How 4% LIHTC and Tax-Exempt Bonds Actually Work Together
The 4% Low-Income Housing Tax Credit and tax-exempt bond financing are so frequently discussed as a package that they're often treated as a single instrument. They're not. They're two separate financing tools that interact in specific ways — and understanding how they work together is essential for evaluating whether a 4% deal is the right structure for a given site.
The basic relationship
The 4% credit is generated by projects financed with tax-exempt bonds. Unlike the 9% credit — which is allocated competitively through state QAPs — the 4% credit is available to any project that meets the requirements. Historically, a project needed 50% or more of its aggregate basis (land plus depreciable property) financed with proceeds from qualified tax-exempt bonds to qualify.
The One Big Beautiful Bill Act (signed into law in 2025) permanently reduced that threshold to 25% for buildings placed in service after December 31, 2025, provided at least 5% of aggregate basis is financed with bonds issued after that date. This is a significant expansion — it allows states to spread volume cap across more projects, unlocking 4% credits for deals that previously couldn't clear the 50% threshold. Most of the expected increase in LIHTC production volume going forward is expected to come from this change rather than from the Act's separate 12% increase in 9% credit allocations.
The 25% threshold is now the critical gate. Projects that barely clear it use bond financing more efficiently than projects that use bonds well beyond it. Understanding this threshold shapes how deals are structured.
Where the bonds come from
Tax-exempt bonds used in 4% LIHTC transactions are typically issued by state housing finance agencies or local housing authorities. The bonds are subject to state volume cap — the total amount of tax-exempt private activity bond authority each state receives annually from the federal government.
Volume cap is a real constraint. In states where demand for bonds is high — California being the most prominent example — volume cap can be scarce, and securing a bond allocation requires navigating a competitive or queue-based process at the state level. In many other states, volume cap is more accessible, which makes 4% deals more straightforward to execute.
The reduction of the threshold to 25% means a given amount of volume cap can now support a larger number of projects — each project needs less bond financing to qualify — which should meaningfully expand 4% deal volume in constrained markets over time.
Understanding volume cap availability in your target market is a fundamental part of evaluating whether a 4% structure is realistic for a given deal on a given timeline.
How the equity and debt interact
In a 4% deal, the tax credit equity generated is lower per dollar of eligible basis than in a 9% deal — roughly 30-33 cents on the dollar at current pricing versus 90+ cents for 9% credits. The lower equity yield is offset by the tax-exempt bond proceeds, which serve as the primary debt instrument at below-market rates.
The capital stack for a typical 4% deal looks something like this: tax-exempt bond proceeds provide the primary construction and permanent debt; 4% LIHTC equity covers a meaningful but smaller share of total development cost than 9% equity would; soft debt fills the remaining gap.
Because 4% equity is lower, 4% deals generally require more soft debt per unit than comparable 9% deals — or they work in markets where restricted rents are high enough to support significant conventional debt service.
When 4% with bonds is the right structure
Several deal characteristics favor 4% over 9%:
Large deal size. 9% credits are allocated in fixed annual amounts. Very large deals may require more credits than a competitive round can realistically award to a single project in most states. 4% deals don't have this constraint — as long as bond volume cap is available, the credit generated scales with deal size.
Markets where 9% competition is intense. In states where winning a 9% allocation is highly competitive and uncertain, 4% provides a path to tax credit equity without going through the competitive QAP process. The trade-off is lower equity per unit, but the certainty of access has real value.
Preservation deals. Many preservation transactions — acquiring and rehabilitating existing affordable housing — are structured as 4% deals because the acquisition cost is significant and the rehabilitation scope may not require the full cost basis that 9% deals typically need.
Speed. 9% deals are constrained by annual credit round cycles. 4% deals can be structured and submitted more continuously (subject to bond volume cap availability), which can be valuable when deal timing is driven by seller or financing constraints.
The complexity that 4% adds
4% deals are generally more complex to structure than 9% deals. The bond issuance process involves additional parties (the bond issuer, bond counsel, underwriters for public bonds), additional documentation, and additional timelines. The interaction between bond compliance requirements and LIHTC compliance requirements adds regulatory complexity that requires experienced counsel and investors.
This complexity is manageable — 4% deals close regularly — but it's real and needs to be reflected in deal timelines and pre-development cost estimates.
Alpha Deal helps development teams model 4% and 9% LIHTC capital stack scenarios during early feasibility — so the right program structure gets identified before the deal is underwritten.