Tax Reform Act of 1986

What Is the Tax Reform Act of 1986?

The Tax Reform Act of 1986 was a broad rewrite of the federal income tax, signed by President Ronald Reagan on October 22, 1986, as Public Law 99-514. Most of its provisions had nothing to do with housing, but two parts reshaped the field.

First, it created the Low-Income Housing Tax Credit (LIHTC). The Congressional Research Service (CRS) calls the LIHTC the federal government’s primary policy tool for developing affordable rental housing. Second, it changed how ordinary rental real estate and housing bonds are taxed.

How It Works

Creating the LIHTC

The act added Section 42 to the Internal Revenue Code. Its basic design still holds:

• State allocation. Each state receives credits based on population, initially $1.25 per resident, according to CRS. A state agency chooses which projects get them through a qualified allocation plan.
• Two credit levels. Buildings placed in service in 1987 received exactly a 4% or 9% annual credit. After that, Treasury set rates by formula to deliver subsidies worth up to 30% or 70% of a project’s eligible costs, the origin of today’s 4% and 9% credits.
• Income and rent limits. Owners must reserve a share of units for lower-income households at restricted rents.
• Private investors. Developers sell the credits to investors, typically through partnerships, to raise equity that reduces the debt a project needs.

Changing real estate tax rules

The same law:

• Created the passive activity loss rules in Section 469. These generally stop investors from using losses from rental property and other passive investments to offset wages and other active income.
• Rewrote the depreciation rules in Section 168. Residential rental buildings are depreciated in equal annual amounts over 27.5 years.
• Created a single annual state volume cap in Section 146 for most private activity bonds, including bonds that finance rental housing and mortgage revenue bonds.

Why It Matters for Workforce Housing

The 1986 framework targets lower-income renters. LIHTC units generally serve households at or below 60% of area median income, or up to 80% for individual units under the income-averaging option Congress added later. Much of the workforce housing band, often described as about 80% to 120% of median income, falls outside the program. That is one reason workforce housing depends on other tools.

Congress continues to adjust the 1986 design. Public Law 119-21, signed in 2025, permanently raised state allocations by 12% and cut the share of a project’s costs that must be financed with tax-exempt bonds to qualify for 4% credits from 50% to 25%, both starting in 2026, CRS reports. For the mechanics, see how the Low-Income Housing Tax Credit works.