A major change is on the horizon for affordable housing development as key provisions of the One Big Beautiful Bill begin to take effect. Among the most significant reforms is the permanent reduction of the bond financing threshold for 4% low-income housing tax credit (LIHTC) projects, slated to begin next year.
The reduction was a long-sought change by affordable housing advocates. The recent legislation also provides a permanent 12% housing credit increase, beginning in 2026.
“The lower bond test and the increased amount of 9% credits is a generational, advocacy win for affordable housing,” says Stockton Williams, executive director of the National Council of State Housing Agencies (NCSHA).
Let’s focus on the change to the bond threshold.
What’s the Bond Test?
Generally, developers must compete to receive an allocation of limited 9% LIHTCs from a state housing finance agency to be able to claim the housing credits. However, there is an exception for qualified affordable housing buildings that are financed with tax-exempt bonds. For years, this rule has allowed developers to qualify for and claim credits for projects where 50% or more of the aggregate basis of the building and land is financed by tax-exempt bonds from the state’s volume cap.
Under the recent legislation, this 50% test has been lowered to 25% for properties placed in service after Dec. 31, 2025. Affordable housing supporters had argued that the 50% threshold was too high, making it difficult for many deals to qualify for the funding in states where demand for volume cap is strong. Lowering the test will mean that states can award volume cap to a greater number of developments, which will make it easier for more projects to access tax-exempt bonds and thus 4% LIHTCs.
It’s important to note that the new 25% threshold is a floor. States that do not face a volume cap shortage could continue to allocate volume cap to projects in an amount equal to or greater than what is needed to meet the threshold.
What About 2025 Deals?
A number of developers are working to close deals between now and the end of the year, so they’re asking about what the change may mean for them, says Beth Mullen, a partner and affordable housing industry leader at CohnReznick, a leading accounting and professional services firm.
“We know there are some states that are trying to accelerate the ability to use the 25% test, meaning they are exploring the possibility of issuing some 2025 bonds to a developer and then issuing some 2026 bonds, so the developer can meet a transition rule,” she says. “This is something to watch for this year.”
While the 25% test largely will be utilized for deals closing in 2026 or later, projects expected to close in 2025—or even those that have already closed but will not be placed in service until after Dec. 31—may have the ability to use the new, lower bond threshold with buy-in from financing partners and appropriate planning to comply with the rules set forth above, says Kent Neumann, founding member of the Tiber Hudson law firm with expertise in bond transactions.
“With approval from the bond allocating authority, it may be possible for developers to receive a smaller portion of the necessary volume cap in 2025 and an additional forward allocation of volume cap for 2026 to support an additional issuance of bonds representing at least 5% of aggregate basis,” he says, noting that he recommends the 2026 issuance to be not less than 10% and, when combined with the 2025 issuance, not less than 30% overall to provide cushion.
In this scenario, upon the issuance of the second series in 2026, the project would qualify for the 25% test, assuming all applicable bond and tax rules with respect to the expenditure of bond proceeds are satisfied. This approach could allow some of the bottlenecks in volume cap scarcity to be spread out over transactions starting this year, according to Neumann.
Additionally, deals that received a bond funding award or allocation in 2025, or even in years prior, but have not yet closed would qualify for the 25% test if the bonds are issued after Dec. 31, 2025.
“In the current marketplace, it is common for transactions to be structured as fully funded executions, in which all bond proceeds are funded at closing,” Neumann says. “However, many deals utilize a draw-down structure, in which bond proceeds are funded in installments over time.”
There are questions about whether a draw-down deal that closed prior to Jan. 1, 2026, could qualify for the 25% test if bonds representing at least 5% of the project’s aggregate basis were not funded until Jan. 1, 2026, or later.
In such a scenario, the project would only be eligible for the 25% test if there is an entirely new issuance of bonds in 2026 for at least 5%, as all bonds included in the original draw-down issuance would be treated as being part of the 2025 issue (and, therefore, would not meet the second requirement outlined above), according to Neumann.
Looking at Deals in 2026 Beyond
During the last five years, private-activity bond volume cap scarcity has become an important issue for the affordable housing industry. Many states have become oversubscribed, meaning demand for volume cap has exceeded supply. Currently, only about 15 states are considered undersubscribed, according to Neumann.
The reduction in the bond threshold to 25% has been long awaited and will have significant implications for the industry.
“In theory, reducing the amount of private-activity volume cap needed for each transaction by half would suggest a doubling in the number of bond deals, especially in states that are oversubscribed, but the reality is that the increase may not be as significant as might be expected, at least immediately, due to potential reductions to equity pricing and the administrative burden of closing additional transactions,” says Neumann. “That said, over the next year, with effective management of the process, deal volume could increase by a third or more across the country.”
The recent legislation could also give rise to certain new opportunities for structuring transactions, including the use of taxable permanent executions in deals where bonds are issued only in the minimum amount needed to access the 4% LIHTCs—for example, Federal Housing Administration programs.
A key will be how states implement the changes, says Alysse Hollis, a director with the Coats Rose law firm.
