United States General Accounting Office

GAO Testimony

Before the Subcommittee on Oversight, Committee on

Ways and Means, House of Representatives

For Release on

Delivery Expected at

1:30 p.m., Wednesday

April 23, 1997

TAX CREDITS

Opportunities to Improve

Oversight of the

Low-Income Housing

Program

Statement of James R. White, Associate Director, Tax

Policy & Adminstration Issues, General Government

Division

GAO/T-GGD/RCED-97-149

Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

Madam Chairman and Members of the Subcommittee,

We appreciate being here this afternoon to discuss our recently issued

report entitled Tax Credits: Opportunities to Improve Oversight of the

Low-Income Housing Program (GAO/GGD/RCED-97-55, March 28, 1997).

Currently, the tax credit is the largest federal program for funding the

development and rehabilitation of rental housing for low-income

households. Under this program, the states award tax credits that could

cost federal taxpayers as much as $3 billion per year.

Our report, which is addressed to you, Madam Chairman, and the

Chairman of the Ways and Means Committee, answers questions about the

characteristics of tax credit projects and their residents and the controls

the Internal Revenue Service (IRS) and the states have over the program.

More specifically, with respect to controls we were asked to assess IRS and

state controls for ensuring that (1) state priority housing needs are met;

(2) housing project costs, including tax credit costs, are reasonable; and

(3) states and project owners comply with program requirements.

In answering these questions, our report makes the following four main

points:

• A substantial majority of the households served by the program had

incomes considered “very low” by the Department of Housing and Urban

Development and about three-fourths of all households benefited either

directly or indirectly from other types of housing assistance. We estimate

the average tax credit cost per-unit, in present value terms, to be about

$27,300.

• All the states had developed qualified allocation plans required by the

Internal Revenue Code to direct tax credit awards to priority housing

needs. Although the states met tax code requirements, we identified

several factors that could affect the housing actually delivered over time.

Some states reserve discretion for amending or bypassing the allocation

process. In addition, many tax credits that were initially allocated may not

have been used. Further, the long term economic viability of tax credit

projects as low-income housing has not been tested.

• All states had cost control procedures in place that were intended to help

ensure the reasonableness of project costs and tax credit awards.

However, some projects lacked complete cost and financial data and some

key data used in determining the basis for tax credit awards were not

independently verified.

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Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

• While states had established compliance monitoring programs consistent

with IRS regulations, the regulations did not provide adequate assurance

that states perform agreed upon monitoring reviews. Also, IRS needs

additional information to adequately monitor states’ tax credit allocations

and taxpayer compliance with credit requirements.

Before elaborating on these points I would like to describe our

methodology and provide some background about how the low income

housing tax credit program works and the responsibilities of the IRS and

states for administration and oversight of the program.

Our analysis of the low-income housing tax credit program is based

primarily on a survey of tax credit policies and procedures in 54 state tax

credit allocating agencies, a review of state files for 423 randomly selected

housing projects, and a survey of project managers for these projects. We

also reviewed IRS’ low-income housing tax credit procedures and

programs.

How the Program

Works

The low income housing tax credit program is a joint federal, state and

private sector initiative. Figure 1 attached to this statement illustrates for a

simple case how tax credits help finance low-income housing

development. Under the program, a developer finances a low income

housing project in part using a private mortgage, with payments made out

of rental revenues, and in part using equity paid into the project from

investors who receive the credit. The greater the private financing, the

smaller the amount of tax credit needed.

The process of awarding tax credits to private investors begins with IRS

annually allocating tax credits to each state housing agency in an amount

equal to $1.25 per state resident. Developers proposing to build

low-income housing apply to the state agencies for credits. Winning

developers receive credits which they in turn offer, in effect sell, to private

investors, often organized into partnerships by syndicators, who use the

credits to offset taxes otherwise owed on their tax returns. In return for

the credits, the private investors provide equity financing for the projects.

This equity financing fills the gap between the development costs and the

non-tax credit financing. The equity paid into a project is less than the sum

of the tax credits. The difference provides the investors with a rate of

return over 10 years as well as compensation for housing project

evaluation and monitoring. A complication not shown in the figure is that

many projects also receive other housing subsidies.

Page 2 GAO/T-GGD/RCED-97-149
Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

About $300 million in new credits are made available nationally each year

for award to new housing projects. Assuming project owners remain

eligible, they would be entitled to take the $300 million in credits each year

for 10 years. Thus, if this occurred, in any one year, 10 years worth of

federal tax credits would be outstanding and the aggregate annual cost to

the federal government would be $3 billion.

