Avoid Tax Credit Recapture When Permitting Employee-Occupied Units
Many tax credit sites permit a resident manager, superintendent, or similar site-level employee to occupy a unit. This arrangement may raise a red flag to state auditors if the unit is not being used as permitted in the original allocation agreement with the state. Operating in the dark with regard to an employee unit can cause the owner to lose the tax credits on the unit and possibly result in tax credit recapture as far back as the first year of the compliance period. If you know the basics about employee units and how to confirm that your employee is handled properly, you can avert these threats to the owner's tax credits.
Employee Unit Basics
The unit in which an employee is housed may be characterized under tax rules in three ways:
Common area. At the time of the original allocation agreement with your state agency, the site owner may have requested that an employee unit or units be set aside as part of the site's “common area,” thereby allowing the owner to get tax credits on that unit. In addition to areas such as swimming pools and laundry rooms, the IRS has expressly permitted units for full-time resident managers to be designated as common areas for tax credit purposes [IRS Revenue Ruling 92-61].
Tax credit unit. Some sites will use one of the tax credit units to house an employee who qualifies as a low-income resident and will handle the unit as they would any other tax credit unit. This isn't really considered an employee unit under tax credit rules, but is just a tax credit unit in which an eligible employee happens to live.
Market-rate unit. Sites that have market-rate units and tax credit units and have no employee unit set aside in the allocation agreement may simply use a market-rate unit to house the resident manager. The unit isn't included in the tax credit calculation and doesn't involve compliance issues with the IRS or state housing agency. It's treated as any other market-rate unit in a tax credit building.
Get Application and Allocation Agreement from Owner
To determine if you are properly using an employee unit, contact the site owner to get copies of the tax credit application and the allocation agreement with your state. These documents will indicate whether the owner set aside the unit as part of the site's common area.
If it has been set aside as a common area, then you must confirm that your employee unit is in compliance with the requirements detailed below. If the unit was not set aside as a common area, you need to confirm whether you should be handling it as a tax credit unit or a market-rate unit.
Here's what to consider when evaluating whether your employee unit complies with tax credit rules.
Unit reserved as common area. In this case, you can only house an employee in the unit who is “full time” and works exclusively for that site. The IRS hasn't defined what constitutes “full-time” employment and each state agency may define full time in its own way. Some states may define full time by hourly requirements, such as 40 hours per week in most states to 35 or fewer hours in other states.
Some states may also require that the employee “perform substantial duties for the residents at the site.” If this is the case in your jurisdiction, full time is most likely considered to be whatever is reasonably required to make operations run smoothly at the site. Consider what's warranted by the type, size, and/or location of the site, as well as what's needed in terms of the resident population. Some sites may not need to employ a resident manager for what's normally considered full time, and other sites may need to employ more than one on-site manager or maintenance person.
As a general guide, a manager who performs management functions such as leasing units, preparing certification paperwork, cleaning, general maintenance, preparing turnovers, collecting rent, etc., and is available to the site on an on-call basis to respond to emergencies will most likely be considered a full-time manager. In addition, according to Revenue Ruling 2004-82, a unit may also be occupied by a full-time security officer and be treated as common space, if reasonably required.
If an employee isn't considered full time or if he splits his time between two or more sites, your state agency may no longer regard the unit to be a common area. As a result, you may lose tax credits for that unit, and depending on how long this has been standard procedure at your site, you may be risking potential tax credit recapture back to year one.
With regard to charging the employee rent for the unit, IRS rules don't expressly forbid it for employee units. However, the IRS frowns on this type of practice, says tax credit expert A.J. Johnson. This practice is considered “double-dipping.” In other words, you are claiming credits on a unit not occupied by a qualified household while collecting rent on the unit. Additionally, IRS rules are clear that you can't charge a fee for the use of common areas [IRS Regulations, 26 CFR 1.42-5]. If you charge the employee rent, you are essentially charging a fee and your state agency may report you to the IRS for noncompliance, resulting in the possible loss and recapture of tax credits.
Another possibility when the owner is charging rent for the employee unit is that the IRS may determine that the employee unit isn't reasonably required by the site because the owner isn't requiring the manager, maintenance, or security personnel to occupy the unit as a condition of employment.
Unit not reserved as common area. In this case, consider it a rental unit. If your employee lives in a market-rate unit, treat the unit as you would any other market-rate unit in a tax credit building. For example, you may charge market-rate rent or you can charge a lesser rent to the employee as part of his pay package. But remember that once the unit becomes vacant, it may be subject to the next available unit rule.
If the employee lives in a tax credit unit, you're required to meet all the same income eligibility, rent restriction, and certification requirements for the tax credit program. This means that you have to treat the employee as a member of the general public. This means the employee, like all other residents, must meet all the resident criteria and sign a lease for six months or more.
Unlike an employee in a common area unit, an employee living in a tax credit unit can pay the applicable rent on the unit. If you don't charge rent, the amount of the uncharged rent will be considered “income” from you as an employer. This may disqualify the employee from the unit if he then exceeds the income requirements.
Treating an employee in a tax credit unit the same as other residents also means that you should not include an employee contract or lease provision requiring the employee to vacate the premises if he's fired or quits in the first six-month lease. With such a vacate clause, you are risking a finding by the state agency that the unit is considered “transient” and therefore excluded as a tax credit unit.
If you discover a mistake in how you've been handling an employee unit, immediately document how and when you discovered the mistake and correct it as soon as is reasonably possible.
If your state agency reports you to the IRS for noncompliance, the IRS may permit you to correct an error within a reasonable time from when the mistake is discovered, and you can possibly avoid denial of the credits on the unit.
Acting on a mistake soon after it's discovered may also protect you if you discover a mistake and you correct it before the state audits you. For instance, if you unknowingly have been using a low-income unit as an employee unit, you need to document how and when you made this discovery and immediately take steps to certify the employee as a low-income resident or require the employee to move out. Or if the employee in your common area unit hasn't been working full time, you may need to redesign the position to make it qualify as full time or stop using the unit to house employees. If a state audit later determines that you were out of compliance on this unit for some period of time, you may avert a threat to the owner's tax credits by showing that you immediately took corrective measures after discovering the mistake.
A.J. Johnson, HCCP: President, A.J. Johnson Consulting Services, Inc., 3521 Frances Berkeley, Williamsburg, VA 23188; www.ajccs.net.
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