Applicable Fraction

What Is the Applicable Fraction?

The applicable fraction measures how much of a building is devoted to qualifying low-income tenants under the Low-Income Housing Tax Credit (LIHTC). It matters because the program pays credits only on the affordable portion of a building.

The calculation runs in three steps:

1. Start with the building’s eligible basis, roughly its depreciable development cost excluding land.
2. Multiply eligible basis by the applicable fraction to get qualified basis.
3. Multiply qualified basis by the credit rate to get the annual credit.

A building with every unit restricted has a fraction of 100%. A mixed-income building with some market-rate units earns proportionally less.

How It Works

Section 42(c)(1) defines the applicable fraction as the smaller of:

• The unit fraction. Low-income units divided by all residential rental units in the building, whether or not occupied.
• The floor space fraction. Total floor space of low-income units divided by total floor space of all residential rental units.

Because the smaller of the two controls, an owner cannot make the affordable units tiny and the market-rate units large while still claiming credit on most of the building.

A low-income unit is one that is rent-restricted and occupied by a household that meets the project’s income test. The fraction is measured at the close of each tax year. In the building’s first credit year, the fractions at the close of each full month the building was in service are added together and divided by 12. Any credit lost to that first-year rule is claimed in an 11th year. If qualified basis falls during the 15-year compliance period, the IRS can recapture part of the credits already taken.

Example

Suppose a 50-unit building has 40 low-income units, so its unit fraction is 80%. But its 10 market-rate units are larger: the low-income units total 30,000 square feet out of 40,000. Its floor space fraction is 75%.

The applicable fraction is the smaller number, 75%. If the building’s eligible basis were $12 million, its qualified basis would be $9 million.

Why It Matters for Workforce Housing

Units rented to households whose incomes are above the project’s limit when they move in count as market-rate and add nothing to the fraction. That is one reason owners often restrict every unit. Income averaging changes the picture: units designated at 70% or 80% of area median income can count as low-income units, so a project can serve some workers earning up to 80% of the area median without shrinking its credits.