Affordable Housing Compliance
July 06, 2022
By James Hill and Cheryl Post
An Introduction to Affordable Housing Compliance Testing
Congratulations, you have successfully developed your Low-Income Housing Tax Credit (LIHTC) property, received your allocation of tax credits and are now subject to annual compliance testing. In addition, your property may be required to file an audited financial statement so you will need to thoroughly read the signed documents. You are probably thinking, what does annual compliance testing mean? Let’s explore the key compliance areas that will be tested.
The regulatory agreement establishes the guidelines you have agreed to comply with when operating the property. For your LIHTC property, the agreement will detail the number of units that must be rented to families that qualify at the 20%, 40%, 50% and 60% of area median income limits as determined by the Department of Housing and Urban Development (HUD). The income and rent limits are published annually by HUD and are prepared by the state and county where the property sits. The income limits are based on the number of people in a unit and the rent limits are based on the number of bedrooms in a unit.
You will meet annually with each tenant to collect the necessary information to complete the tenant income certification (TIC). The TIC will be a component of the better software packages but can also be found on your local state agency website. The TIC is completed with the following information: household composition, gross annual income, and income from assets. The software will perform the calculations and allow you to enter the maximum income and rent limits which are compared to the calculated amounts to determine the percentage of area median income for the tenant.
The initial TIC is critical to the project’s compliance, since it establishes the tenant’s eligibility at move-in. Once a tenant is eligible, they remain eligible even when their income exceeds the maximum amount established by HUD. At that point, the tenant no longer qualifies for subsidy and will pay the maximum rent for that unit. If the tenant’s income exceeds the maximum income limit by 140% then the project will be subject to the next available unit rule. The next available unit rule means exactly what it says, the next available unit must be rented to an eligible tenant. This rule will only be a concern if your property is not 100% tax credit property.
On an annual basis, you are required to submit to the state agency the Owner’s Certificate of Continuing Program Compliance along with the rental schedule attachment. Both forms must be submitted through the state agency’s automated web entry system by January 31. The Owner’s Certificate of Continuing Program Compliance must be completed in its entirety and signed by the owner to avoid noncompliance with program requirements. The submission for the first year of compliance will also require you to submit IRS Form 8609.
Now that you understand the compliance testing areas, let’s discuss the tax considerations and implications for non-compliance. Since the LIHTC was created, it has subsidized over 41,000 projects and over three million housing units in the United States and in fact is the largest source of affordable housing financing.
The LIHTC is made up of two major credit types, the 4% credit and the 9% credit. The credits are taken by the investors every year for ten years and are calculated as 4% or 9% of the project’s qualified basis. The 4% credit is awarded through the federal government and does not affect a state HFA’s annual allocation of credits. The 4% credit is for projects that are already receiving most of their funding through tax-exempt bonds or other government subsidies.
The 9% credit is awarded through a competitive allocation process by the state HFAs. Each state has developed a qualified allocation plan and the criteria for each state is different. The states do have several similar goals in that most of the state HFAs are looking for which are number of affordable units, project cost thresholds and the quality of the housing.
LIHTC projects receive either the 4% or the 9% credit, but they cannot get both credits for the same project. The 4% and 9% credits, after the ten-year stream of credits, roughly equate to 30% and 70% of the qualified basis. The final value of the 4% and the 9% credits are called the Appropriate Percentages and are set by the IRS.
In a perfect world the low-income housing project delivers the LIHTC to is owners over ten years, otherwise known as the tax credit period; and the property earns the credits over 15 years, otherwise know at the compliance period. These credits are reported on Form 1065 Schedule K and Form 8586 and are passed through to the owners on Schedule K-1. Since the credits are earned over 15 years but are claimed over ten years, there is a portion of the credits that are being claimed in years one through ten that have not yet been earned. These credits are referred to as the accelerated portion of the credits.
If the low-income housing projects fails to operate as was planned, the accelerated credits may have to be returned (recaptured) to the IRS proportionate to the percentage of the project that is failing to operate as planned. There are three triggers that can cause recapture: disposition, noncompliance, and casualty loss.
The sale of LIHTC property before the end of the compliance period to a new owner can trigger the recapture of the credits that were previously claimed by the original owner, since the original owner is not fulfilling their duties to operate the low-income property for the remainder of the compliance period. This recapture was mitigated through the passing of The Housing Act of 2008. LIHTC property sold after July 30, 2008, can avoid recapture if it is reasonably expected that the building will continue as a low-income housing building for the remainder of the compliance period. Before this July 30, 2008, date the old owner would have to post a surety bond to avoid recapture.
Noncompliance happens when previously qualified units of the project no longer qualify for the program. This can happen by moving an over-income household into a low-income unit, charging rents above the applicable limit, leasing on a transient basis or a variety of other compliance related issues. The items of noncompliance are reported to the IRS by the state HFA on Form 8823. Obviously, mistakes will happen, and the project owners must correct any noncompliance within a reasonable period after the noncompliance is discovered or reasonably should have been discovered. If the correction is made, then there is not a recapture of the credits.
The third trigger is a casualty loss in which there is a decrease to the eligible basis of the property due to a casualty loss of some kind. Casualty losses do not automatically trigger recapture, and the owners of the property have an opportunity to restore the property without penalty of recapture if the damage is repaired within a reasonable time (not to exceed two years from the close of the year that the casualty loss occurred). In the year of the loss the credits should not be claimed, but the owners do not need to recapture any previously claimed credits. There are special rules for federally declared disaster areas. The property must still be repaired within the two-year time frame, but credits can still be claimed in the loss year if the repairs are not completed by the end of the year of the loss.
If one of the triggers for recapture cannot be corrected timely, then the low-income housing project reports the recapture of the LIHTC on Federal Form 8611. Affordable housing compliance and tax compliance can be a lot of work, but with proper planning and documentation you can avoid any recapture issues, fund your project with investors looking for LIHTC, and provide much needed low-income housing units to many areas.