The states and IRS share responsibility for administering the tax credit

program. Once projects have been placed in service, state agencies are

responsible for monitoring the projects for compliance with federal

requirements concerning household income and rents and project

habitability. Noncompliance with these requirements may result in IRS

recapturing or denying previously issued or used tax credits.

IRS is responsible for issuing regulations on state monitoring requirements,

ensuring that taxpayers take no more tax credits than they are entitled to

take, and ensuring that states allocate no more credits than they were

authorized to allocate. In implementing these responsibilities, IRS requires

annual reports from the states on the amount of tax credit allocations

made in total and amounts awarded to individual projects. IRS also requires

taxpayers to disclose tax credit information on their tax returns and

requires the states to report findings of project noncompliance.

Housing Delivered

Under the Program

We estimated, based on our random sample, that about 4,100 properties

with about 172,000 tax credit qualified units were placed in service in the

continental United States between 1992 and 1994. We also estimated that,

for these projects, the states annually awarded tax credits with a potential

value over their 10-year lifetime of about $2 billion (about $1.6 billion in

present value terms), or about $6.1 billion for the three years combined.

On the basis of information from our survey of property managers, we

estimated that the 1996 average annual income of households in units

qualifying for tax credits was about $13,300. The distribution of incomes is

shown in figure 2, which is attached to this statement. About three-fourths

of tax credit households met HUD’s definition of “very low income”—that

is, their incomes were below 50 percent of their area’s median income.

About 71 percent of the tax credit households, benefited directly or

indirectly from one or more types of housing assistance besides tax

credits. One type of housing assistance, direct rental assistance, enabled

the tax credit program to serve many households whose reported income

was well below the qualifying limits established by the program. Overall,

Page 3 GAO/T-GGD/RCED-97-149
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Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

an estimated 39 percent of the households received direct rental

assistance. The average income for these households was about $7,900.

Tax credit households were small—about two-thirds were one or two

person households. About a quarter of the projects were developed

primarily to serve the elderly.

Tax credit properties were located throughout the country. The most

common type of property was a walk-up/garden-style apartment building

but properties ranged from row houses to elevator buildings. Most of the

projects were newly constructed.

The average monthly rent was about $450. For some tenants rental

payments were covered in part by other federal housing assistance.

We estimated that for the tax credit properties placed in service between

1992 and 1994, the states had annually awarded tax credits with a potential

value over 10 years of about $2 billion (about $1.6 billion in present value

terms). Thus, the taxpayer costs for the tax credits attributable to these

three years could be as high as $6.1 billion over the 10-year credit period.

We also estimated that the present value of the average tax credit cost per

unit would be about $27,310. As shown in figure 3, which is attached to

this statement, about 60 percent of the units had tax credit costs at or

below the estimated average and about 2 percent had tax credit costs of

$100,000 or more. The federal costs of the tax credits is a function of many

factors, including property development costs and the market price of the

tax credit.

Project development costs, including land and building acquisition outlays,

construction costs, builders’ profit, and financing costs, varied widely. We

estimate that the average cost of developing the units was about $60,000.

About two-thirds of these units cost less than or the same as the average

unit. As shown in figure 4, which is attached to this statement, the per-unit

costs of the properties varied widely. About 10 percent of the properties

cost less than $20,000, and about 10 percent cost more than

$100,000—including 3 percent whose costs exceeded $160,000 per unit.

Development costs may vary because of differences in the physical

characteristics of properties, broader community development needs, and

the extent to which tax credit allocating agencies use various controls to

limit costs.

Page 4 GAO/T-GGD/RCED-97-149
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Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

State Controls for

Allocating Credits to

Housing Needs Vary

All the states had developed qualified tax credit allocation plans required

by the Internal Revenue Code to direct tax credit awards to meet priority

housing needs. The plans generally targeted the credit to the priority

housing needs identified by the states. Consistent with the latitude given

them in the Code, the states had defined and weighted the selection

criteria for awarding credits in different ways. Most states used some sort

of scoring system to rank project proposals. The states also used varying

amounts of data and analyses in assessing housing needs.

Although all states had adopted required allocation plans for meeting state

set housing priorities, we identified several factors that could affect the

housing actually delivered over time.

