Compliance Basics of Acquisition and Rehab Credits
The LIHTC program is an indirect federal subsidy used to finance the construction and rehabilitation of low-income affordable rental housing. LIHTC sites receive funding either as new construction or acquisition rehab. A recently published U.S. Government Accountability Office report on LIHTC development costs stated that the median per-unit LIHTC equity investment was about $147,000 for new construction projects (about 67 percent of the total development cost) and $103,000 for rehabilitation projects (about 61 percent of the total development cost).
New construction is straightforward. A developer builds a site from the ground up, whereas a developer in an acquisition rehab scenario works with an existing building. An owner can receive tax credits on both the acquisition or purchase and rehabilitation of an existing building. With a rehabilitation, the building could have been utilized for any purpose, such as a factory, or it could have existed previously as apartments and is now being repurposed for affordable housing. If the building was a factory, then it’s not currently occupied and the developer probably needs to perform a substantial amount of construction work needed to get the building ready for occupancy.
Once all construction is completed, the manager begins marketing and lease-up as if it was new construction. However, many acquisition rehab credits are awarded to existing apartment buildings. These presumably don’t need major construction and probably are already occupied.
We’ll discuss the key differences in LIHTC compliance between new construction sites and acquisition/rehabilitation projects.
Two Credit Streams
“Eligible basis” is the total amount of development cost that would be eligible for generating low-income housing tax credits if all of the housing units are used for low-income housing. New construction costs can be the eligible basis for a building. In addition, the costs to rehabilitate an existing building may be a basis for LIHTCs. Finally, the cost of acquiring an existing building can be used, as long as the building will also be rehabbed.
Because the costs that go into the eligible basis for acquisition of an existing building are different from the costs for rehab of the building, each basis establishes a separate credit stream. Since each must be accounted for separately, each building subject to acquisition and rehabilitation will have two allocation Form 8609s. These forms represent the official allocation of LIHTCs from the state allocating agency for each building. The state agency completes the top portion and sends the form to the owner. The owner completes the bottom portion and submits it with first-year tax returns.
It’s important to note that an owner cannot claim acquisition credits without rehab credits. However, rehab credits can be claimed without acquisition. Also, each credit will have its own credit percentage. The rehab credits can have a 9 percent applicable credit percentage as long as the rehab isn’t financed with tax-exempt bonds. Acquisition credits, however, are always limited to a 4 percent credit, regardless of financing.
Placed-in-Service Dates and Start of Credits
An important difference between new construction projects and acquisition rehab projects is how placed-in-service (PIS) dates and the start of credits work. The date a building is placed in service is the start date for monitoring.
The PIS date is “the date on which the building is ready and available for its specifically assigned function.” For new construction, this is when a certificate of occupancy is issued. This date becomes important as a starting point. Leases and resident occupancy should not predate the PIS date for a new construction building. Also, LIHTCs cannot be claimed on a building before its PIS date.
For existing buildings that are occupied at acquisition, however, the building is ready for its intended occupancy purpose as of the acquisition date. Thus, the PIS date is the date of acquisition. Acquisition credits may start as early as the date the building is acquired, but must start the same year as the rehab credits do. If rehab credits are placed in service in a later year, the acquisition credits are deferred.
The definition of PIS for rehab is based on an expenditure test or how much is spent. That test involves time limits and minimum expenditures to establish the needed eligible basis for the rehab. The owner selects a time over a 24-month period when at least the greater of 20 percent of the adjusted basis or the federal/state per-unit minimum is spent. A sufficient eligible basis must have also been achieved. In other words, each acq/rehab building has two PIS dates, one for the acquisition and one for the rehab. Each date will show up on its respective 8609.
With new construction, once a building is placed in service, credits may be claimed either starting that year, or they may be deferred one year. This is also true for an acquisition rehab project. However, the deferral option is based on the year the rehab is placed in service, not the date of acquisition. If a building was acquired in 2018 but the rehab was placed in service in 2019, credits may be claimed in 2019 or may be deferred to 2020. Thus, the acquisition placed in service may predate the start of credits by two or more years. This is different from new construction, where the credits must be claimed no later than the year after it’s placed in service.
