Pros & Cons of Tax Credit Fund Investing

Tax credit funds are investments that grant the ability to reduce the amount of taxes that you pay on a dollar-for-dollar basis. They are typically tied to socially desirable investments like low-income housing or projects using renewable energy, giving you the opportunity to make money while theoretically helping the community. They carry a unique mix of benefits and risks.

Socially Responsible Investing

Investing in tax credits means that you're investing in projects that should be good for society. Credits get issued for projects like restoring historic buildings, constructing housing for seniors and low income individuals, and installing green energy systems. In fact, they're such an effective instrument of social good that many banks buy into tax credit funds just to meet their obligations under the Community Reinvestment Act.

Healthy Yields

When you invest in tax credit funds, you're getting two types of returns. First, many tax credit investments are fundamentally sound investments, even without the tax credits. For example, many tax credit properties are positioned to serve the growing senior market. In addition, the credits that come with the funds can be very valuable, especially if you are an investor in a high tax bracket. From the period from 1991 through 2008, yields on tax-credit housing properties were always higher than yields on treasury bonds or tax-free municipals -- in many cases by more than 300 basis points.

Limited Supply

Tax credit funds aren't always easy to find when you're an individual investor. Many of the low-income housing funds that were created by companies like Centerline Capital and Boston Capital have closed to new investors as of the date of publication. However, funds related to green energy remain readily available.

Compliance Risks

The biggest risk in tax-credit investments is that the right to collect the tax credits will go away. With energy investments that frequently generate tax credits over a short period of time, this risk is less significant. Investments with credits that flow over a long-term, though, like low income housing, require careful management to ensure that the underlying assets remain in compliance. Unfortunately, if the project falls out of compliance, the investor will have little to no recourse when the IRS comes to collect his taxes.

Highly Complicated Investments

Tax credit funds aren't like regular mutual funds. Frequently, to take advantage of them, you will need to invest in a limited partnership. Furthermore, to receive credits, you must invest at the right time, in the right amount, and in the right fashion. Once you're invested in a fund, you also might not be able to sell your interest until the fund allows you to. Finally, you may also need to take business risk related to the project to get the credit.

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About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.

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