• One factor involves the use of discretionary judgment. Nearly all of the

agencies reserved some discretion for amending or bypassing their

allocation process. We recognize that discretion can be beneficial —it can

target needs resulting from unforeseen circumstances. But, unless the use

of discretion is well documented and made public it could undermine the

credibility of the allocation process. For example, in one recently

completed allocation cycle in Texas senior managers overrode over half

the decisions made through the allocation process without documenting

their decisions.

• A second factor involves the timely use of tax credits. Data from the

states, IRS, and a study contracted by HUD suggest that the states may not

be fully using their tax credit allocations. The data show a significant gap

between the amount of tax credits that have been allocated by the states

to proposed projects and the tax credits that have been awarded to

projects when they were completed and been placed in service. For

example, IRS data showed that the cohort of projects proposed in 1992

received tax credit allocations of about $322 million. However, by the end

of calendar year 1994 only about half the credits had been actually

used—that is, awarded to projects placed in service. These data raise the

question of whether the allocating agencies produced the total amount of

housing that the federal government was prepared to fund. From the

available data, we cannot determine how much of the total federal

allocation that has not been awarded may have lapsed and how much may

have been reallocated for future use.

• A third factor involves the long-term economic viability of the tax credit

projects after the 15 year tax credit compliance period ends. Under the

Code, projects receiving tax credits are required to have an extended-use

agreement requiring that the property serve low-income tenants for 30

years, but with a contingency clause that allows for conversion to market

Page 5 GAO/T-GGD/RCED-97-149
Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

rate housing after 15 years under certain conditions. Within the next

decade, the first properties subsidized with tax credits will enter the

period covered by extended-use agreements. Whether these properties

convert to market rate housing, continue to provide high-quality housing

for low-income tenants, or gradually deteriorate will depend on such

factors as the economics of the alternative uses, the states’ ability to find

buyers willing to keep the properties in low-income use, and the need to

obtain additional subsidies.

State Controls for

Ensuring the

Reasonableness of

Project Costs Can Be

Strengthened

All states had some cost control procedures in place that were intended to

help ensure the reasonableness of tax credit awards. However, we

identified opportunities for the states to improve their cost controls.

Figure 5, which is attached to this statement, provides an overview of the

development costs or uses of funds and the financing or sources of funds

for projects placed in service from 1992 through 1994. The height of the

bars represents total development costs or the uses of funds. The

financing of these development costs, the sources of funds, was provided

by the three components shown:

• Equity paid into projects by tax credit investors, which was about

$3.1 billion and which was generated by about $6.1 billion in tax credits

investors can claim on their tax returns over 10 years.

• Commercial mortgage loans of about $3.8 billion.

• Concessionary financing of about $3.8 billion, which was provided

primarily by other federal housing programs.

Controlling the amount of tax credits awarded to individual projects limits

federal taxpayers’ cost for the project and allows a state, with an overall

tax credit allocation proportional to its population, to finance more

projects. To do this the states should consider

• the reasonableness of a project’s development cost;

• the extent of a project’s financing gap, which is the difference between the

cost of a project and the amount of non-tax credit financing that a project

can raise to cover those development costs; and

• the yield obtained from a project’s tax credit award, which is the amount

of equity investment a project could raise for each tax credit dollar

received.

All state agencies had controls over development costs. Many states relied

on HUD cost standards, others believed their own standards were more

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Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

effective in limiting costs, and some relied on their staffs’ expertise

because they said that differences in project types and location made

setting standards impractical. These standards acted as a ceiling on costs.

Additionally, most supplemented these practices by using competition

among project developers to control costs, i.e., cost was a factor in

ranking projects applying for tax credit awards. State agency practices for

determining the reasonableness of the non-tax credit financing varied, but

they generally included reviewing projects’ rents and operating expenses,

private mortgage terms, and non-tax credit public subsidies—in the case

of HUD financing the evaluation is called a “subsidy layering review”.

As already mentioned, the equity yield per dollar of tax credit is a factor

influencing the federal cost of an individual project and the $3.1 billion in

equity paid in by investors during 1992 through 1994 was generated by

$6.1 billion in tax credits. This works out to about $0.53 on the dollar.

States generally relied on the market to determine the yield obtained from

a project’s tax credit award. The tax credit yield or price has gone up over

time, from about $0.45 in 1987 to over $0.60 in 1996, according to several

major syndicators and state allocating agency officials.

In controlling costs—that is, in evaluating the reasonableness of project

costs, the financing gap, and the tax credit price—allocating agencies are

largely dependent on information submitted by developers. To the extent

that the agencies do not have complete and reliable information, they lack

assurance about the effectiveness of their cost controls.

