Industry Looks Boldly Toward the Future as Bond Financing Threshold Requirements are Halved

For years, housing advocates have sought tweaks to the Low Income Housing Tax Credit program that intend to bolster the number of affordable units produced each year.

Recently, those advocates succeeded in their efforts, as two essential changes were codified as part of the sprawling One Big Beautiful Bill Act (H.R. 1), signed into law early last month.

The first is important, and increases the annual amount of nine percent credits by 12 percent (indexed for inflation moving forward).

However, it is the other change to the LIHTC program that advocates say will have the most significant impact for housing in the near future: a reduction from 50 to 25 percent in the amount of tax-exempt private activity bonds (PABs) required to qualify for four percent credits.

“It’s exciting – this will be, we think, the biggest change to the four percent tax credit industry in the last 20 years,” says Kent Neumann, founding member at Tiber Hudson.

Many industry leaders see this as a positive and helpful change in the ongoing effort to build more housing. “Achieving the 25 percent bond financing threshold is a major victory that will enable a significant increase in the number of affordable units that are possible using the Housing Credit,” says James Tassos, deputy director of tax policy and strategic initiatives at the National Council of State Housing Agencies.

Introducing the 25 Percent Test
Known formerly as the “50 percent test,” this rule allowed properties, whose aggregate basis costs were funded by 50 percent or more via tax-exempt PABs, to claim tax credits outside of the allocating agency’s nine percent LIHTC volume cap. These tax credits are what today is known as the four percent LIHTC program.

In addition to unlocking funding via the LIHTC program, PABs also provide low-cost capital to a project by allowing developers to receive low-interest, tax-exempt loans from investors via bond proceeds. Known in the industry as “permanent supportable debt,” these loans are then paid back to investors over time, plus interest.

Thus, the 50 percent test has historically been the mechanism by which the four percent LIHTC program has functioned. Though there are no state or federal allocation limits to the four percent LIHTC program, the federal government can functionally limit the number of four percent LIHTC projects in any given year by tying these awards to tax-exempt PABs, since states are given an annual volume cap of tax-exempt PABs that they may allocate.

In recent years, PAB allocations for affordable housing have skyrocketed, with multifamily PAB bond issuance ballooning from $6.6 billion in 2015 to over $20 billion in 2020 and the years following, according to data compiled by the Council of Development Finance Agencies (CDFA)  and published by Novogradac.

Although states can use PABs for a host of purposes, they have increasingly targeted multifamily housing. According to the April 2024 Novogradac Journal of Tax Credits, just under 20 percent of PAB issuance went to multifamily housing; by 2020, that figure increased to over 60 percent.

As multifamily PAB allocations have increased, more states have also reached their multifamily bond issuance capacity. According to April 2025 estimates from Tiber Hudson and Novogradac, only 15 states currently have unallocated bond authority, down from 18 states in 2024.

Because four percent LIHTC deals required a substantial amount of tax-exempt PABs to meet the 50 percent test, the growing number of volume-capped states meant that yearly affordable housing production would be limited.

Additionally, very few deals were able to fully utilize their bond allocation, as all deals have a set limit on the amount of permanent supportable debt they can carry. Neumann says that despite some outliers on either side, most affordable housing transactions can support long-term debt between 30 and 45 percent of aggregate basis, depending on various market factors.

“Historically, over a third of all multifamily volume cap allocated for four percent deals nationwide have been issued just to meet the 50 percent test, above what otherwise is supportable permanent debt on these deals,” Neumann says. Because of this, the extra bond issued to those four percent deals “is not really used,” creating wasted “overhang” bonds. Neumann says that simply eliminating those overhang bonds “would free up over $7 billion of the $21-plus billion annually issued for new transactions. So that’s a pretty big increase in and of itself.”

In response to these issues with the 50 percent test, advocates have for years called for a lowering of the bond threshold requirements, so that an increased number of deals can receive PAB allocations.

