Essential Addendums and Clauses to Include in Your LIHTC Lease
When someone agrees to rent or lease an apartment, he signs a lease or rental agreement outlining the terms of the agreement. It’s a legally binding contract between the tenant and the owner that details the rights and responsibilities of each party. Unlike a typical market-rate apartment, a tax credit site or unit participates in the federal Low Income Housing Tax Credit (LIHTC) program. This means the provisions of Section 42 of the Internal Revenue Code (IRC) are applicable to the lease. An income-eligible tenant in a tax credit unit pays a restricted rent, and the site owner receives valuable tax credits in return for keeping a required percentage of units affordable.
The LIHTC program doesn’t have its own mandatory lease. However, many owners have tenants sign typical apartment leases that include lease clauses or addendums specific to the tax credit program. For example, a tenant at a mixed-income site can probably expect a clause requiring cooperation when recertifying and verifying his income each year, and there may be language saying that if the owner learns that the tenant knowingly gave false or incomplete income information when determining eligibility, this could be grounds for terminating the lease. These types of clauses ensure that you have the authority you need to keep the site in compliance.
To protect your ability to comply with the tax credit law and to get the right to adjust rents mid-lease under certain circumstances, make sure your leases with low-income households include the following provisions. If your leases need to further address any of the following areas, remember to show the addendums or clauses to an attorney in your area before using them in your leases.
Income Limits and Utility Allowances
Two instances in which an owner may increase rent mid-lease involves HUD-issued income limits and utility allowances. Since the rent amount is connected to income limits, if the income limits increase, does your lease allow you to increase the rent? Or if the utility allowance decreases during the lease term, are you allowed to raise the rent in this situation?
The maximum allowable rent you can charge a low-income household is affected by its unit’s utility allowance. If the utility allowance increases, the maximum rent you can charge decreases, and if the allowance decreases, you can increase your rent without violating the tax credit law. Your lease should say that both the maximum allowable rent and the utility allowance might change during the term of the lease, which may cause you to increase the rent. And the lease should also say that any rent increase will be made in accordance with the law, and that you’ll give households proper notice (as required under state or local law) of any rent increase.
With regard to income limits and the maximum allowable rent, unlike HUD subsidy programs in which tenants pay 30 percent of their income for rent, the amount of rent paid by a LIHTC resident is not necessarily based on the actual income amount of that particular household. LIHTC rents are not adjusted upward or downward when a resident experiences an increase or decrease in household income. Rather, the maximum allowable rent is based on rent derived from HUD-issued income limits.
If the rent limits for the county in which your project is located changes in the middle of a lease term, and the maximum rent that can be charged goes down, the owner must reduce the rents of all low-income units to conform to the new limits, regardless of the lease terms. You will have 45 days to implement the new rent amount. However, in situations in which rent limits rise during the term of a resident’s lease, you must comply with local landlord-tenant law in order to raise the rent in the middle of a lease term.
In this situation, your lease will probably govern, and it should tell households that their rent is based on area median income (AMI) and may change during the course of the lease. It should say that any increases will be made in accordance with the law, and that you’ll give households 30 days’ notice (or more, if your state or local law requires it) before increasing the rent (see Addendum #1, below).
This provision can boost revenues because the maximum rent the tax credit law allows you to charge low-income households is tied to AMI. So when AMI increases, you’ll want to increase your rent as well. By including a lease clause that lets you increase rents mid-lease if AMGI increases, you won’t have to accept less than the maximum allowable rent for the rest of a household’s lease term.
Sometimes households may try to house additional unauthorized occupants in the apartment. The household may be doing this for additional income and not seeking permission for the additional household members out of fear that their rent will increase. This could pose a compliance problem at your site. If your state housing agency finds that the number of people living in a unit is greater than the number you listed on the certification form, this could lead to a report of noncompliance to the IRS.
Adding a new occupant to a household may make the household go over-income, which means you’ll have to follow the next available unit (NAU) rule to keep the owner’s tax credits safe. And you may have more people living in a unit than your occupancy standards allow. You must certify the new occupant’s income and, if the household is still qualified, you should include the new occupant in the lease.
Your lease itself should require household to get your written permission before any new occupant can move into the unit. And it should be clear that failure to comply with this requirement is a “substantial violation” of the lease. Model Lease Addendum #2 is an example of language you can use to do this. Be sure to get your attorney’s approval before you insert this clause in your lease.
Disabled or inoperable smoke detectors is a leading violation cited by state housing agencies during tax credit site physical inspections. Tenants frequently remove the smoke detector’s batteries or otherwise disable it because of nuisance alarms caused by cooking.
Your lease addendum should state that disconnecting the smoke detector is a substantial lease violation that may lead to eviction and that the tenant is responsible for its maintenance in good working order during tenancy. Model Lease Addendum #3 clearly explains the tenants’ responsibilities for maintaining their units’ smoke detectors in good working order, such as replacing the batteries at least twice a year, testing the alarm occasionally, and alerting management immediately if the alarm does not appear to be working properly. Be sure to provide a copy of the smoke detector manufacturer’s maintenance requirements to residents along with the agreement.
If you discover fraudulent information such as income, asset, or household composition reported by a tenant, you should make this a substantial lease violation. Applicants and tenants who commit fraud cause big problems for tax credit owners and managers. Applicants and tenants may lie about their qualifications for the tax credit program because they think this will increase the chances that they’ll appear eligible to occupy a low-income unit and pay below-market rent.
According to the IRS, “Low Income Housing Credit property owners should demonstrate due diligence to prevent tenant fraud. Fraud includes deliberate misrepresentation of fact in order to induce someone else to part with something of value or surrender a legal right. In this case, the outcome of deliberate misrepresentation by a tenant can result in the property owner renting a residential unit to an ineligible tenant at a below market rate” [Guide for Completing Form 8823, p. 25-1].