We found some control weaknesses in terms of the way states assured the

reliability of information from developers about their sources and uses of

project funds. For example, although all but one state required some form

of independent verification of cost and financing data, the scope of the

required cost verification work varied. It ranged from audits to more

limited work, that did not require verification of costs included in the base

for calculating the tax credit award. Overall, we estimated that for about

14 percent of the total projects, the states lacked complete information on

the sources and uses of project funds. Without assurance of the validity of

developer costs and without a complete and documented basis for

determining equity needs, such as a detailed sources and uses of funds

analysis, states are vulnerable to providing more (or fewer) credits to

projects than needed.

Accordingly, we recommended that the Commissioner of Internal Revenue

amend regulations for the tax credit program to establish clear

Page 7 GAO/T-GGD/RCED-97-149
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Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

requirements for ensuring independent verification of key information on

sources and uses of funds submitted to states by developers.

State and IRS

Oversight Can Be

Improved

The Internal Revenue Code provides for dual oversight of the tax credit

program by state tax credit allocating agencies and IRS. In general, we

found that not all allocating agencies fulfilled the requirements of their

compliance monitoring programs; and although IRS has been developing

programs, it did not have sufficient information to determine state or

taxpayer compliance.

State Monitoring Programs In general states are responsible for monitoring project compliance with

rent, income, and habitability requirements after the projects are placed in

service and for reporting any noncompliance to IRS. In 1995, several states

did not do the number of desk reviews and on-site inspections they had

agreed to do. Because IRS’ regulations do not require states to submit

annual reports to IRS on the number of monitoring inspections made, IRS

was not in a position to readily determine whether states met their

agreed-upon monitoring responsibilities. Also, IRS’ monitoring regulations

do not require states to make on-site visits to projects or obtain

information from other sources, such as local government reports on

building code violations, that would allow states to detect violations of the

Code’s habitability requirements. For IRS to better ensure that habitability

problems are identified during monitoring reviews, states would have to

do on-site inspections or obtain information on these types of problems

from other sources. We also found that IRS was not collecting enough

information from states on the number of units in each project where

states found noncompliance for IRS to determine whether the

noncompliance has a tax consequence for the project owners.

Accordingly, we recommended that the Commissioner of Internal Revenue

amend regulations for the tax credit program to (1) require that states

report sufficient information about monitoring inspections or reviews,

including the number and types of inspections made, so that IRS can

determine whether states have complied with their monitoring plans; and

(2) require that states’ monitoring plans include specific steps that will

provide information to permit IRS to more effectively ensure that the

Code’s habitability requirements are met. We also recommended that IRS

explore modifying the form states use to report noncompliance so that IRS

can better determine whether the noncompliance has a tax consequence

for the project owners.

Page 8 GAO/T-GGD/RCED-97-149
Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

IRS Compliance Oversight

Activities

IRS is responsible for ensuring that taxpayers claim only those tax credits

for which they are entitled and for ensuring that states do not exceed their

annual tax credit ceilings.

In 1995, IRS instituted an audit program to determine whether taxpayers

are entitled to the credits claimed on their tax returns. As of the end of

fiscal year 1996, IRS had completed work on 35 audit cases and found 12 to

be in noncompliance.

IRS is relying on the results of its audit initiative to provide estimates on the

extent and types of noncompliance that exist in the tax credit program. It

is important for IRS to have information on compliance so that it can

determine how best to allocate its compliance resources. However, IRS’

current audit program is not based on a random sample of returns and will

not provide statistically reliable compliance data.

With respect to monitoring state use of tax credits, IRS is currently

developing a document matching program using state tax credit reports to

determine whether states have allocated more credits than allowed by law.

However, the reports do not contain information on the allocation year of

the tax credits that developers returned to the allocating agencies for

reallocation to other projects. IRS needs this information in order to

determine whether states stay within their tax credit ceilings. Collecting

this additional data on returned credits would also allow IRS to determine

whether the states are fully using their tax credit allocations. As I

indicated earlier, a significant gap exists between the amount of tax

credits that have been allocated by states and the amount of credits that

states and IRS records show were awarded to projects that were placed in

service.

