LIHTC gap financing: HOME, HTF, CDBG, trust funds and seller notes

Almost every 4% deal, and many 9% deals, has a gap: total cost minus equity minus the first mortgage. The worked deal in how LIHTC financing works has a $9.3 million gap on 120 units. Closing it is usually the longest part of predevelopment, because each source has its own application cycle and its own strings.

The sources

Source	Administered by	What it adds to the deal	Primary rules
HOME Investment Partnerships	Participating jurisdictions (states, cities, counties, consortia)	HOME rent limits on assisted units; 90% of HOME rental units for households at or below 60% AMI; affordability period of 5 to 20 years; Davis-Bacon if 12 or more HOME units	24 CFR Part 92; 2025 HOME final rule, 90 FR 870
Housing Trust Fund (HTF)	States and state-designated entities	Units for extremely low-income (30% AMI or below) and very low-income households; rents capped at 30% of the greater of 30% AMI or the federal poverty line for ELI tenants; 30-year minimum affordability	24 CFR Part 93
CDBG	Entitlement cities, counties and states	Acquisition, site work, infrastructure, rehab; new construction of affordable housing now eligible up to 20% of the allocation (amounts appropriated after July 11, 2026)	Pub. L. 119-101 sec. 204; 42 U.S.C. 5305
CDBG-DR	Grantees named in disaster appropriations	Disaster recovery housing under each allocation’s Federal Register notice	Federal Register notices per allocation
FHLB AHP	Federal Home Loan Banks, through members	Grant or subsidized advance; at least 20% of units at or below 50% AMI; 15-year retention	12 CFR Part 1291
State and local housing trust funds	State HFAs, cities, counties	Varies; usually deeper targeting, longer affordability, local preferences	Each program’s guidelines
State LIHTC	State HFAs	Additional credit equity rather than a loan	State LIHTC programs
Seller financing	The seller, usually in preservation deals	Acquisition note, often accruing, paid from cash flow or at exit	Bona fide debt principles
Deferred developer fee	The developer	The developer’s own earned fee left in the deal	Developer fees

What changed in 2026

The 21st Century ROAD to Housing Act (Pub. L. 119-101, enacted July 11, 2026) made three changes that reach the gap layer (text):

1. CDBG new construction (sec. 204). New construction of affordable housing, as HOME defines it in section 215 of the Cranston-Gonzalez Act, is now an eligible CDBG activity, limited to 20% of the amounts allocated to the recipient. The low- and moderate-income benefit rule now covers new construction too. It applies only to funds appropriated after enactment, so most 2026 CDBG money still runs under the old rules.
2. HOME reauthorization (sec. 501). HOME is now permanently authorized. The CHDO definition was loosened, HUD can’t restrict a participating jurisdiction’s choice among eligible activities unless the statute authorizes it, and jurisdictions that don’t receive CDBG may use HOME for infrastructure directly related to, and within or immediately adjacent to, HOME-assisted or section 42 housing. The rental income targeting rule (90% of HOME units at or below 60% AMI) did not change.
3. Bank public welfare investment cap (sec. 203). National banks and state member banks may now hold public welfare investments up to 20% of capital and surplus, up from 15%. That is credit equity capacity rather than soft debt, but it affects how much of the stack needs to be gap money.

Grants vs loans: the basis problem

Under IRC 42(d)(5)(A), eligible basis excludes any costs financed with the proceeds of a federally funded grant. A $1,000,000 HOME grant spent on construction cuts eligible basis by $1,000,000, and in a QCT the boosted basis by $1,300,000. At a 4% rate that’s $52,000 a year of credit, or $520,000 over 10 years, worth about $426,000 of equity at $0.82.

The fix is structural: the jurisdiction lends the money to the partnership, at a low or zero rate, repayable from residual receipts or at maturity. A loan with real terms is debt, not a grant, so the costs it pays for stay in basis. A common pattern is the jurisdiction granting to a nonprofit sponsor, which lends to the partnership. Get tax counsel’s read on the specific structure, because form alone doesn’t settle it.

Residual receipts: who gets paid when

Soft lenders are repaid from cash flow after operating expenses, reserves and first-mortgage debt service, and they share that cash with the deferred developer fee and partnership fees. A typical waterfall:

1. Operating expenses and required reserves
2. First mortgage debt service
3. Investor asset management fee
4. Deferred developer fee, often first claim on remaining cash until paid
5. Soft lenders, frequently splitting the remainder with the general partner (local programs set the split)

Investors look hard at step 4. A deferred fee that can’t be paid within the period they require may have to come out of basis. When soft lenders insist on sharing cash before the fee is repaid, the fee takes longer to pay off, and the investor may cut the credit it underwrites.

Stacking rules: the strictest one wins

A unit with HOME, HTF and LIHTC must meet all three sets of rules at once:

Rule	LIHTC	HOME	HTF
Income at move-in	Up to the elected set-aside level (60%, or 20-80% designations under averaging)	90% of HOME units at or below 60% AMI; the rest at or below 80%	ELI or VLI per program targeting
Rent cap	30% of the imputed income limit, including utility allowance (42(g)(2))	High and Low HOME rents (92.252)	30% of the greater of 30% AMI or the federal poverty line for ELI; 30% of 50% for VLI (93.302)
Term	15-year compliance period plus extended use of at least 15 more years (42(h)(6)(D))	5 to 20 years	At least 30 years
Utility allowance	26 CFR 1.42-10 methods	Set by the participating jurisdiction	Set by the grantee

Note one convenience in the HOME rule: a Low HOME Rent unit can meet its rent test by being a LIHTC unit with rents no higher than the section 42(g)(2) gross rent limit (24 CFR 92.252(a)(2)(iii)). Check whether your jurisdiction uses that option.

Seller notes in preservation deals

When a nonprofit or long-time owner sells an existing property into a new tax credit partnership, the price often exceeds what the new first mortgage and equity can pay. The seller takes back a note for the difference. For the acquisition basis to hold up, the note should look like real debt: stated interest, a maturity date, security, and a reasonable expectation of repayment from cash flow, refinancing or sale. IRS examiners look at these notes in LIHTC audits; see IRS Publication 5913 and the Form 8823. Acquisition credits also require the 10-year rule to be met or waived.

A practical sequence

1. Size the gap with the capital stack builder using conservative equity pricing.
2. Map which sources open when: local NOFAs, HOME and HTF cycles, the 9% round or bond cap calendar. Many QAPs score committed local funds.
3. Design the unit mix once for all sources; the income averaging tool can test deeper targeting against rent loss.
4. Get term sheets that say loan, rate, term, repayment source and subordination.
5. Confirm subordination and standstill terms with the first mortgage lender before you accept a soft commitment.

The Janover Capital desk can rerun the first mortgage as the soft-fund mix changes.