Credit Where Credit Is Due: Surviving an IRS Audit of the Low-Income Housing Credit

In 2015, a prominent developer pleaded guilty to two counts of conspiracy to commit theft of government money. The developer’s scheme involved submitting inflated construction contracts to the Florida Housing Finance Corporation in order to apply for more federal low-income housing credits than the company was entitled to claim. The inflated contracts resulted in the loss of $34 million to the program.

While the developer’s actions were deliberate attempts to defraud the United States government, partnerships may unknowingly run afoul of IRS requirements to maintain eligibility for the low-income housing credit. Partnerships involved with claiming the credit should take action to confirm they are in full compliance with all IRS requirements.

What Is the Low-Income Housing Tax Credit?

The Low-Income Housing Tax Credit (“LIHTC”) was created in 1986 as an incentive to build and maintain housing for low-income individuals. While the credit is authorized at the federal level, the program is administered by state housing authorities. These housing authorities are responsible for selecting which taxpayers qualify for the credit through a competitive application process governed by a Qualified Allocation Plan. Through this process, the state housing agencies determine how much of the credit each applicant is eligible to claim.

Once awarded, a taxpayer may claim the credit over a ten-year credit period. However, the obligations extend well beyond that period. The taxpayer must maintain compliance with the LIHTC rules for 15 years and is generally bound by an extended use agreement for at least 30 years from the start of the compliance period.

As with most credit programs, there are many regulations prescribed by the IRS that must be followed by taxpayers in order to qualify for and maintain credits throughout their ten-year life.

How the IRS Audits LIHTCs

IRS examinations of partnerships claiming LIHTC credits are not as common as some others because of the immense oversight required to apply and become eligible for low-income housing credits at the state level. However, the risk of examination is not negligible. The IRS LIHTC Compliance Unit actively reviews noncompliance reports filed by state agencies on Form 8823. A single filing by a state agency may be sufficient to trigger an IRS audit. If a taxpayer that claimed low-income housing credits is selected for audit, there are several key issues that the IRS will review for compliance.

1. Form 8609, Low-Income Housing Credit Allocation and Certification

Form 8609, Low-Income Housing Credit Allocation and Certification is issued by a state agency to establish a taxpayer’s eligibility to claim the LIHTC. Form 8609 is first approved by the state agency and is used to allocate the credit dollar amount, assign a building identification number, and state the minimum qualified basis under IRC Sec. 42. Part I of the Form is completed and signed by the state housing agency. Part II is completed by the taxpayer and filed with the IRS as the first-year certification required under IRC Sec. 42(l)(1). This Form is a required component of the tax return claiming the credit. If a taxpayer cannot produce a fully executed Form 8609 during an examination, the IRS may disallow the entire credit for all open years. This makes securing and retaining Form 8609 one of the most important recordkeeping obligations in the program.

2. Form 8823, Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition

Form 8823, Low Income Housing Credit Agencies Report of Noncompliance or Building Disposition is the formal communication from a state agency to notify the IRS of noncompliance with the LIHTC requirements. Form 8823 is used when a state housing agency determines that a taxpayer is noncompliant or has failed to provide required certifications or records upon request. When the state determines that a taxpayer is noncompliant, it must notify the taxpayer and allow for a correction period of 90 days. The correction period may be extended up to six months for good cause. After the correction period, the state agency is required to file Form 8823 with the IRS to inform the agency of the noncompliance. Examples of noncompliance include failure to meet the minimum set aside tests, health and safety violations, rent restriction violations, and failure to conduct required physical inspections. Importantly, a filed Form 8823 is reviewed by the IRS LIHTC Compliance Unit and is one of the most common triggers for a formal IRS examination.

3. Eligible Basis

A taxpayer’s eligible basis is a frequent focal point of IRS examinations. The IRS may review a LIHTC claim when there is a discrepancy between the eligible basis reported on the tax return and the cost certification submitted to the state housing agency. Taxpayers generally have issues with basis where improper nonqualifying costs are added to the property’s basis. Improperly including non-qualifying costs may lead to IRS downward adjustments in eligible basis, which could result in recapture. Common examples of costs that do not qualify to be included in basis include land costs, costs financed with federal grant proceeds, and inflated developer fees.

4. Tenant Income Certification Files

Maintaining robust tenant files is essential to demonstrate that each unit in a LIHTC building meets and maintains compliance with the program’s income and eligibility requirements. Deficiencies in tenant files may jeopardize a unit’s status as low-income housing. Annual income certifications and supporting third‑party documentation must be obtained and kept for each low‑income tenant. A taxpayer’s failure to properly verify or document a tenant’s income is an issue that could lead to a Form 8823 filing by the state housing authority. Generally, a tenant file will include income verification documenting that the tenant qualifies for low-income housing. The file may also include a self-certification that certifies that the tenant’s household assets are valued under $5,000. In addition, student status must be verified at move-in and confirmed annually. Units occupied entirely by full-time students do not qualify as low-income units unless a specific exception applies under IRC Sec. 42(i)(3)(D). Exclusions for student status include where the household consists of a single parent and children and married students who file a joint return.

If a taxpayer claiming the LIHTC is selected for audit, the best defense is good recordkeeping. It is important to make sure to retain copies of Form 8609, cost certifications, tenant income certification files, and evidence of loans in case of audit.

LIHTC compliance is a long commitment, and even well-run partnerships can find themselves answering IRS questions years after a project is placed in service. If you need help with documentation or have received communication from the IRS, our Tax Controversy & Dispute Resolution team is here to assist. Contact us below if you have questions.