3 Household Changes to Watch for at Annual Recertifications
If you manage a mixed-income site, you’re probably gearing up to kickstart annual recertifications as a result of the expiration of IRS Notice 2021-12. This notice temporarily postponed the income recertification requirement for owners until Sept. 30.
As recertifications begin again, you may discover that there have been many changes with your households since the recertifications were last conducted before the COVID-19 pandemic began. Incomes may have changed; household members may have decided to exit the workforce and become full-time students; or household compositions have altered. We’ll go over how these changes can affect your site’s compliance with LIHTC program rules and what you must do to protect your site’s tax credits after discovering these changes.
Income changes are important to track because when a household’s income rises above tax credit program limits, you have to comply with an IRS rule known as the “next available unit” (NAU) rule. If the appropriate NAU isn’t rented to a qualified, low-income household, the IRS may take back credits that the owner has already claimed and bar the owner from taking credits in the future.
The NAU rule applies whenever a household’s income rises above 140 percent (or 170 percent at deep rent-skewed sites) of the tax credit program’s income limits. In general, the rule permits units occupied by households whose income exceeds 140 percent of the maximum allowable income (or 170 percent of deep rent-skewed limits) to remain eligible for tax credit purposes, but only if you rent the next available market-rate or rent-restricted unit of comparable or smaller size in the same building to a qualified, low-income applicant [Internal Revenue Code §42(g)(2)(D)].
Drop in income. In most instances, you’ll probably find that many of your site’s households income fell over the past year. The sudden drop in consumer demand in the early months of the pandemic had a disastrous effect on employment. According to the U.S. Bureau of Labor Statistics, the national unemployment rate climbed as high as 14.8 percent in April 2020 before dropping to 6.2 percent in February 2021.
It’s possible that a household that was over 140 (or 170) percent of the maximum allowable income at the last annual certification has fallen back below 140 (or 170) percent with the current one. If the household falls back below the income limits and you have no other households above 140 (or 170) percent of the maximum allowable income, the NAU rule no longer applies.
Increase in income. However, if you discover that a household earns more income than it did at its last annual recertification, to the point where it’s now considered over-income, the NAU rule applies. You don’t have to evict or transfer the household. Instead, you must rent the next available unit of comparable or smaller size in the same building to a qualified low-income household at the tax credit rent.
Student Status Changes
Whenever you certify or recertify a household, you must ask the household whether any members are full-time students or were full-time students at any time during the past calendar year. It may be the case that some of your households have opted to pursue additional schooling or vocational training due to the uncertainties in the labor market.
If you find that some or all of a household’s members have changed their student status, the household might violate the student rule. Tax credit rules bar households composed entirely of full-time students. According to Chapter 17 of the Audit Guide for Completing Form 8823, for the LIHTC program, a student who’s a full-time student for any portion of five months out of the current calendar year is considered a full-time student for the entire calendar year. The months don’t need to be consecutive [Treas. Reg. §1.151-3(b)].
Also, the determination of student status as full- or part-time should be based on the criteria used by the educational institution the student is attending. An educational organization, as defined by IRC §170(b)(1)(A)(ii), is one that normally maintains a regular faculty and curriculum, and normally has an enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The term “educational organization” includes elementary schools, junior and senior high schools, colleges, universities, and technical, trade, and mechanical schools. It doesn’t include on-the-job training courses.
Exceptions. A household consisting entirely of full-time students may not live in a tax credit unit unless at least one household member falls under one of several exceptions:
- A student receives assistance under Title IV of the Social Security Act (TANF);
- A student was previously in the foster care program;
- A student is enrolled in a job training program receiving assistance under the Job Training Partnership Act or under other federal, state, or local laws;
- The household is comprised of single parents and their children, and such parents are not dependents of another individual, and such children are not dependents of another individual other than a parent of such children. In the case of a single parent with children, the legislative history explains that none of the tenants (parent or children) can be a dependent of a third party; or
- The household contains a married couple entitled to file joint tax returns.
If no exceptions apply, you risk losing tax credits on the unit if your state housing agency audits the site and finds the unit out of compliance. If you determine at a household’s recertification that it violates the student rule, do one of the following to protect the owner’s tax credits:
- Transfer the household to a market-rate unit (ideally at higher rents);
- Let the household stay in its unit, but raise its rent to market rate (if you no longer need to count the unit as low-income); or
- Refuse to renew the household’s lease.