“I think you will see structures that work really well in some states that don’t work as well in other states,” says the affordable housing bond expert. “For example, if you are in a state where volume cap is limited, you may get only 30% of your project funded with tax-exempt bonds next year and not 55%. That changes the economics. You are going to have to find taxable debt or other funding sources for a larger percentage of that capital stack. You may see cash-collateralized deals work well in states that lower the threshold to 25% or 30%. In other states, you may see no change in what works well there.”
In July, the California Tax Credit Allocation Committee became one of the first states to come out with proposed emergency rulemaking in response to the legislative changes.
NCSHA’s Williams expects to see other states follow and start to put in writing what their initial steps will be to address the program reforms.
“Every person that I’ve talked with generally believes that in states where volume cap allocations are limited today, volume cap allocations will be limited tomorrow,” Hollis says. “In states where you have allocating agencies that have a limit of say 55% of eligible basis today will likely lower their threshold to maybe about 30%. I think everyone feels strongly that where there is that threshold percentage limitation on cap, we will see that drop back some. So, if it’s 55% today, maybe it’s 40% or 35%. I doubt anyone goes to 25% because that gives no cushion.
“In many states, there is more demand for bond volume cap than there is available supply. For example, Texas is one of these states, and it has been allocating a project up to 55% of its eligible basis because there is pressure on the state volume cap and officials doesn’t want to over-allocate to a project. States like Texas that are oversubscribed for bonds may be more likely to lower the threshold than those that don’t have a big demand.”
Recommendations for Volume Cap Allocation
Based on some research, most 4% deals can support permanent debt equal to roughly 35% to 45% of the project’s aggregate basis. There are exceptions to this on both sides, but this is a general assessment nationally, based on the thousands of deals closed, explains Neumann.
“If issuers begin to limit volume cap too restrictively (with the intent to allocate cap only to the minimum amount needed to meet the 25% test), those transactions that can support additional permanent debt would be forced to make up that difference in the form of taxable debt (or recycled tax-exempt bonds as discussed below),” he says. “In the current interest rate environment, the interest rate on taxable debt can be anywhere from 60 to 100 basis points higher than on a tax-exempt alternative, and many transactions do not have sufficient cushion in the budget to absorb the lost proceeds that would stem from the higher rate.”
Neumann’s recommendation is for issuers to allocate volume cap in an amount equal to the greater of 30% of aggregate basis and supportable permanent debt. “Based on current estimates and market trends, this approach would still free up around one-third of all of the volume cap annually around the country to be redeployed to new deals, given that approximately $7 billion of the approximately $21 billion of multifamily bonds issued annually in recent years were issued just to meet the 50% test and not otherwise supportable long term,” Neumann says.
Recycled Bonds
“Recycled bonds” are previously issued private-activity bonds that were initially allocated to a multifamily housing project that can be redeployed once to a new multifamily deal. For the original bonds to be eligible for recycling, they must be refunded to the new deal within four years of the original issuance date.
While recycled bonds are not taken into account for purposes of the 25% or the 50% test and, therefore, do not generate 4% LIHTCs, they do provide the full tax-exempt benefit and can minimize or eliminate a project’s need to take on taxable permanent debt.
Several states have established a formal bond volume cap recycling program, but recycled bonds are an option under the federal tax code even in states that do not have a program in place, Neumann says.
Issues to Watch
More deals would likely lead to a greater supply of 4% LIHTCs, which could impact equity pricing absent offsetting changes in demand. The recent legislation’s phase-out of other tax credit programs, including those for renewable energy, could move some of those investors into the 4% LIHTC space.
In addition, Fannie Mae and Freddie Mac have suggested an increase in their appetite for credits in the coming year.
Still, many LIHTC leaders say the market is likely to soften at least somewhat, resulting in lower credit pricing in the near term.
Many organizations involved in tax-exempt bond transactions, including bond issuers, base their fees on the amount of bonds being issued. Many of these groups are already operating at capacity, so it will be important to monitor potential changes for these groups as they navigate the additional administrative burden and increased staffing needs as a result of the projected growth in volume of deals, notes Neumann.
NCSHA’s Williams also points to the importance of other financing in deals. “Many states— large and small, red and blue, every part of the country—have made a historic commitment to housing in the last four or five years. Much of that investment has gone into LIHTC developments. Hopefully, they will continue to want to make these investments, and many will hopefully be able to.”
However, developers and states could face growing pressures. Recent federal budget proposals have called for severe cuts to key housing and safety-net programs. For example, a recent House bill eliminates HOME Investment Partnerships Program funding, which NCSHA estimates are in about 15% to 20% of LIHTC deals.
Federal cuts could potentially force states to reduce investments they’ve been making in housing in order to support health care or other needs, according to Williams.
While unknowns remain, officials are optimistic about the prospects of bond deals in the months ahead. Williams and others say they have not heard any major issues with the lowering of the bond test.
“The folks who put these provisions into the bill consulted with the industry to get the language right,” Mullen says. “It’s clear what deals qualify and when and how. It’s something that can be implemented immediately without waiting for IRS guidance. That’s a good thing.”