When applicants and residents aren’t truthful about their qualifications, they endanger your compliance efforts and put the owner’s tax credits at risk. One way to protect your site is to have them sign a lease addendum that warns them against giving you information about their income or student status that they know is false or incomplete. And it gives you the right to evict residents if you learn, at any time, that they weren’t truthful at their initial certification or at any annual recertification [Addendum #4].
140 Percent Rule
In a building that’s not 100 percent LIHTC units, suppose that, a few months after determining that a tax credit household is over-income, you’ve rented enough units to satisfy the next available unit (NAU) rule. Are you able to make the over-income unit a market unit and charge market rent? If your lease doesn’t give you the right to raise the over-income household’s rent once you’ve complied with the NAU rule, you may not be able to maximize your site’s earning potential. The unit no longer earns any tax credits, and it doesn’t bring in market-rate rent either.
A lease clause will give you the right to raise the rent to market rate once you’ve complied with the NAU rule. By signing a lease that includes the clause, the household agrees that its rent may increase during the lease term, and isn’t surprised by a sudden jump in rent. Your clause should make it clear that the household will be considered over-income for rent determination purposes if its income exceeds 140 percent of the tax credit limit. The clause should also specify the amount of notice you’ll give the household before you increase the rent to market rate. If you operate a deep rent-skewed site, use 170 percent when defining an over-income household.
Model Lease Clause
Increase in Household Income
Household will be considered “over-income” for rent determination purposes if its income exceeds one hundred forty percent (140%) of the applicable income limit as governed by the Tax Credit Program. If the household’s income increases above one hundred forty percent (140%) of the applicable income limit, Management, upon [insert #] days’ notice, may increase household’s rent to the applicable market rate.
Households that temporarily need to live elsewhere may decide to sublet their units while they’re gone. Although many owners and managers of conventional sites allow this practice, letting low-income households sublet units at a tax credit site could lead to noncompliance.
The tax credit law prohibits transient use of LIHTC units and requires that a unit be continuously occupied, meaning that the unit must be in the household’s possession at all times. In addition, tax credit law requires you to certify the income of all households that occupy your low-income units. But if a qualified, low-income household sublets its unit, you’ll have a situation where the unit’s actual occupants were never certified. As a result, your state housing agency may cite you for noncompliance. And if you don’t correct the problem, the owner’s tax credits may be at risk.
Your lease should make clear that households don’t have the right to sublet or assign their units or any part of them. The lease should also warn households that subletting or assignment is a substantial violation of the lease.
Model Lease Clause
Household acknowledges that the tax credit program requires income certifications to determine Household’s eligibility to occupy the Unit. The Household must live in the Unit and the Unit must be the Household’s only place of residence. The Head of Household shall use the Unit only as a private dwelling for himself/herself and the individuals listed on the Lease.
The Household agrees not to sublet or assign the Unit, or any part of the Unit. Household shall not permit any roomer or boarder occupancy of any portion of the Unit, nightly or otherwise.
Any failure by Household to comply with this provision is a material breach of the Lease that can lead to eviction.
IRS regulations don’t require annual certifications for properties that are 100 percent tax credit. However, for mixed-income sites, recertifications serve an important function. Annual certifications ensure affordable housing units are occupied by income-eligible households, and provide a means to ensure compliance with the next available unit rule and student status.
The IRS requires all households at mixed-income sites to recertify annually for income qualification and continued eligibility. You must establish a recertification anniversary date for each household, and you must notify households of their annual recertification responsibilities.
It’s important to note that state agencies have authority to impose additional requirements upon IRC Section 42 projects and may require income recertifications after completing the initial income certification at the time the household moves into the low-income unit. For example, a state agency may require a one-time income recertification after the first year of occupancy.
State agencies may place such restrictions on an owner for a variety of reasons. For example, the state agency may have little confidence that an owner can consistently identify income-qualified households without frequent technical errors, or is willing to provide sufficient due diligence. In other cases, the state agency may be providing financing and, as part of its own internal controls and due diligence, is ensuring that the state’s funds are used for the purposes intended.
If you have a mixed-income site or your state agency requires recertifications, your lease should require households to attend a recertification interview, provide sources and documentation to verify income and assets, and sign a new income certification form. With a strict lease clause, you can make households report for recertification. If a household doesn’t cooperate in the recertification process, you can try to evict it for that reason alone. But judges usually are not inclined to evict a resident who’s paying rent. However, you can gain additional leverage to get households to cooperate by adding a strict lease clause as a warning. A lease clause turns the failure to cooperate with recertification into a material breach of the lease and then enables you to take action to secure the household’s cooperation. In addition, a strict lease clause can help prove that you made a good-faith effort to comply with recertification requirements.
Model Lease Clause
A. Annual Recertification Responsibilities. Resident acknowledges that the Tax Credit Program requires an annual recertification of eligibility. Resident must complete the recertification process. This includes attending an interview with management to determine continued program eligibility; providing sources and documentation to verify all income, assets, and other eligibility information; and signing a new Income Certification Form. It is Resident’s responsibility to provide all necessary information so that management may perform this task. Occupancy is subject to continued eligibility under the Tax Credit Program Requirements.
B. Timetables. Resident’s next annual recertification must be completed by [insert date]. Management will contact Resident by [insert date 90 days earlier than date above] to begin processing the necessary paperwork.
C. Failure to Comply. Resident must fully cooperate and provide all necessary information to expedite this process. Failure to comply with these recertification requirements is a material breach of the terms of this lease and may result in nonrenewal of Resident’s lease or the Resident’s eviction from the unit.