Tax-Exempt Multifamily Housing Bonds

How It Works

Normally, when a state or city borrows money by selling bonds, investors don’t pay federal income tax on the interest. Congress lets that benefit extend to some privately owned projects that serve a public purpose. These are called private activity bonds. Affordable rental housing is one of the qualifying uses.

In a typical deal, a housing finance agency or local issuer sells the bonds and lends the proceeds to the developer. The issuer acts as a conduit: the developer, not the government, repays the bonds. Because investors accept a lower, tax-free interest rate, the project can borrow for less than it could with a taxable loan.

Before bonds are issued, the law requires public approval. An elected official or body must approve the bonds after a public hearing with reasonable notice, or voters must approve them by referendum.

The Link to the 4% Tax Credit

The bonds matter most for what they unlock. When a large enough share of a building and its land is financed with volume-capped tax-exempt bonds, the building can claim the 4% tax credit without receiving a slice of the state’s competitive credit allocation. The long-standing threshold is 50% of the combined basis of the building and land, known as the 50% test. For buildings placed in service after 2020, the rate on these credits cannot fall below 4%.

Public Law 119-21, signed July 4, 2025, added a lower threshold. For buildings placed in service in tax years beginning after December 31, 2025, the test is also met if bonds finance at least 25% of aggregate basis. At least one bond issue must be dated after 2025 and finance at least 5% of basis. Because each project needs less bond financing to qualify, a state’s volume cap can stretch across more projects.

Who It Serves

The issuer elects one of two income tests when the bonds are issued:

• 20/50: at least 20% of units occupied by households at or below 50% of area median income
• 40/60: at least 40% of units occupied by households at or below 60% of area median income

The test must be met throughout a qualified project period. That period starts when 10% of units are occupied and ends at the latest of three dates: 15 years after half the units are occupied, the day no bonds remain outstanding, or the day Section 8 assistance ends.

The bond rules limit tenant incomes but, apart from an optional “deep rent skewed” election, do not cap rents. A project that also takes tax credits must follow LIHTC rent limits.

How to Access It

Each state receives an annual volume cap on most private activity bonds. Under Rev. Proc. 2025-32, the 2026 cap is the greater of $135 per resident or $397,625,000. Housing competes for that cap with other uses, including single-family mortgage revenue bonds. Federal law sets a default split between state agencies and local issuers, but a state can adopt its own allocation formula by law. Unused cap can be carried forward for up to three years for a chosen purpose such as rental housing.

Developers apply to the state agency or local issuer that holds the cap. Many bond deals also need other gap financing on top of the bond loan and tax credit equity.

History

The Revenue and Expenditure Control Act of 1968 made interest on most “industrial development bonds” taxable, but it listed specific private activities that could still use tax-exempt financing. Residential rental projects were on that list. The Tax Reform Act of 1986 reorganized these rules into today’s Section 142, created the Low-Income Housing Tax Credit, and made housing bonds subject to an annual state volume cap. That cap started at the greater of $75 per resident or $250 million and dropped to $50 or $150 million after 1987. It has since been raised and indexed to inflation.

Limitations

• Volume cap is limited, and housing competes for it with other qualifying projects.
• Bond transactions carry legal, underwriting and issuance costs, which can make them hard to justify for small projects.
• The income tests set aside units only for households at or below 50% or 60% of area median income. The remaining units can rent at market rates, so the bond rules alone create no restricted units for moderate-income households.
• The bonds lower borrowing costs, but projects often still need tax credits and additional subsidy to reach affordable rents.