Now, upon the passage of July’s reconciliation bill, the 50 percent test will become the 25 percent test. The new reduced threshold will affect any deals placed in service after Jan. 1, 2026. All deals placed in service for the remainder of 2025 will still have to abide by the rules of the 50 percent test.

The new 25 percent test is “going to be a potentially large benefit,” says Judith Crosby, an attorney within the tax credit division of Kutak Rock, stressing that states with capped out PAB allocations stand to benefit the most.

Some developers and bond issuers may be interested in delaying project timelines to follow the new 25 percent test, rather than the 50 percent test. On this point, Neumann is clear: “If your deal works under the 50 percent test and is ready to close this year, we recommend moving as quickly as possible to get to closing and not delay. There are far too many variables in the current market to take that risk.”

Finding the Allocation Sweet Spot
A few decisions face state agencies as they plan their transitions into the new world of 25 percent tests.

Some of these decisions are short-term. For example, some state agencies may have already allocated bonds for deals that will close in 2026, says Tassos. These bonds may be well in excess of the 25 percent required by the new rules, and state agencies must decide how to handle those allocations – either by leaving them as is or reducing them. “In some cases, there may be no need to modify anything if the development is financially feasible as originally underwritten using the 50 percent bond financing test,” Tassos says.

Another, longer-term consideration is whether state agencies will develop policies on the amount of bond financing to provide individual deals.

Though the 50 and 25 percent tests act as floors—and thus don’t limit the maximum amount of PABs issuable to deals—allocating authorities generally play close to the vest to maintain future PAB volume cap.

However, cost overruns and project delays usually mean that final aggregate basis numbers end up higher than they were at the time of original issue, necessitating “cushion” allocations that are slightly higher than the minimum threshold, to build a buffer and avoid missing the test. “If you miss it even by a little bit, it’s catastrophic,” says Neumann. “You can try to reduce your aggregate basis, and usually that means cutting developer fees, which is pretty painful.”

Typically, states issued around 55 percent of aggregate basis under the previous bond threshold rules. Now, “states may consider a similar cushion (potentially 30 percent of aggregate basis) to the optimal amount of bond financing to provide developments under the new 25 percent threshold test,” says Tassos

However, even the 30 percent aggregate basis issued with a cushion under the 25 percent test may not be enough to cover a deal’s permanent supportable debt. This would leave deals with gaps that must be closed with capital that is harder to find or more costly than tax-exempt PAB proceeds.

Neumann says that issuers will now have to find the balance between utilizing bond volume cap to fund more deals and allocating enough PABs to fully support deals that receive allocation. “Although most transactions can’t support 50 percent of aggregate basis, they can support over 25 percent of aggregate basis,” he says.

In situations where issuers only allocate the minimum threshold (plus a cushion) to meet the 25 percent test, Neumann says that developers may now have to seek out supplementary debt sources to fund the deal. These sources are likely to be far more expensive than tax-exempt PABs. “The most likely scenario is that transactions will have to do taxable debt of some kind, which is trending anywhere from 75 to over 100 basis points higher interest rates,” than tax-exempt PABs, he says. “That can make the financing much more expensive compared to using all tax-exempt debt.”

Because of this conundrum, Neumann advocates a “thoughtful” approach to new state regulations surrounding PAB allocations, urging issuing authorities to “come up with new criteria that don’t just automatically cut deals to the minimum.”

The most workable solution, Neumann says, is for state agencies to issue the greater of either 30 percent of aggregate basis or the full amount of PABs that could fund a project’s maximum permanent supportable debt, which he estimates will generally fall in the 35 to 45 percent range. “If developers are able to get that slightly higher amount of volume cap from the state, they can build their entire permanent capital debt stack as tax-exempt, getting that lower competitive interest rate and being able to move forward.”

