was $2.70 per capita, which worked out to $108 million in credits in California that can be taken by investors each year for 10 years. Unlike 9% LIHTC, federal 4% tax credits are not capped, however they must be used in conjunction with tax-exempt private activity mortgage revenue bonds which are capped and are administered by the California Debt Limit Allocation Committee

In 1987, the legislature authorized a state LIHTC program to augment the federal tax credit program. State tax credits can only be awarded to projects that also receive federal LIHTCs, except for farmworker housing projects, which can receive state credits without federal credits. Investors can claim the state credit over four years. Projects that receive either state or federal tax credits are required to maintain the housing at affordable levels for 55 years.

Changes to the LIHTC: AB10 would increase the state LIHTC allocation by an additional $500 million. In addition to increasing the total amount of state LIHTC, AB 10 proposes to increase the amount of state tax credits awarded to a project that is also receiving 4% federal tax credits from 13% to 50% of the qualified basis. This would more than triple the amount of equity that an investor purchasing a state tax credit would receive, which would bring the return on 4% credits in line with 9% credits and result in greater affordability for the project.

Federal LIHTC can be used anywhere in the state, but projects are given an additional 30% boost on their eligible basis if the project is located in a DDA or a QCT. Because these areas by definition have a higher poverty level and there is a higher concentration of extremely low-income or homeless individuals and families, housing needs deep subsidy to make it affordable. Existing state law does not allow state tax credits to be awarded in DDAs and QCTs with one exception: housing developments where 50% of the units are for special needs populations. The rationale for this prohibition is projects in these areas can qualify for more federal tax credits and therefore are already advantaged. AB 10 would also allow state tax credits to be awarded to projects without regard to DDA or QCT status, with the main purpose of providing enough state tax credits to match the value of a 9% federal tax credit.

AB 10 includes a set-aside from the $500 million increase to the LIHTC program of $25 million for farmworker housing. There is currently a $500,000 set-aside of low-income housing tax credits for farmworker housing developments serving farmworkers and their families. AB 10 would require any unused credits from the $25 million set-aside to go to qualified non-farmworker housing projects that don't receive funding under the main program.

Many low-income housing developments in the state are older and in need of rehabilitation. These projects need higher levels of equity investments because of their age, level of repairs needed, and the low rents. It is hard for these projects to compete for state tax credits because the assessed value is low and therefore the eligible basis upon which the amount of tax credits the project can qualify for is also low. To assist these older projects, AB 10 would allow them to receive state tax credits of 95% over four years. To qualify, projects would need to be at least 15 years old, serve low and extremely low-income households, be a single room occupancy, in a rural area, and have insufficient state credits to complete substantial rehabilitation due to a low appraised value.

Impact of Federal Tax Package on LIHTC: As a result of the H.R. 1, the Tax Cuts and Jobs Act, California will lose 48,870 affordable rental homes, 55,230 jobs, $4.6 billion in business income, and $1.7 billion in local, state, and federal taxes. The federal reduction in the corporate tax rate from 35% to 21% will have significant effect on the price of federal LIHTC. Novogradac & Company, LLC (Novogradac), a certified public accountant, estimates the price of the federal LIHTC has dropped from $1.03 in March of 2016 to $0.89 in December of 2017.

Although the price of the federal credit has been reduced, the decrease in the federal corporate tax rate could result in an increase in value to the state LIHTC. In general the state LIHTC equity pricing for allocated credits is strongly inversely correlated to the investor's federal income tax rate. According to Novogradac, "there is an inverse correlation because the state credit that reduces the investor’s federal deduction for state income taxes, such that the higher the federal tax rate, the less valuable the state credit. When the corporate federal rate was 35%, state LIHTC equity prices were generally in the range of, but slightly greater than, 65 cents. Now that the federal rate has been reduced to 21%, equity pricing for allocated state credits is expected to increase, possibly in the range of 20 percent." An increase in the state LIHTC could help mitigate the loss resulting from the federal tax change.

In addition to increasing the total amount of the credit, California can make changes to tax law to increase the value of the state LIHTC. California uses "modified conformity" to federal income tax law, meaning it mirrors federal law, with certain exceptions. California’s modified conformity to the federal passive activity loss rules restricts the ability of individual investors to use state LIHTCs. California caps the amount of passive activity for rental real estate activities an individual can offset with a state tax credit. According to Novogradac, "a revision to state tax law exempting state LIHTCs from the passive activity loss rules could significantly increase the state LIHTC equity pricing, even more so since tax reform limits individual taxpayers’ federal deductions for state and local income taxes to $10,000 and subjects individuals to federal tax rates that are significantly higher than corporate rates." The new federal tax law also establishes an individual tax rate of 37%, compared to a corporate rate of 21%. Individuals will have a greater incentive to invest in state tax credits.

