LIHTC Compliance: A Guide to Annual Testing & Credit Recapture

Key Takeaways

• LIHTC properties must complete annual compliance testing, including tenant income certifications (TICs), to maintain their tax credit eligibility under IRC Sec. 42.
• HUD publishes income and rent limits annually by state and county. Limits are based on household size for income and bedroom count for rent.
• Once a tenant qualifies at move-in, they remain eligible even if income rises. However, income exceeding 140% of the limit triggers the next available unit rule.
• The LIHTC provides a 4% or 9% credit calculated on the project's qualified basis. Credits are claimed over ten years but earned over a 15-year compliance period.
• Three events can trigger credit recapture: property disposition, noncompliance with program requirements, and casualty loss that reduces eligible basis.
• Property owners can avoid recapture by correcting noncompliance within a reasonable period and repairing casualty damage within two years of the loss.

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 audited financial statements, so you will need to review the signed documents thoroughly. You are probably thinking, "What does annual compliance testing mean?" Let’s explore the key compliance areas that will be tested.

What Is LIHTC Compliance Testing?

The regulatory agreement establishes the guidelines you have agreed to comply with when operating the property. For your LIHTC property, the agreement will specify the minimum set aside election which may be the 20-50 test, the 40-60 test, or the Average Income Test, under which units are designated in 10% increments from 20% to 80% of AMI with an average not exceeding 60%.

How Are Income and Rent Limits Determined?

The income and rent limits are published annually by HUD based on a property’s geographic area. This typically takes place sometime in April. State housing finance agencies then implement and administer those limits for LIHTC compliance purposes. 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.

What Is a Tenant Income Certification?

You will generally meet annually with each tenant to collect the necessary information to complete the tenant income certification (TIC), although certain 100% low-income buildings may be exempt from annual recertification requirements. Owners should also confirm any state agency or investor requirements. 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.

What Happens When a Tenant’s Income Exceeds the Limit?

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 if their income later exceeds the HUD-established maximum. The reasoning is that the program’s intention is not to negatively impact someone that has improved their income. At this point, the owner needs to carefully monitor the income of the tenant. If the tenant’s income reaches a point which exceeds 140% of the applicable limit, 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.

What Are the Annual Reporting Requirements?

On an annual basis, you are required to submit the Owner’s Certificate of Continuing Program Compliance to the state agency, 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 to the state agency. In addition, Form 8609-A is filed with the federal return each year of the credit period to report the annual credit calculation for each building.

How Do the 4% and 9% LIHTC Credits Work?

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 3 million housing units in the United States and, in fact, is the largest source of affordable housing financing.

The LIHTC comprises two major credit types: the 4% credit and the 9% credit. The investors claim credits over a 10-year period, calculated at 4% or 9% of the project’s qualified basis. The 4% credit is associated with projects financed with private activity tax-exempt bonds and meet certain specified criteria. The 4% credit does not reduce a state HFA’s competitive 9% credit ceiling.

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 differ. The states do share several similar goals, including the number of affordable units, project cost thresholds, and the quality of the housing.

A LIHTC ownership entity receives either the 4% or the 9% credit, it does not receive both credits for the same project. For LIHTC purposes, the credit rate is generally referred to as the applicable percentage or applicable credit percentage, which Section 42 defines by reference to the appropriate percentage prescribed by the IRS for the relevant month.

In a perfect world, the low-income housing project delivers the LIHTC to its owners over 10 years, known as the tax credit period, and the property earns the credits over 15 years, known as 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 claimed over 10, a portion of the credits claimed in years one through 10 have not yet been earned. These credits are referred to as the accelerated portion.

What Triggers LIHTC Credit Recapture?

If the low-income housing projects fail to operate as 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. Three triggers can cause recapture: disposition, noncompliance, and casualty loss.

Disposition of the Property?

The sale of LIHTC property before the end of the compliance period to a new owner can trigger the recapture of the credits previously claimed by the original owner, because the original owner is not fulfilling their duty 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 to be used as low-income housing for the remainder of the compliance period. Before July 30, 2008, the old owner would have to post a surety bond to avoid recapture.

Noncompliance With Program Requirements

Noncompliance occurs when previously qualified units of the project no longer meet the program's requirements. 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 state HFA reports the items of noncompliance to the IRS on Form 8823. Obviously, mistakes will happen, and the project owners must correct any noncompliance within a reasonable period after it is discovered or should have been discovered. Timely correction can help avoid recapture in many cases, depending on the nature of the noncompliance and applicable IRS/state agency guidance.

Casualty Loss

The third trigger is a casualty loss, which results in a decrease in the property's eligible basis. 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.

How to Avoid LIHTC Recapture

If one of the triggers for recapture cannot be corrected in a timely manner, the low-income housing project reports the LIHTC recapture on Federal Form 8611. Affordable housing compliance and tax compliance can be a lot of work. Still, with proper planning and documentation, you can avoid recapture issues, fund your project with investors seeking LIHTC, and provide much-needed low-income housing units in many areas.

How EisnerAmper Can Help With LIHTC Compliance?

Affordable housing compliance and tax compliance require careful attention, but with proper planning and documentation you can protect your credits, attract investors, and deliver much needed low-income housing. EisnerAmper's affordable housing team works with developers, investors, and syndicators across the full lifecycle of LIHTC projects, from initial cost certification through year 15 exit.

If you have questions about your compliance obligations or need support preparing for a state agency review, contact our team to start the conversation.