Despite this guidance, some states are already preemptively limiting the amount of bonds that a project can apply for. For example, the Indiana Housing & Community Development Authority (IHCDA) released a notice on July 9 that limits bond volume applications beyond Nov. 1, 2025 to between 25 and 30 percent aggregate basis. A complete list of states with published 25 percent test policies is available via National Housing & Rehabilitation Association.

The Future of Bond Recycling Under the 25 Percent Test
One potential gap-filler for projects left needing extra tax-exempt PABs can come from the practice of bond volume cap recycling, a creative and nuanced method that some states have begun to employ to reallocate previously issued multifamily PABs.

Bond recycling becomes possible when a deal issues more PABs than it can use as permanent supportable debt (for example, to meet the 50 percent test). Through a carefully coordinated and regulated process, those extra bonds are then “recycled” into a new deal, which can use them to generate proceeds for the project.

Importantly, recycled bonds cannot count towards the bond threshold minimums and are thus unable to generate four percent LIHTCs.

Until recently, bond recycling was underutilized, since most deals were receiving an excess of bonds under the 50 percent test. However, now that the 25 percent test will leave more deals needing extra tax-exempt PABs, bond recycling can allow savvy state agencies to be “very strategic” about bond deployment, says Neumann.

Rather than allocating the full amount of new PABs towards a deal’s permanent supportable debt, an agency can instead allocate the 30 percent needed to meet the 25 percent test and fold in recycled bonds for any additional supportable amount, allowing developers to maximize the amount of tax-exempt capital in their debt stack while also allowing jurisdictions to preserve the rest of their PAB volume for other four percent deals. “That’s the best of both worlds,” says Neumann.

Crosby concurs, noting that it may be in the best interests of states to begin exploring bond recycling programs now. “It’s not super complicated to create such a program,” she says. “You just have to put the language in the documents and do it.”

Neumann adds that his firm has helped many issuers and developers integrate recycled bonds into new deals in many states that don’t have a formal “program” but can still be managed on a deal-by-deal basis.

Bifurcating Bond Issuances to Maximize Impact
Across the country, there are a handful of potential deals in the lurch, as they are ready to move forward with closings in 2025 but wish to utilize the 25 percent test, rather than the 50 percent test. Fortunately, the new laws surrounding the 25 percent test allow for a bifurcated issuance structure, which will enable deals to receive some allocation now and some in 2026 while conforming to the 25 percent minimum bond threshold.

Under the One Big Beautiful Bill Act (H.R. 1), multiple issuances can be made and the 25 percent test can still be met, so long as the issuance made after Dec. 31, 2025 is no less than five percent of aggregate basis. “That opens up the ability to get a partial issuance of bonds this year in 2025, move forward with your project, and get comfort from the allocating authority that they will issue at least five percent of aggregate basis in 2026,” says Neumann.

Previously, bifurcated issuances only occurred in niche contexts. Now, oversubscribed states could explore spreading out some of their volume cap between fiscal years, freeing up allocation that can be used for—theoretically—an increased number of affordable housing projects.

Crosby stresses that communication and trust between issuers and developers will be necessary for these bifurcated issuances to be successful. “Investors in particular will need confirmation that second bond issuance is coming,” she says.

Though this bifurcated structure allows for a five percent issuance at a minimum, Neumann recommends generally allocating at least ten percent aggregate basis to account for potential cost overruns or inflation down the line. For example, suppose the second award is set to be exactly five percent of a project’s initial aggregate basis. Still, at cost certification, the same project’s basis has gone up by even one percent, the second bond allocation no longer meets the five percent threshold required by law. “You then have to go back for supplemental bonds, which will be very costly to issue, what could be a couple of hundred thousand or even a million dollars of bonds. You’re going to end up paying quite a bit of extra money by essentially doing another bond deal.”

“If you’re going to do this bifurcated structure, try to push more of a cushion to the 2026 issuance,” Neumann says. For example, if a developer and issuer want to achieve a total tax-exempt bond allocation of 30 percent, Neumann suggests allocating 20 percent in 2025 and ten percent in 2026.