Because LIHTC buildings can be acquired and rehabilitated, or constructed, over a two-year period, or the beginning of the credit period can be delayed to the year subsequent to the year the building is placed in service, it’s reasonable to expect that LIHTC units may be rented to income-qualified households before the beginning of the credit period. For this situation, the owner must demonstrate that the household was income qualified at the beginning of the first year of the credit period to include the unit in the applicable fraction. The IRS has provided a safe harbor for this situation in Revenue Procedure 2003-82.
Safe harbor. Under Revenue Procedure 2003-82, a unit occupied before the beginning of the credit period will be considered a low-income unit at the beginning of the credit period, even if the household’s income exceeds the income limit at the beginning of the first year of the credit period, if the unit is rent restricted and the following two conditions are met:
The household must be income-qualified at the time of acquisition or time of move-in, and
The household’s income is tested at the beginning of the first year of the credit period. If the household’s income has increased to 140 percent or more of the income limit, the Available Unit Rule is applied.
In other words, the IRS allows that any certification done 120 days after (or before) acquisition may have an effective date as of the acquisition PIS date. Therefore, effective dates may predate the date the paperwork is completed and signed by up to 120 days and still be compliant. Certifications for households that were in place as of the acquisition date but were signed after the 120 days will have an effective date as of the date of the last household adult signature. Move-ins after acquisition will need to qualify and have an effective date as of move-in, as with any other move-ins.
In any case where credits are deferred after the year that people start occupying a building, those residents are still qualified for tax credit units once credits start, even if their income goes up over the limits by the start of the first year credits are claimed. Since acquisition may predate the start of credits, the initial certifications may predate the start of credits by more time than is often seen with new construction projects. However, these households are still good for the start of credits as long as IRS safe harbor provisions are followed.
Example: An owner purchases a building in March 2018. The tenant in unit A1 is income qualified and a full certification package is completed. Construction begins in March 2018 and is completed in March 2019. The owner will begin taking credits in 2019. However, the tenant started a new job in December 2018 with enough income that he is now over the limit. Because an acquisition certification was completed the owner can include unit A1 in the applicable fraction used to claim credits. However, if the owner waited until 2019 to certify the tenant, the unit would not be credit qualified.
It’s important to note that the safe harbor protects income only. The household must remain student eligible throughout their tenancy to be considered LIHTC qualified.
Income limits. You should use the income limits in effect on the date of acquisition for all tenant income certifications (TICs) that you complete within the 120 day window surrounding the date of acquisition. For any TICs completed after 120 days, use the income limits that correspond to the TIC effective date. (The TIC effective date will match the date all paperwork and signatures were finalized).
If your acquisition date falls in the 45-day grace period after new income limits are announced but before they become mandatory, you can choose the higher of the two available limits. In most cases you will use the rent limits that correspond to the same year income limits.
Nonqualified existing tenant. It may be that there are existing tenants who have too much income to qualify, or they might be ineligible full-time students. If this is the case, the owner most likely structured the site as mixed income rather than a 100 percent LIHTC site, and you would simply treat these households as market-rate tenants with no credits claimed.
If the site is structured as 100 percent affordable, however, you could negotiate an incentive with the tenant to voluntarily leave the apartment so you can re-rent to a qualified household. It’s important to note that you may not simply evict or not renew leases without good cause. An LIHTC site must be able to demonstrate if challenged in state court that good cause existed to support the eviction or termination of a tenant from a low-income unit. For purposes of Internal Revenue Code §42(h)(6)(E)(ii)(I), good cause is determined by the state and local law applicable to the location in which the LIHTC site is located. State or local law examples of good-cause evictions may include nonpayment of rent, violations of the lease or rental agreement, destruction or damage to the property, interference with other tenants or creating a nuisance, or using the property for an unlawful purpose [IRS 8823 Guide, Chapter 26].
Make sure the household chooses to leave in a voluntary manner, and be aware that some households may simply choose not to leave despite your best efforts. In those cases you must treat the unit as an over-income nonqualified unit.