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Tax credit 101: How the Section 42 program works

For developers and investors, building affordable housing can be rewarding, both financially and as a civic achievement. Here's how the process works.

The federal government issues tax credits to states based on population. A developer applies for credits competitively at a state housing finance agency and uses a syndicator to sell the credits to an investor, such as a life insurance company.

Typically, the developer, who earns a project fee, forms a limited partnership with the investor, taking a small ownership stake and managing the property, while the investor gets a 99.9% interest, but remains a silent partner.

The developer uses the equity from the sale of credits to partially finance an affordable housing project, typically covering 30% to 40% of the cost. The remaining financing often comes from other government-funded programs and conventional loans.

Developments financed under Section 42 of the IRS tax code must house a percentage of residents earning less than 60% of the area median income.

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