To supplement its tax credit audit initiative, IRS is exploring the possibility

of computer-matching these data against tax credit amounts reported on

housing project partnership returns. However, this match would not detect

noncompliance at the partner level. But overreporting of tax credits by

partners could be detected by matching tax credits reported on the

Schedule K-1s, which shows the individual partners’ credit allocations, to

the partners’ income tax returns. In a June 1995 report on partnership

compliance, we recommended that IRS match Schedule K-1 to tax returns.1

However, resource constraints have prevented IRS from transcribing all the

1

Tax Administration: IRS’ Partnership Compliance Activities Could be Improved (GAO/GGD 95-151,

June 16, 1995).

Page 9 GAO/T-GGD/RCED-97-149
Statement 

Tax Credits: Opportunities to Improve

Oversight of the Low-Income Housing

Program

Schedule K-1s reporting tax credits it receives so that it could have an

effective matching program.

Accordingly, we recommended that the Commissioner of Internal Revenue

(1) explore alternative ways to develop an estimate of tax credit

compliance so that IRS can better determine the resources needed to

address noncompliance and (2) explore alternative ways to obtain better

information to verify that states’ allocations do not exceed tax credit

authorizations.

Independent

Oversight of the Tax

Credit Program

Unlike most programs operated by state and local governments that

receive federal financial assistance, the low-income housing tax credit

program is not covered by the Single Audit Act. The Single Audit Act,

which is an important accountability tool for the hundreds of billions of

dollars of federal financial assistance administered by state and local

governments and nonprofit organizations, does not apply to tax credits

because credits are not considered federal financial assistance under the

Office of Management and Budget’s implementing guidance. Subjecting

the low-income housing tax credit program to the single audit process may

be a more efficient, effective, and less federally intrusive way of

monitoring state agency controls than other types of independent audits.

Accordingly, to help ensure appropriate oversight of state allocating

agencies’ overall compliance with tax credit laws and regulations, we

recommended that the Director, Office of Management and Budget,

incorporate the low-income housing tax credit program in the definition of

federal financial assistance included in implementing guidance for the

Single Audit Act so that the program would be subject to audits conducted

under the Single Audit Act.

Madam Chairman, this concludes my prepared statement. I would be

pleased to answer any questions.

Page 10 GAO/T-GGD/RCED-97-149
Page 11 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

Figures Figure 1: Transferring Tax Credits From the Federal Government to the

Private Sector

Figure 2: Estimated 1996 Incomes of Households in Tax Credits Units

Figure 3: Estimated Average Per-Unit Credit Costs of Properties Placed in

Service, 1992-94

Figure 4: Estimated Average Per-Unit Develpment Costs of Tax Credit

Properties Placed in Service, 1992-94

Figure 5: Estimates on Housing Project Sources and Uses of Funds

Page 12 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

Investors

(Corporations)

Investors

(Individual)

Syndicator

(General partner of an

investment partnership)

State housing

agency

IRS

Developer

(General partner

of the project)

Lender

Rent

Loan Loan

payment

Legend:

Tax benefits (tax credits/deductions)

Money (equity financing/rent)

Housing project proposal submission

Money (equity)

Money (equity)

Money

(equity)

Housing project

proposal submission

Tax benefits

(tax credits &

deductions)

Tax benefits

(tax credits)

Tax benefits

(tax credits &

deductions)

Tax benefits

(tax credits)

Tax benefits

(tax credits &

deductions)

2

1

3

4

Page 13 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

0

5

10

15

20

25

30

35

Household current income in dollars

Percent of households

Less than $5,000

$5,000-9,999

$10,000-14,999

$15,000-19,999

More than $25,000

$20,000-24,999

Page 14 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

0

5

10

15

20

25

30

Percent of units

Less than $10,000

$10,000 - $19,999

$20,000 - $29,999

$30,000 - $39,999

$40,000 - $49,999

$50,000 - $59,999

$60,000 - $69,999

$70,000 and over

Page 15 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

0

10

20

30

40

Less than $20,000

$20,000 to $39,999

$40,000 to $59,999

$60,000 to $79,999

$80,000 to $99,999

$100,000 to $119,999

Over $160,000

$120,000 to $139,999

$140,000 to $160,000

Percent of units

Page 16 GAO/T-GGD/RCED-97-149
Figures Used in GAO’s Low-Income Housing

Tax Credit Testimony

0

2

4

6

8

10

12

Dollars in billions

10.7 10.7

Sources of funds to

balance projects

Uses of funds to

develop projects

Equity investments raised

through the award of tax credits

Commercial mortgage loans

Concessionary financing

(e.g., CDBG loans) and other

Construction expenses

Construction-related fees

Other 

(e.g., acquisition of property)

(268796) Page 17 GAO/T-GGD/RCED-97-149
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