Household Composition Changes
It may be the case that your household has added another member or lost a member since the last recertification. In cases where you find that there’s an extra person living in the unit, compared with the occupants you listed for that unit at the household’s last annual recertification, depending on who the new occupant is, you may need to count him as a household member. If the additional occupant is a guest or live-in aide, you aren’t required to count the occupant as a household member. However, if he or she is a foster child or foster adult, you would count the additional occupant as a household member.
New member joins household. Additional household members can be problematic because adding the new member’s income to the household’s total can make the household over-income, triggering the NAU rule. When considering if a household with additional members is over-income, be sure to switch the income limit you use to reflect the addition of the new member. For example, if you find that a three-person household has an additional member, you would use the four-person limit for your area instead of the three-person limit [Handbook 4350.3, par. 3-6(E)(2)].
If adding the new member will cause the household to go over income, you can allow the household to add the member, and rent the next available unit of comparable or smaller size in the building to a new qualified low-income household; or refuse to let the household add the new member.
Member leaves household. You might not think that a household can go over income simply by losing one of its members. After all, if a household member dies, for instance, no income is added to that household’s total. And if the deceased household member had been earning income, the household’s total income will now drop as a result of the member’s death.
But losing a member can cause a household’s income to exceed 140 percent of AMGI. Remember, income limits are based on household size. So if a household member leaves, you must switch to a lower income limit at the household’s next annual certification, based on the smaller household size. Using this lower income limit makes it less likely that the household’s income will stay below the acceptable limits. And if the departing household member earned little or no income, it’s even more possible that the household’s new total income (without that member) will exceed 140 percent of AMGI.
No Annual Recertifications at 100 Percent LIHTC Buildings
Under IRC §142(d)(3)(A), as amended by the Housing Assistance Tax Act of 2008, owners aren’t required to complete annual income recertifications if the building is part of a 100 percent low-income project. However, for purposes of applying the NAU rule only, all households documented as initially income-qualified households are treated as initially income-qualified as long as the owner demonstrates due diligence when completing the initial income certification.
In other words, owners of 100 percent LIHTC buildings, where all the residential units are low-income units, typically don’t have to worry about violating the NAU rule and don’t have to complete annual tenant income recertifications. This is because tax credit law allows low-income units to remain qualified even when a household goes over-income. Also, at 100 percent low-income unit sites, the NAU is theoretically rented to a qualified household anyway.
However, in passing the Housing Assistance Act of 2008, lawmakers didn’t specifically rule out 100 percent LIHTC projects from the application of the NAU rule. So, what happens if an owner unintentionally rents a unit to a nonqualified household?
It turns out that when an owner unintentionally rents a unit to a nonqualified household, being able to show the IRS that the mistake was unintentional and a result of exercising “ordinary business care and prudence” when income qualifying new households is necessary to stay compliant.
IRS examiners will look at whether your site’s initial tenant certifications are timely, accurate, and complete. Here are some basic questions an IRS examiner might ask when considering whether the owner’s tenants are income-qualified:
- Have all the potential sources of income been identified?
- Was income verified with third parties?
- Are the methods for estimating income reasonable based on the facts?
- Was the correct income limit used?
- Was the computation correct?
- Is the documentation sufficient?
Auditors will also evaluate an owner’s internal procedures. In evaluating your processes, an examiner might ask:
- What oversight does an owner provide a property manager? Is the property manager trained?
- Are written procedures in place for qualifying households? Who makes sure the procedures are followed? Is there a review process?
- Does the owner use standardized forms?
- Does the owner conduct independent internal audits?
- What happens if noncompliance occurs?
- Are households monitored for changes in family size?
- How are the files maintained?
If the IRS determines that a 100 percent LIHTC site owner has shown enough business care and prudence in qualifying households, an IRS audit showing that one household wasn’t income-qualified at the time the household moved into the unit would be considered unintentional. The applicable fraction will be recomputed and the allowable credit for the year will be less. And the IRS wouldn’t determine that the taxpayer violated the NAU rule.
However, if the IRS determines that a 100 percent LIHTC site didn’t exercise proper care and diligence when certifying household income, it would conclude that the owner rented to over-income households intentionally, disregarding the NAU rule, and the building’s qualified basis would be reduced to zero. And no credit would allowable until the owner can establish compliance with the NAU rule.