This bill would expand the ability of individual tax payers to claim the LIHTC by eliminate the $75,000 cap on an individual tax payer’s offset for passive rental real estate activities in computing taxable income.

Arguments in support: According to the California Housing Partnership Corporation, AB 10 builds on the successful track record of the LIHTC programs in California, which have produced or preserved more than 350,000 homes, created 400,000 jobs, and generated $35 billion in local income and $14 billion in tax revenues in California since 1986. AB 10 would expand the successful state LIHTC by $500 million annually, leveraging an additional $1 billion in federal funds to build more than 5,000 affordable homes each year.

Arguments in opposition: The California Association of Teachers (CTA) is opposing all new tax credits this year and is part of an education tax coalition asking the state to pause the creation of any additional tax credits until a comprehensive evaluation, including broader transparency and accountability can be created for all existing tax credits.

Related legislation:

AB 3037 (Chiu) of 2018 would have increased the LIHTC by $300 million and eliminated the $75,000 cap on an individual tax payer’s offset for passive rental real estate activities in computing taxable income. This bill was held on suspense in Assembly Appropriations Committee.

AB 71 (Chiu) of 2017 would have eliminated the mortgage interest deduction on second homes, increases the state Low-Income Housing Tax Credit (LIHTC) Program by $300 million, and makes changes to the LIHTC. This bill died on the Assembly Floor.

AB 571 (Eduardo Garcia, Chapter 372, Statutes of 2017) made changes to the farmworker housing tax credit set-aside within the state LIHTC Program and to the Department of Housing and Community Development’s Office of Migrant Services.

AB 2817 (Chiu) of 2016 would have increased the state Low-Income Housing Tax Credit (LIHTC) Program by $300 million, and makes changes to the LIHTC. This bill died on the Suspense File in Senate Appropriations Committee.

AB 35 (Chiu) of 2015 would have increased the state Low-Income Housing Tax Credit (LIHTC) Program by $300 million, and makes changes to the LIHTC. This bill was vetoed by the Governor. Veto message below:

I am returning the following nine bills without my signature:

Assembly Bill 35
Assembly Bill 88
Assembly Bill 99
Assembly Bill 428
Assembly Bill 437
Assembly Bill 515
Assembly Bill 931
Senate Bill 251
Senate Bill 377

Each of these bills creates a new tax credit or expands an existing tax credit.

Despite strong revenue performance over the past few years, the state's budget has remained precariously balanced due to unexpected costs and the provision of new services. Now, without the extension of the managed care organization tax that I called for in special session, next year's budget faces the prospect of over $1 billion in cuts.

Given these financial uncertainties, I cannot support providing additional tax credits that will make balancing the state's budget even more difficult. Tax credits, like new spending on programs, need to be considered comprehensively as part of the budget deliberations.

Double referred: This bill was also referred to the Assembly Committee on Revenue and Taxation where it will be heard should it pass out of this committee.

REGISTERED SUPPORT / OPPOSITION:

Support

California Housing Consortium (co-sponsor)

California Housing Partnership (co-sponsor)

Housing California (co-sponsor)

Non-Profit Housing Association of Northern California (co-sponsor)

Burbank Housing
California Apartment Association

California Asian Pacific Islander Chamber of Commerce

California Association of Housing Authorities
California Association of Local Housing Finance Agencies

California Coalition for Rural Housing

California YIMBY

C & C Development
EAH Housing

East Bay Asian Local Development Corporation

Eden Housing

First Community Housing

Housing Authority of the City of Alameda
Housing Trust Silicon Valley

John Stewart Company
League of California Cities

League of Women Voters of California
Los Angeles Homeless Services Authority 

Many Mansions

National Association of Social Workers, California Chapter

Palm Communities
Paulett Taggart Architects
San Diego Housing Federation
San Francisco Housing Action Coalition
Southern California Association of Nonprofit Housing

The Coalition for Homeless Services Providers
Valencia Real Estate and Consulting

Ventura Council of Governments

Wakeland Housing and Development Corporation

Opposition

California Teachers Association

Analysis Prepared by: Lisa Engel / H. & C.D. / (916) 319-2085